With the Toronto Stock Exchange down 11.1% in 2011, few investors made money last year. It would have been much worse without the strong appreciation from dividend-paying stocks in the Utilities, Telecom, and Real Estate sectors. After all, almost half the exchange is comprised of Materials and Energy companies. Because clients at Baskin Financial Services were underweight these sectors, the average portfolio was up 1.5% last year.
In today’s environment, dividend-paying stocks have become the new fixed income. Bond yields produce a negative return after inflation is considered, so investors have taken comfort in chasing equities that pay high dividend rates. However, when the economy improves and interest rates start to creep up — as we know they will eventually — investors may not feel so comfortable holding these securities.
The winning sectors of 2011 were Utilities (+14.8%), Real Estate (+20.3%), and Telecom (+24.3%). Historically, Utilities stocks trade at 17.5 times the next year’s earnings. Today, they trade at a 14% premium to that valuation. Furthermore, Real Estate Income Trusts trade at a 10% premium when compared to its 2007 valuation before the credit crisis began. Depending on which metric is used, Telecom stocks appear fully valued given the competitive environment it now faces. While their historic P/E is 20% higher than today’s valuation, the sector did not face the same pricing pressure and capex demands in the past that it does today.
The sectors that appear undervalued based on historic metrics are the same ones investors loved to hate in 2011. These are found mainly in the Energy, Materials, and Financial sectors. Several companies that look attractive include:
| Company | Sector | Discount |
| Brookfield Asset Management | Financial Real Estate | 53% discount to historic Price-to-Book Ratio |
| Suncor | Energy | 49% discount to historic Price-to-Cash Flow Ratio |
| Manulife Financial | Financial | 49% discount to historic Price-to-Book Value Ratio |
| Cameco | Materials | 48% discount to historic Price-to-Cash Flow Ratio |
| Potash Corp | Materials | 47% discount to historic Price-to-Earnings Ratio |
| Talisman | Energy | 34% discount to historic Price-to-Cash Flow Ratio |
| High Liner Foods | Consumer | 33% discount to historic Price-to-Earnings Ratio |
Going forward, investors that assume history will repeat itself may be mistaken. If valuation is your guide, the stable, dividend-paying companies may prove to disappoint as the economic recovery begins to accelerate.
*The performance figures shown above are a composite return for all accounts managed by Baskin Financial during each period, representing a range of investment objectives, after all fees and expenses, and include the return of all assets in those accounts, calculated as if all the assets had been pooled in one account and converted to Canadian currency. Results for individual accounts will vary widely depending, inter alia, on the actual securities held in each individual account, the objectives of the account owner and the date at which the account was opened. Comparisons to the TSX Composite index and the S&P 500 index are made for reference only and do not reflect the objectives or compositions of any or all accounts. Past performance is not indicative of future performance and no representation, express or implied, is made that individual accounts in future years will achieve similar results.
*This author is a shareholder of Manulife Financial and Suncor.
*Clients of Baskin Financial Services own shares in all of the companies listed above.
