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Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
We're quickly approaching the season for feasting on figgy pudding and watching Ebenezer Scrooge have a change of heart. It's also a charitable time of year for value investors who lend a helping hand to people who desperately want to sell their shares for tax reasons.
Yes, 'tis the season for tax-loss selling when the upper crust unload their shares in an effort to reduce the amount of money they have to ship off to Ottawa for young Justin to spend. While some might complain about these tax-minimizing humbugs, value investors can earn a few extra shekels by buying their castoffs at reasonable prices.
It's shaping up to be a very good year for bargain hunters because the Canadian stock market is jam packed full of stocks trading well below their highs. The evisceration of the resource sector helped to push more than half the stocks on the Toronto Stock Exchange below half their five-year highs, according to data from S&P Capital IQ.
Going a step further, nearly 400 of these half-off stocks also declined over the past year. The abundance of misery is nearly Dickensian in proportion. It should encourage a great deal of tax-loss selling and the brave souls who pick through capitalism's rubble ought to be able to find a few choice morsels.
Value investors like stocks with low prices in comparison to their earnings, book values or sales. Moving beyond these common ratios, it's also a good idea to look for firms with low ratios of enterprise value to earnings before interest and tax (EV/EBIT). You can think of the ratio as being something like a price-to-earnings ratio, with price replaced by enterprise value and earnings by EBIT. (Enterprise value is a fancy name for the market value of a company's equity plus net debt.)
Money manager Tobias Carlisle devoted a large part of his book Deep Value to extolling the virtues of stocks with low EV-to-EBIT ratios.
It's not hard to see why because they've outperformed over the long term. U.S. stocks with the lowest 10 per cent of ratios, rebalanced each year, returned an average of 12.50 per cent annually from 1951 to 2013. By way of comparison, the market gained 8.36 per cent a year over the same period. That's a hefty 4.14-percentage-point average annual return advantage for the low-ratio stocks.
The accompanying table highlights a few stocks with low EV-to-EBIT ratios that have also seen their shares decline over the past year to below half of their five-year highs. In other words, they trade at reasonable prices and have shareholders who might be keen to sell before Christmas for tax reasons.
Of the bunch, clothier Reitmans Canada is perhaps the most well-known company on the list. The Montreal-based firm has a market capitalization of about $300-million after running into more than a little difficulty over the past few years.
Its stock traded a touch above $27 a share during the good times before the crash of 2008. It then tumbled to a temporary low near $8 a share in late 2008, rebounded to $20 in 2010 and fell to just a hair above $4 this September. The low prices attracted several noted value investors over the years, including money manager Francis Chou and Fairfax Financial's Prem Watsa.
Reitmans's latest quarterly results were far from inspiring. The firm posted a narrow loss of $200,000, which compares poorly with its profit of $9.6-million in the same period last year. That doesn't bode well for the company's prospects for the holiday season and the weak Canadian dollar probably won't help.
But that's the thing about value stocks; usually only their prices look good. In this case, the stock trades at 0.9 times tangible book value and it pays a 4.3-per-cent dividend yield.
A little positive news will likely go a long way for shareholders and may result in big profits over the next few years. Mind you, so far Reitmans's stock has only caused indigestion, which threatens a visitation from the spirit of Christmas tax-loss selling.