Entries from May 2017 ↓

The Big 6

RYAN  By Guest Blogger Ryan Lewenza

Today we’re going to have some fun with numbers. Well, fun may be a stretch since we’re not talking about some crazy Hangover movie-like experience with the “Smoking man” in Las Vegas. This is more nerdy fun like hanging out at Comic-Con dressed up as Chewbacca.

Our industry loves its acronyms (CDS’s, MBS, ROEs etc.) with “FANG” stocks being one of the more recent and popular ones. FANG stocks include Facebook, Amazon, Netflix and Google. When we add in Apple and Microsoft we get a variation of the “Big 6” we are well familiar with here in Canada. These “Big 6” US stocks have done much of the heavy lifting for the S&P 500, with these six stocks contributing roughly 40% of 2017 YTD gains and over 20% of the total gains for the index since 2013. Given how topical this investment theme is these days we thought it would be interesting to compare and contrast the US “Big 6” with our very own “Big 6” banks and see what conclusions can be drawn.

It has been a great run for these six US stocks with their combined market cap up 165% to US$3 trillion since 2012. To put this into perspective this is the equivalent in US dollars of the combined total market cap of Canada’s TSX and Germany’s DAX stock exchange value! So if you had US$3 trillion lying around (or had God as your private banker) you could either purchase 6 (great) US companies or every company listed on both Canada’s and Germany’s stock exchange!

Let’s now compare those six US stocks to the “Big 6” Canadian banks which are pretty sizable banks on a global basis and are highly profitable. The “Big 6” banks include Royal Bank, TD Bank, Bank of Nova Scotia, Bank of Montreal, CIBC and National Bank. Their combined market cap in US dollars is $344 billion or roughly 1/10th of the combined market cap of FB, AMZN, NFLX, GOOGL, AAPL and MSFT.

Here in Canada we view the Canadian banks as larger than life but we’re looking at them through the lens of a small country with just 35 million people. As President Trump would likely say, the “Big 6” US stocks are HUGEEE and our “Big 6” Canadian banks are just a bunch of “Little Marcos”.

Market Cap of the US “Big 6” & the “Big 6” Canadian Banks

Source: Bloomberg, Turner Investments

Where it gets interesting (again assuming you’re a nerd like me who gets worked up over financial stats) is when you compare the profitability of the US “Big 6” stocks with the “Big 6” banks. Looking at trailing 12-month combined earnings of the US stocks, they earned an incredible US$98 billion with Apple delivering half of this.

In contrast, the Canadian banks earned a very impressive US$29 billion over the last 12 months. So comparing the US stocks to the Canadian banks, they make 3.5x more in earning than our banks, but have a combined market cap nearly 9x that of the Canadian banks.

Net Income of the US “Big 6” & the “Big 6” Canadian Banks

Source: Bloomberg, Turner Investments

Therefore the missing piece to this analysis is stock valuations. Currently, the “Big 6” US stocks trade at weighted average P/E ratio of 56x with Amazon and Netflix trading at nosebleed P/E levels of 180x and 206x, respectively. The Canadian banks on the other hand trade at a much more reasonable 12x earnings, and you get some nice divys every few months.

P/Es of the US “Big 6” and the “Big 6” Canadian Banks

Source: Bloomberg, Turner Investments

Ok, so what’s the takeaway here?

* First, buy broad-based index funds since it’s very hard to know which stocks are going to be the big winners in a given year. Many portfolio managers have taken a pass on Amazon, Facebook and the like since they are expensive. Well not owning those stocks likely caused many PMs to underperform the S&P 500
* Canadian banks punch above their weight class delivering massive and steady earnings for investors. And they trade at very reasonable valuations while providing attractive dividends. This is why we believe investors should continue to have some exposure to them in portfolios
* Finally, if you’ve hit a big winner by owning one these US stocks then maybe it’s not a bad time to “ring the register” and take a few chips of table. Especially, if “Smoking man” is sitting at your poker table ordering double JD and cokes.

Ryan Lewenza, CFA,CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.

What to do?

It took three months, but Gary finally got a letter from the federal minister of finance.

“It is a two page speech about all the Liberal policies addressed at making Taxes Fair for the middle class,” says the Kelowna self-employed blog dog.  “At no point does it address any of my concerns. So much for the govt listening to the people. Kind of disheartening. What to do?”

Gary wrote about some issues raised on this badass blog before the last budget – namely what the T2 gang intend to do about all the people who are now creating their own jobs through self-employment. After all, full-time, salaried employment with benefits and pensions is becoming a thing of the past. The typical Millennial’s grand-dad had one job for life and retired with a monthly allowance. The poor kid will probably have eight gigs and never have a safety net.

Anyway, Gary decided to speak out. He wrote this in his first-ever letter to a politician:

My wife and I have owned and operated two businesses in our working lives.  We personally did without things, saved and invested so that we could look after ourselves later in our lives.   We were reasonably successful in that we are now financially independent and can live off of our investments.

We collect dividends, capital gains, interest etc on our investments.  I have never collected a dime of EI benefits.   We have RRSPs and TFSAs.  However we also have non registered investments.   We will pay Capital Gains tax on whatever we cash out at a 50% rate.  This is on top of the income tax we paid on the original income that we saved and invested. How many times and how much tax are we supposed to pay tax on this money?

Now your government wants to raise this tax rate to penalize “the rich” as Mr. Trudeau refers to us.   We are by no means rich.  We have achieved where we are by our own hard work and diligence.

His concerns? That taxes will be increased on capital gains, or people like him who operate through an incorporation because the government thinks entrepreneurs should be treated the same way as politicians – paid by salary. But without the tax-free expense allowance, housing allowance, travel vouchers, free electronics, office staff and budget plus indexed pension, of course. I mean, fair is fair, right? Why should a guy who puts up eavestroughs all day be treated like some kind of tax-advantaged god? Who the hell do these corporate titans think they are?

The response was a two-page excerpt from the last budget with Bill Morneau’s signature at the bottom. And, as you know, the issue faded a little after the T2 gang retreated from their higher-tax agenda in the March budget.

But, sadly, it’s back. So prepare.

This week Bill donned his pointy Robin Hood hat and trusty codpiece and gave a speech in Toronto suggesting the next budget will be way less kind than this year’s. It was the boldest hint yet that the federal government is, in fact, gunning for the self-employed

“We have identified three areas of concern,” he said. And, yes, they are exactly those which this blog whined, moaned and gnashed over some months ago. It’s only a matter of time now before incorporated people will no longer be able to split income with others, keep retained earnings invested within the company at a reasonable rate, or enjoy the existing capital gains tax rate.

Here are his exact words:

“Take this example: if you are an employee living in Ontario and you make $220,000 a year, you would pay roughly $80,000 in income tax. Now, your neighbour owns a private corporation and sprinkles that same amount between themselves, their spouse and their adult child. In many cases, the family is involved in the business and it’s completely legitimate. But in cases where the spouse or child have no role in the business, suddenly your neighbour is paying roughly $30,000 less tax than you do. And we see no good reason why that should be the case.

“The second example is passive investment income. That’s when people hold money inside a corporation, not to grow the business by investing in it, but simply to shield it from the higher personal rate.Again, this sort of arrangement is not available to someone who collects a paycheque every two weeks.

“The third and last example relates to capital gains. Converting a private corporation’s regular income into capital gains can reduce income taxes—again, by taking advantage of the lower tax rates. This is about making sure that the rules – as they were intended – are being followed and that people are paying their fair share.”

Morneau cloaks everything in the syrupy mantra of ‘middle class fairness’ but these are desperate actions from a government mired in deficits and over-spending. In just 48 months of governing, the feds will spend about $130 billion more than they collect – so taxes are going up. And not just for the wealthy, who already hand over 50% of their income when they hit $220,000.

Many doctors and medical professionals, for example, earn money through corporations which means they have no pensions, no benefits and start their careers at a later age, with huge student loans. Income-splitting with a spouse allows for some relief, and also means docs cost the system $250,000 a year instead of $500,000. (They can always go south…)

Anyway, what this blog vexed about last winter is about to become reality. Ottawa will first release a discussion paper outlining its reasons for attacking incorporations, and then will move to do so. There will be no compensation allowed for non-employees; retained earnings will be taxed at the beneficial owner’s personal tax (or perhaps the top marginal rate) and you can kiss the 50% capital gains inclusion rate adios.

How do you like fairness so far?