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The Top 200 Canadian Stocks for 2009

The market crash of the past few months reminds many people of the Great Depression. But we have a bit of different take on things. As Warren Buffett likes to say, you make money by being fearful when others are greedy and greedy when others are fearful. As agonizing as the past year has been, we think we are now in the middle of a tantalizing buying opportunity.

The market is oozing fear and Buffett himself recently loaded up on stocks for his personal portfolio. We think investors should take heed. History shows that buying in bear markets has been extremely profitable for patient investors. By many measures, stocks are now cheaper than they have been in a decade. While we don't want to minimize the risks involved - the stock market could take years to recover from its recent losses - we believe that long-term buy-and-hold investors should do well by investing at today's prices.

To help you uncover some of the most promising propositions, we took a hard look at Canada's largest companies and graded each of them for investment appeal. Our fifth annual MoneySense Top 200 is designed to be easy to use, logical, and appealing to all types of investors. In fact, we think the Top 200 provides you with a more objective look at large Canadian stocks than you're likely to find from any other single source.

Among other virtues, The Top 200 offers a very honest approach to picking stocks. Our results are based entirely upon the numbers - our feelings and opinions about a company don't matter a bit when it comes to assigning grades.

Each year we pick what we call All-Around All-Stars - stocks that score well on both our growth and value tests. We think these stocks make up an extremely promising roster of potential investments. But while we wish we could guarantee big gains every year, all we can vow is that we will be upfront about the results.

Like many other stock portfolios, our 2007 All-Stars suffered through a horrible year. They gave up 33% not including dividends. But despite the ugly results, we're happy to report that our long-term gains remain excellent. Our All-Stars have produced 14% average annual returns since we started in 2004. That's about 10 percentage points more than the annual return of the S&P/TSX Composite.

We remain happy with our long-term track record, but the loss we suffered this past year points out the risks involved with any stock investment. Our goal is to beat what the market produces by a couple of percentage points over an entire market cycle. So far, we're well ahead. But with reward comes the risk of a loss, and we want you to be aware of that.

To arrive at the Top 200, we begin by identifying the largest 200 companies in Canada by revenue. Using data supplied from Bloomberg, we evaluate each stock, first for its attractiveness as a value investment, then on its appeal as a growth investment. (Value investors like profitable stocks that trade at low multiples of book value and pay juicy dividends. Growth investors like companies with momentum and ballooning earnings.) Our value and growth screens employ sophisticated measures of financial virtue, but in the end we reduce everything about a stock to two grades - one for value appeal, one for growth potential.

The grades work just like they did back when you were in school. Top-of-the-class stocks earn an A. Solid students get by with a B or a C grade. Those in need of improvement go home with a D or even an F.

A select group of stocks - those that manage to achieve at least one A and one B on the value and the growth tests - make our All-Around All-Stars. Only nine stocks made it to the head of the class this year.

Before we talk about our new All-Stars, here's the low-down on how we rate all 200 stocks:

The value test:

Value investors like solid stocks selling at low prices, so we begin by looking for stocks with low price-to-book-value ratios (P/B). This number compares the market value of a company to how much cash you could raise by selling off the company's assets (at their balance-sheet prices) and paying off the firm's debts. You can think of a low P/B ratio as an assurance that you're not paying much more for a stock than its components are worth. To get top value marks in our system, a stock has to possess a low price-to-book-value ratio compared to the market and also compared to its peers within the same industry.

We also like to look at price-to-tangible-book-value ratios. Tangible book value is like regular book value, but it ignores any intangible assets (such as goodwill) a firm may have. So, it's an even sterner test of how much a company would be worth if it had to be closed down and sold off for scrap.

Other factors matter, too. Good companies produce profits so we award higher scores to firms that have positive price-to-earnings ratios over the past year (this backward-looking figure is known as the trailing P/E ratio). We also reward a company if industry analysts expect it to be profitable and have a positive P/E over the next year (this number is known as the forward P/E ratio).

Because we like to have a little spending money in our wallets, we award extra marks to dividend-paying stocks. (Cautious investors may want to pay particular attention to such stocks in this market. Dividend payers have historically held up very well during market downturns.)

To ensure a company won't be sunk by excessive debt, we penalize spendthrift companies living on credit. We award the best grades to firms with low leverage ratios (defined as the ratio of assets to stockholder's equity) compared to their peers.

Finally, we combine all these factors into a single value grade. Only 20 out of 200 stocks got an A this year.

The growth test:

The first mark of a good growth stock is, not surprisingly, growth. We start by awarding high marks to any stock that achieved robust earnings-per-share and sales-per-share growth over the past three years. We also track each firm's growth in total assets over the last year to get a sense of its recent momentum.

We want to be sure that the market is taking note of a growth company's improving situation, so we hand out additional marks to stocks that are strong performers relative to the overall market. In particular, we favor stocks that have provided good total returns, compared to the market, over the past year.

As great as growth is, we don't want to buy into fads, so we hedge our bets by checking out each stock's return on equity (ROE). This vital statistic measures how much a firm is earning compared to the amount that shareholders have invested. It is an important indicator of the quality of a business. Only those stocks with strong returns on equity compared to others in their industry earn our top marks.

Finally, since no one wants be the last buyer in a bubble, we examine each stock's price-to-sales ratio (P/S). This ratio measures the stock's price in comparison to the company's sales. We figure that low to moderate price-to-sales ratios indicate stocks that are reasonably priced, so we award them extra marks. In contrast, firms with high price-to-sales ratios may be riding a market fad and might have become detached from sensible expectations.

Putting all these growth and quality indicators together, we arrive at a final growth grade. Only 20 out of 200 stocks earn an A this year.

The All-Star team:

As we mentioned above, a mere nine stocks earn at least one A and a B on both our value and growth tests. The single stock to return from last year's All-Star list is Methanex (MX). Momentum slowed for the Vancouver-based methanol producer, but it became even more appealing as a value investment. It scores an A for value and a B for growth.

The two biggest stocks on our new All-Star team are Petro-Canada (PCA) and TD Bank (TD). Petro-Canada was clipped this fall when oil prices collapsed. But with the world running out of oil, the Calgary company offers not only outstanding value, but also a way to hedge your portfolio against future spikes in petroleum prices.

TD Bank, like most Canadian banks, managed to avoid the worst of the financial storm this fall. It has also managed to boost its earnings by an average of 16% a year over the past three years.

Canadian Tire's (CTC.A) stock is holding a 40%-off sale. Investors worry that we're heading into a recession but the Toronto firm's most recent quarterly results showed little indication that consumers were spent. Perhaps it's time to save like Scrooge by buying a few shares?

Transcontinental (TCL.A), a big North American printer and publisher of magazines and newspapers, isn't growing all that quickly. But, at 82% of book value and seven times earnings, the Montreal-based company offers outstanding value appeal.

Gold bugs might be disappointed that the yellow metal's price hasn't skyrocketed during the credit crunch. But we're happy to be able to pick up gold miner IAMGOLD (IMG) for a reasonable price.

Our last three All-Stars are smaller stocks. Algoma Central (ALC) runs cargo ships on the Great Lakes from its headquarters in St. Catharines. Velan (VLN), based in Montreal, produces industrial valves and is the only stock to pick up top marks for both value and growth this year. High Liner Foods (HLF), hailing from Lunenburg, NS, serves up seafood to millions and a good value to investors.

Before buying any stock, make sure that its situation hasn't changed in some important way. Read the firm's latest press releases and regulatory filings. Scan newspaper stories to make sure you've figured out all the important developments and breaking news. Remind yourself that while today is a stressful time to be an investor, stress usually pays.

Investing in hard times
How to build a panic-proof portfolio

It's hard to protect your portfolio from downturns and to also benefit from bull markets. But there are a few practical things you can do to reduce your risk without having to flee to GICs.

Most important, you should diversify your holdings. Your first step in this direction should be to maintain a sensible split between stocks and bonds in your portfolio. If in doubt, put 50% of your money in stocks and 50% in bonds. This gives you a good balance between the risky but higher returns that you can get from stocks and the dependable but sometimes meager yields from bonds.

Remember, though, that everyone has a different ability to take on risk. If you're younger or more comfortable with risk, you might want to bump up your stock component. If you're older or averse to risk, you may choose to boost your bond holdings. But don't go to the extreme in either direction. To ensure that you're protected from both market crashes (the stock picker's worst enemy) and also inflation (the bond investor's worst nightmare), it's best to keep no more than 75% of your portfolio in stocks and no more than 75% in bonds.

When it comes to picking your specific investments, spread your bets around. Don't just stick to Canadian stocks. Look further afield and pick up U.S., European, and Asian issues as well. Similarly, don't fall in love with any single industry. Diversification doesn't mean holding 20 Internet stocks - or, for that matter, 20 oil companies. It means holding a variety of stocks that span many sectors, from pharmaceuticals to farming, from miners to media companies.

One common mistake is to bet a huge portion of your portfolio on just one stock. Sure, holding a single stock may make you fabulously rich. But you don't want to gamble your retirement on one big bet. (This is doubly true if you also happen to work for the company you've invested in. If you only own shares of your employer and its business declines, you can find yourself both out of work and out of money.) Even aggressive investors shouldn't invest more than 10% of their stock portfolio in any one company. Conservative investors should be even more cautious and put no more than 5% in any one stock. By restricting the size of your bets, you ensure that your losses will be contained if things don't work out quite as you hoped.

From the December/January 2009 issue

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Disclaimers: Consult with a qualified investment adviser before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, financial advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...