The Globe and Mail, Report on Business
Published October 18, 2008

This earnings season is going to be more interesting than most. There will be some good news, but the bad will dominate the headlines. If I were a chief financial officer and had some stuff to clean out of the closet, this would be the quarter to do it.

But as the news unfolds, we should keep in mind something my former partner, Peter Guernsey, used to say: "When a stock is beaten up, you don't need to spend time looking for the warts - they're easy to see - it's time to go looking for the positives."

In the spirit of Peter's advice, there have been a number of interesting news items over the past couple of weeks, particularly in the woe-begotten financial sector.

This week, JPMorgan surprised the Street by reporting better-than-expected earnings, albeit much reduced from previous years. Part of the surprise came from a strong performance by its investment bank, which won new business from its weakened competitors. Chairman and CEO Jamie Dimon commented that the bank's relative financial strength would continue to be a competitive advantage during the turmoil. In addition, JPMorgan recently purchased Washington Mutual's banking operations and is now the largest depository institution in the United States.

Wells Fargo reported a profit of $1.6-billion (U.S.) in the third quarter. In the press release, CFO Howard Atkins said the company benefited from "a tremendous inflow of deposits in the latter part of the quarter, especially at the end of September, reflecting what we believe is a significant flight to quality." This internal growth (10 per cent quarter over quarter) will be enhanced even further if Wells Fargo manages to complete the purchase of Wachovia Corp.

In Canada, the strong banks and insurers are quietly taking advantage of the Wall Street meltdown to secure better positions in businesses where they want to grow. Royal Bank is hiring talented people on Wall Street from former firms like Bear Stearns and Lehman Brothers. Bank of Nova Scotia bought Sun Life's stake in CI Financial to enhance its wealth management platform. Sun Life in turn is getting liquid so it can go hunting for cheap insurance assets in the United States.

I highlight these news items because they feature strong companies ("strong" being a relative term in the banking sector) that are using the current dislocation to enhance their future earnings power.

So far, the most concrete examples of this long-term value enhancement (Love for short) have been in the financial industry. As the Financial Times noted this week, it is a sector where "a wildly speeded-up version of natural selection" is going on right now. But we'll see activity in other sectors also, either through mergers and acquisitions as weak players get shaken out, or through internal investment.

Big tech companies like Cisco are floating in cash and have the capability to make large investments or acquisitions. The global energy companies now have an opportunity to build reserves through acquisition, given the declining stock prices of oil and gas producers, including Canadian companies like Talisman and Nexen.

When looking around for opportunities for Love, I find myself gravitating south of the border, where there are so many profitable, cash-rich companies to look at. In Canada, the large resource companies have the heft to do some buying in the liquidity-challenged junior sector, but a good number of our leading companies are tapped out right now. Thomson Reuters and Toronto-Dominion Bank are in the middle of integrating major acquisitions. Many of the energy companies have their hands full with oil sands megaprojects. Teck has done its deal to buy Fording. Frank Stronach at Magna has issues to deal with in Russia and Detroit. And the telecom companies are absorbed with their own issues - new wireless entrants, Bell's strategy and smarter smart phones.

Of course, good stuff like this - opportune asset purchases and market share gains - comes in the context of dour short-term news and hyper-sensitive shareholders. Executives should expect that aggressive expansion and/or asset purchases may push their stock down in the near term. Anything that hints of more risk will get a "sell first and ask questions later" reaction. We can only hope that the truly strong ones ignore the noisy shareholders and pursue their own Love story. It's time for the strong to get stronger.