The Globe and Mail, Report on Business, Guest Column March 17 2006
As I sat and watched the Neil Young movie Heart of Gold last week, I was reminded how great it is to be Canadian. Throughout the movie, Neil talked fondly about his upbringing on the prairies and his Canadian influences. For me, his words reinforced the pride I was already feeling following our Olympic team's stellar performance in Italy.
Unfortunately, emotion and pride have no place in an investment portfolio. Getting too attached to a stock or strategy can be detrimental to your net worth. So rather than list off the reasons why Canada is the place to be right now, my purpose here is to look at the country as if it were a corporation and ask the question, what would our stock recommendation be on Canada Inc.?
You must realize that I'm an old equity analyst and I still tend to look at everything as if it's an investment. It's an occupational hazard. My favourite sports teams are assessed on that basis. So is my golf game (a "random walk?"). Only my wife escapes such analysis, although I'm sure she'd garner a "buy" rating.
What does Canada Inc. look like from a stock analyst's perspective?
Our current assessment would show that things are going exceptionally well. In fact, it's hard to see how they could get any better. The country is running both fiscal and current account surpluses. Unemployment is at a 30-year low. The currency is strong. Commodities are in demand and garnering high prices. The housing market is humming and prices are up. And Canada's stock market has beat the U.S. in each of the past four years.
Canada Inc. is on a good run. It should be noted that this run has been all the more dramatic because it started from a very low base. Just a few years ago, Canada was a dog. The dollar was plummeting. The commodity environment was poor. And because of weak government finances, Canada and the International Monetary Fund were being mentioned in the same sentence.
But we won't make any money by looking back, or even assessing the current state of affairs. What does the future hold for Canada Inc.?
First of all, we need to do a competitive analysis. Does Canada Inc. have a business model that will allow it to continue outperforming the rest of the world? We all know that it has one huge advantage - natural resources. Unfortunately, Canada is a bit of a one-trick pony. Beyond commodities, its competitive situation is not particularly noteworthy. Indeed, as a trading nation, it is rapidly losing its cost advantage as a result of a rising dollar. And Canada is pretty average on most other variables that would distinguish it from its competitors (education, research and development, tax policy).
Second, what are Canada Inc.'s growth prospects? How is it positioned in the fastest-growing markets - Asia, the developing countries of South America and Europe? Its resources help position it well in many of the emerging economies, although some of them are emerging as a result of their own resources. Beyond commodities, however, Canada's penetration of these markets has been poor. The country remains highly dependent on one customer (the U.S. consumer) and that buyer is a little stretched at the moment and starting to find Canadian goods expensive.
Third, how attractive is Canada Inc.'s valuation? This is a critical part of any analysis and a key to making money. At this point, we'd have to say that Canada Inc. is getting expensive. Most of the valuation measures are at the top of the charts, whether it be the dollar or prices for energy, metals and housing.
And finally, a stock recommendation. Canada Inc. has gone from being a turnaround situation to a momentum stock. Its powerful competitive advantage, a rich resource base, is working for it right now, but we must recognize that this strength is cyclical and can disappear quickly (there are times when you can't give zinc or heavy oil away).
Determining where we're at in the current cycle is difficult to do, although I'd suggest we are in the later innings of the game. This analysis would suggest that any further outperformance by Canada Inc. will be highly dependent on the commodity cycle and therefore should be viewed as speculative. Investors with large positions would be advised to sell some Canada Inc. and begin to diversify their holdings. In the words of Neil Young, "there comes a time."
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