Achi news desk-
Fully valuation conscious investors would have underperformed badly in recent years as high growth stocks with higher price to earnings (PE) and enterprise value to earnings before depreciation and interest tax amortization (EV to EBITDA) multiples have lead the market. Morgan Stanley consultant Michael Mauboussin explains why in a new report this month.
Mauboussin’s Valuation Multiples: What They’re Missing, Why They Differ, and the Connection to Fundamentals typically brilliant for the adjunct professor of finance at Columbia University, former head of global financial strategies at Credit Suisse, leader at the Sante Fe Institute and author of what I still believe, after 20 years, is the short paper single best ever written for the average investor.
The new report argues that the most common multiples used to pick stocks no longer reflect a company’s value-creating power. For Mr Mauboussin, companies become more valuable to the extent that their investments produce a higher return than the average cost of borrowing money over the long term. (In technical terms, ROIC (return on invested capital) is greater than WACC (weighted average cost of capital).
The problem is that the nature of corporate investment has changed dramatically. In previous generations, companies invested in plant and equipment that was listed on the balance sheet and depreciated over time through the income statement. Modern companies, on the other hand, invest in intangible assets such as customer acquisition and branding, and these costs are immediately and fully recouped. The latter practice reduces returns compared to traditional accounting.
Modern companies are much more profitable than old economy stocks – even more so than PE ratios indicate. The paper uses Microsoft’s PE ratio at the end of 2023 as an example. After adjusting for intangible assets, Microsoft’s PE ratio falls from 34.9 to 30.5.
Widely used stock valuation ratios have always been shorthand for complete calculations of discounted future cash flows for the life of the business. Over time, the assumptions built into valuations have drifted further from accuracy to the point of being deceptive in many cases. If this is true, then it’s little wonder why value investors have been struggling to outperform.
— Scott Barlow, Globe and Mail market strategist
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Stocks to consider
Boeing Co. (BA-N) The aircraft manufacturer is facing major problems which have been weighing heavily on its share price this year. But the aerospace giant has been down before, and investors who swooped in on a deal were rewarded. David Berman says this could be another buying opportunity.
UnitedHealth Group Inc. (UNH-N) This is the world’s largest health insurance provider by revenue, and Gordon Pape calls it one of the most boring and rewarding companies in the world. Its share price shows an average annual growth rate of 22 percent over the past 15 years, with an attractive dividend that has increased for more than 15 consecutive years. He thinks now is an ideal time to buy the stock if you are not already doing so.
The Decline
Why aren’t Canadian dividend ETFs more popular with investors?
Canadian investors love dividends. Dividend ETFs, not so much, based on asset levels. Rob Carrick has some ideas as to why. (And if you haven’t seen it yet, check out his new ETF Buyer’s Guide installment on these income-producing investments).
Investors: Don’t do something, just stand there
Tim Shufelt on how your success as an investor can depend on whether you can keep your composure when the market has lost it.
High U.S. stocks leave investors bracing for earnings disappointments
Highly valued US stocks are leaving investors with little tolerance for disappointment, raising the stakes ahead of a week when two more tech and growth giants are set to report.
Others (for subscribers)
The most oversold and overbought stocks on the TSX
Monday analyst upgrades and downgrades
Insider report Monday: Couche-Tard co-founder sells $11 million worth of shares
Ask Globe Investor
A question: I have two questions regarding the tax free savings account. First, let’s say I contributed a total of $90,000 to my TFSA but the account value has risen to $120,000. If I withdraw $20,000 one year, can I contribute that $20,000 back the following year? Or am I limited to the $7,000 annual contribution limit? Second, what happens if my TFSA, instead of rising to $120,000, drops in value to, say, $60,000, before I withdraw the $20,000?
Answer: When you withdraw money from a TFSA, the amount is added to your contribution room on January 1 of the following year. Your contribution room would also include the annual limit ($7,000 currently) that all TFSA holders are entitled to on January 1 of each year, plus any unused contribution room from previous years.
Regarding your first question, assuming you were at least 18 years old when the TFSA was introduced in 2009, your cumulative TFSA contribution room through 2024 would total $95,000. After subtracting the $90,000 you have already contributed, you would have $5,000 of untouched contribution room to use at any time.
If you withdrew $20,000 this year, that amount would be added to your contribution room on January 1, 2025, plus the annual limit for that year, which we’ll assume continues to be $7,000. So that would be $27,000 of additional contribution room, on top of the $5,000 carried over from previous years, for a total contribution room of $32,000 from next January 1.
To answer your second question, a decrease in the value of your TFSA would not change the math. You would still have $5,000 of unused contribution room, plus the $20,000 withdrawal amount that would be added back to your contribution room next year, plus the $7,000 annual limit for 2025, for a total of $32,000 – the same as in your first example.
In other words, for purposes of calculating contribution room, it doesn’t matter if the assets inside your TFSA go up, down or sideways. What matters is how much room for unused contributions you have from previous years, the value of any money raised that will be added back the following year and the annual contribution limit for that year.
Still confused? The Globe and Mail has an online TFSA contribution limit calculator that will help you determine your maximum contribution. (See online calculator at www.theglobeandmail.com/investing/personal-finance/tools/tfsa-limit/) It is important to keep detailed records of all TFSA contributions and withdrawals so that you can determine your contribution room correctly and avoid the penalty. a tax of 1 per cent per month on excess contributions. A final word of caution: Do not rely on the Canada Revenue Agency’s calculation of your TFSA contribution room, as its numbers may be out of date and not reflect your recent contributions.
-John Heinzl (Email your questions to [email protected])
What’s up in the coming days
Jennifer Dowty talks to TD chief economist Beata Caranci about her views on the economy, interest rates, and implications for bond and stock markets.
Click here to view Globe Investor’s earnings calendar and economic news.
More Globe Investor coverage
For more Globe Investor stories, follow us on Twitter @globeinfuddsoddwr
Compiled by Globe Investor Staff
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