Canadian value stocks have been on a roll in recent months after sagging when interest rates shot up in 2022.
The rebound helped the Screaming Value portfolio jump 84 per cent from the end of September, 2022, through to the end of 2024. In comparison, the S&P/TSX Composite Index gained 59 per cent over the same period.
The portfolio’s recent gains boosted its average annual returns to 14.5 per cent over the 25 years through to the end of 2024. The market index trailed with average annual gains of 7.2 per cent over the same period. (The returns herein are based on backtests using data from Bloomberg. They include dividend reinvestment but not fund fees, taxes, commissions or other trading costs.)
The Screaming Value portfolio looks for value by starting with the largest 300 common stocks on the Toronto Stock Exchange by market capitalization. It then invests an equal-dollar amount into the 10 stocks with the lowest EV/EBIT ratios each month.
Put simply, enterprise value, or EV, is the market value of a company’s equity plus its net debt, while EBIT is an abbreviation for earnings before interest and taxes. Investors might think of EV/EBIT as being a fancier version of the more familiar price-to-earnings ratio with EV standing in for price and EBIT for earnings.
The portfolio holds a fixed number of stocks but the EV/EBITs of the stocks it holds varies over time. For instance, the 10 lowest-EV/EBIT stocks might have ratios below 5.9 one month and their ratios might be below 5.2 the next.
Alternately, investors can employ a fixed-ratio test while allowing the number of stocks in the portfolio to vary over time.
Six fixed-ratio portfolios highlight some of the benefits, and drawbacks, of taking the alternate path. Like the Screaming Value portfolio, they start with the largest 300 stocks on the TSX but they then invest an equal-dollar amount in stocks with EV/EBITs of less than five, six, seven, eight, nine or 10 each month.
The first accompanying graph shows the average annual returns of the six fixed-ratio portfolios, over the 25 years to the end of 2024. Generally speaking, lower-ratio stocks offered better returns and the portfolio of stocks with EV/EBITs of less than five provided average annual gains of 15.5 per cent over the period.
The second graph shows how the number of low-EV/EBIT stocks varied over the 25-year period for portfolios with EV/EBITs below six, eight and 10.
The portfolio with EV/EBITs of less than 10 owned at least 13 stocks over the last 25 years and its membership swelled to a high of 138 stocks in 2008. It was the only fixed-ratio portfolio that held at least 10 stocks over the whole period.
At the other end of the spectrum, the portfolio with EV/EBITs of less that five failed to find a single stock to invest in once over the 25-year period and owned fewer than eight stocks a little more than half of the time.
The number of stocks in the portfolios grew dramatically in market crashes and hit highs in the financial crisis of 2008-09. At the time, there were 64 stocks with EV/EBIT of less than six, 108 stocks with ratios under eight and 138 with ratios of less than 10. (In hindsight, early 2009 was an excellent – but very frightening – time to load up on low-EV/EBIT stocks.)
The number of Canadian value stocks in the fixed-ratio portfolios at the end of 2024 was close to their averages of the last 25 years. While the availability of bargains isn’t as good as it was in the fall of 2022, the market hasn’t run out of bargains yet.
I’ve high hopes that the Screaming Value portfolio will continue to do well over the long-term. Mind you, it isn’t for the fainthearted because it suffered from some dramatic downturns in the past.
You can find a list of stocks with EV/EBITs of less than 10 via a link in the online version of this article, which also provides updates to many of the other portfolios I track for The Globe and Mail.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.