The Best Long-Short Strategy of the Year!

Two companies I have followed closely for some time, Home Capital Group Inc. (TSX:HCG) and Air Canada (TSX:AC)(TSX:AC.B), have certainly diverged as far as their share prices are concerned. Of course, calling Home Capital the short of the year on a number of occasions (starting at the end of January), and Air Canada as one of the Canadian companies with significant upside for 2017 may have been easy to do in hindsight; however, going forward, the jury remains out on how these companies will continue to perform, with other analysts and contributors suggesting opposite strategies.

Taking the time to look at how a long-short strategy (long Air Canada, short Home Capital) has worked out so far for investors who’ve listened, we can see from the numbers that investors who’ve followed such a strategy since the beginning of 2017 would have seen growth of more than 70% for the Air Canada position and more than 55% on the Home Capital position.
An average 62.5% return for such a play isn’t too shabby, but that’s all history. What investors want to know is this: Where are these companies headed from here?
How will these companies perform for the remainder of 2017?
I expect Air Canada to continue to outperform its peers, including WestJet Airlines Ltd. (TSX:WJA). I recommend investors take a look at isolating Air Canada and the airline’s potential for outsized returns compared to its largest competitor in the Canadian market by undertaking a long-short strategy to take advantage of the value gap that exists between the two Canadian airlines.
While the significant value gap that exists between Canada’s two largest airlines (a price-to-earnings ratio of 11.7 for WestJet compared to only 7.7 for Air Canada) may not completely close, the current divergence of the two airlines from a valuation standpoint does not make fundamental sense, and I expect that, over the medium term, these valuation multiples will come more in line with investor expectations, creating a situation where an investor can grab much of the value that is currently being left on the table by the market.
In the case of Home Capital, I would recommend a long-short strategy, but this time I would recommend investors go long the “Big Five” Canadian banks and short a consortium of alternative lenders to take advantage of the mispriced risk profile many of these alternative lenders display, which I believe has not yet been fully priced in to the share prices of Home Capital and its peers.
Bottom line
Investors need to think critically about how a company will perform relative to its peers and the overall industry it operates in before undertaking a long-short strategy. I suggest investors maintain the aforementioned Air Canada and Home Capital long-short strategies through the remainder of 2017, as a significant value gap remains in both cases, and reassess as market changes take place.
Stay Foolish, my friends.

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Chris MacDonald has no position in any stocks mentioned in this article.

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