You may not remember, but in 1994 there was a small stock market correction — “small” being around 10 per cent. I had started to invest in the stock market just a few years before, and it was my first experience with a correction.
But I was mentally prepared: I had read Peter Lynch’s book One Up on Wall Street and Warren Buffett’s annual letters, so I already knew corrections were part of the life of an equity investor. More important, I knew they offered opportunities to acquire stocks at better prices.
I remember vividly an interview back then with John Templeton, one of the greatest investors of all time. Sir John was in his 80s and had ample market experience. Asked about the correction, Templeton answered: “Markets have always been volatile. Corrections are a normal part of markets.” Asked if the correction was over, he responded quite wisely: “No one knows those things.” Since then, I’ve known it is futile to try to predict market fluctuations.
So here we are 21 years later with another stock market correction. The Dow Jones Industrial Average was down Monday from a high of 18,351 to 15,871.28, or the equivalent of more than 13.5 per cent. The S&P/TSX was down from a high of 15,685 to 13,052.74, or the equivalent of an almost 16.8-per-cent drop. In Canada, the main cause of the fall is related to oil stocks, which are in deep bear market territory.
Instead of fearing them, market corrections should be viewed as investment opportunities. If you have some cash or regular savings, you can acquire more shares at better prices. Even if you are 100-per-cent invested, corrections can be beneficial. Out of a portfolio of, say, 20 securities, there are some that are down only a few points and some that are down 20 to 25 per cent. You can reduce the ones that have gone down less to increase your investments in the ones that are now more attractive, relatively speaking. If you’re right on the valuation assessments, the correction will help you increase the long-term return of your portfolio.
I do believe that stocks in general are trading at very reasonable valuations these days. The most important element in valuing stocks is the comparative yield of bonds. The Dow Jones components, for instance, trade at around 15 times this year’s earnings estimates. Compared with the 10-year U.S. treasury bonds rate of two per cent, stocks are at least three time more attractive than bonds.
If we look at a few Dow Jones companies, we can see how attractive they are. American Express is trading at 14 times estimated earnings for this year. IBM seems very attractive at nine times earnings. Johnson & Johnson trades at around 14 times earnings. Even J & J’s dividend yield of three per cent is higher than the one from a 10-year bond. And the solid bank JP Morgan is trading at around 10 times earnings.
In Canada, it’s a little more complicated. The fundamentals of many natural resources companies are hard to assess, and so it is much more complicated to get an idea of their discount to intrinsic value. If you’re a little adventurous and want to look into the world of oil-related Canadian companies, there are some solid companies that are not oil and gas producers per se, but related to the industry. They are a little less risky, in my opinion.
One example would be Mullen Group. The stock has come down by close to 50 per cent to a low of $15. The company provides transportation and related services to the oil and natural gas industry in Western Canada. In its latest quarter, oilfield services revenues were down 37 per cent, but trucking/logistics was up 26 per cent. So earnings per share and cash flow from operation were down only 25 per cent. The company is still quite profitable. At some point in the future, I believe the company will see its oil-services division improve. And while you’re waiting, the company pays a close to eight per cent dividend, which, in my opinion, can be sustained.
Finally, some very solid Canadian companies are also down: Valeant Pharmaceuticals’ stock is down 17 per cent from, $347 to $287. The stock trades at around 13 times earnings estimates for 2016. The stock of MTY Food Group (also a Montreal-based company) is down from $37 to $31, or the equivalent of 16 per cent. It now trades at only 14 times next year’s earnings. I used the word “only” since the company has grown at around 17 per cent annually over the last five years. Even with their strong track records, both stocks still trade at a market multiple.