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TSX 60 for value investors

The summer weather attracted a flock of tourists to downtown Toronto. I spotted a happy crowd of them taking pictures of Union Station and nearby buildings, but mostly of themselves.

I'll join in the fun by taking a few snaps of the Canadian stock market with an eye to the fortunes gained, and lost, by value investors. My focus will be on large blue-chip Canadian stocks and more specifically the 60 stocks that make up the S&P/TSX 60 index.

The index itself fared reasonably well over the past couple of decades with average annual gains of 7.8 per cent from the end of January, 2002, through to the end of last month. The long-term returns were pretty good considering the period started during the Nortel-fuelled internet crash. It also included the financial crisis of 2008 and the pandemic collapse of 2020.

You can see the ups and downs of the index-tracking portfolio in the accompanying graph. It also highlights three concentrated value portfolios that zoom in on stocks in the index using factors beloved by value investors.

Value in the TSX 60

The first value portfolio uses the price-to-earnings ratio (P/E) as its guide. The ratio compares a stock's price with its earnings per share over the prior 12 months. Value investors are naturally attracted to stocks with low ratios because they offer lots of earnings for bargain prices.

The low-P/E portfolio starts off with an equal-dollar amount invested in each of the 10 stocks with the lowest ratios. The stocks are held for a month and then a new crop of low-P/E stocks replaces them, and so on. Stocks move into, or out of, the portfolio each month as the ratios change owing to price and earnings fluctuations. Historically the turnover hasn't been huge, with one or two stocks typically being replaced by new ones each month.

The low-P/E portfolio fared the best of the bunch with average annual gains of 10.8 per cent from the end of January, 2002, through to the end of last month. It handily beat the index by an average of about three percentage points a year. You'll notice that it fared poorly in the crashes of 2008 and 2020 while largely shrugging off the decline in the early 2000s. (Although every downturn is different, value stocks tend to fall quickly in crashes and snap back in recoveries.)

Value investors also like to weigh up stocks based on their price-to-book-value ratios (P/B). This ratio compares a firm's market value with the amount of money that could be theoretically raised by selling off its assets (at their balance-sheet values) and paying off its debts. A low-P/B ratio provides some assurance you're not paying much more for a company than its parts are probably worth.

The low-P/B portfolio took second spot on the winners list with average annual gains of 9.9 per cent.

Income investors will appreciate the third measure of value because it's a variant of the popular Dogs of the Dow (or Dogs of the TSX) approach.

It tracks the 10 stocks with the highest dividend yields in the index each month, while the original Dogs method swapped stocks each year.

The high-yield portfolio gained an average of 9.2 per cent annually since January, 2002.

Of the stocks in the S&P/TSX 60, Manulife stands out because it appears in all three value portfolios. The Toronto-based insurance firm trades near five times earnings and 0.9 times book value and pays a 5.6-per-cent yield. (By way of disclosure, I own a few shares of Manulife and several of the other stocks in the portfolios.)

I think the three value portfolios provide a nice starting point for blue-chip bargain hunters. With a little luck, investors will be able to use them to build their own portfolios and fund more than a few vacations to cities, big and small, over the next couple of decades.

First published in the Globe and Mail, August 14 2022.

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