Paul Harris, partner and portfolio manager, Harris Douglas Asset Management

FOCUS: North American and European large caps

MARKET OUTLOOK:

The bear market so far has all been mostly multiple contraction. The S&P 500 price-to-earnings has gone from 24 to 16 but earnings per share and forward EPS has no changed. In the stock market, two key factors drive share prices over time‐ the expectations for corporate earnings and interest rates. Today, investors are concerned about the prospect of lower corporate earnings, due largely to a combination of rising costs and the potential for declining demand. Interest rates determine how the cash flow of all types of assets is valued. Today’s rising interest rate environment means that the valuations being applied to the expected future earnings of companies are declining. The risk premium contracted from 2009 until 2021 and the unexpected inflation and the increases in interest rates has caused the risk premiums to widen, as a result risk assets are being repriced. From an economic point of view it’s hard to ignore recessionary signals that are getting louder by the day. The most closely watched indicator, real GDP, contracted again in second-quarter (-0.9 per cent annualized, after a -1.6 per cent print in first-quarter). Not once has the U.S. escaped recession in the past when there were two consecutive quarters of contracting output. 

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TOP PICKS:

Alphabet (GOOG NASD)

It is a top search destination on the web and provides a leading search marketing platform for advertisers and merchants. The company continue to see growth in YouTube and its ability to monetize advertising. The stock trades at 20 times earnings. It will generate $50 billion in free cash flow in 2022 and has no debt. It has significant secular growth form internet advertising, strong market share in search and other internet advertising segments. Google has 30 per cent share of U.S. digital ad revenue and global ad revenue is expected to reach well over 400 billion in 2024 and digital advertising accounts for more than 50 per cent of total ad spend. The restrictions that Apple has put on iPhone helps google. 

Zoetis (ZTS NYSE)

Zoetis is the largest public animal-health company. Zoetis was spun off from Pfizer in 2013. In 2018 U.S. pet owners spent $15.5 Billion on over the counter medicine and supplies — double $6.2 billion in 2001. Healthcare for animals has a certain advantage over health for humans. The industry doesn’t have to compete with pricing pressure from the insurance industry as most medical expenses are paid out of pocket. Developing drugs for pets, compared to humans, is generally faster and less expensive, since it requires fewer clinical studies that involve fewer subjects. Most companies try to find compounds that have worked in humans, so we don’t to start from scratch. Generic drugs are less of a threat. This company has strong free cash flow growth, generating $2 billion in 2022, a strong balance sheet and covers interest on debt 14x and has high conversion rates in free cash flow to net income.

FirstService Corp (FSV TSX)

This company focuses on residential property management and services (California Closets). It has room to grow marketshare in the U.S. in what remains a very fragmented business. The company has grown through acquisitions and organic growth. Trades at 30x next year’s earnings and yields 0.60 per cent. 

PAST PICKS: August 24, 2021

EssilorLuxottica (ESLOY OTC)

• Then: $94. 84
• Now: $75.26
• Return: -21%
• Total Return: -19%

Stryker (SYK NYSE)

• Then: $271.10
• Now: $206.30
• Return: -24%
• Total Return: -23%

Meta Platforms (META NASD)

• Then: $365.51
• Now: $161.81
• Return: -56%
• Total Return: -56%

Total Return Average: -33%