Invesco Canada blog

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Jason Whiting | November 30, 2012

Question: High yield is in fashion, but will it run its course?

In this market I personally believe that a missed opportunity is a higher risk.  My members are of the opinion of the blogger though; they don’t want to see a loss.  Is there the best of both worlds?  High Yield are in fashion currently but do you think they will run their course too quickly and leave us trying to do damage control? –Tammy

When Warren Buffett is asked to comment on his biggest mistakes he rarely mentions ConocoPhillips (a multibillion dollar loss) or Dexter Shoe Co. (which essentially went bankrupt), but usually mentions Wal-Mart.  Buffett started to buy Wal-Mart many years ago but stopped because the price went up a little, a decision he was later quoted as saying cost Berkshire Hathaway $8B in missed profits.

There are situations where you can find wonderful opportunities with very little chance of permanent loss of capital. Sticking with Buffett, he began to purchase Coca-Cola in 1988 at around 15x trailing earnings and something like 13x forward earnings. For one of the great consumer goods franchises of all time, you could easily say Coca-Cola had both (upside) opportunity and limited downside risk. Over the next decade Coke went up nearly 2,000%!

Of course, opportunities like that come along only a few times in a lifetime. However, with patience you can find smaller versions today. For example Rocky Mountain Dealerships* (a top 10 holding in Trimark Canadian Small Companies Fund) trades at about 8.5x earnings, has a clean balance sheet and the opportunity for both revenue growth (through acquisition) and margin expansion (through improved integration of previous acquisitions) to provide that upside opportunity.

The difficulty in finding these types of investments is one of reasons I run such a concentrated portfolio, as it is better to be in cash than to risk unitholders’ money.

Regarding your question on yield, I’d agree that anything that is extremely popular is generally risky, whether it’s the Nifty Fifty in the 1960s and 1970s, emerging markets in the early 1990s or technology in the late 1990s. While I don’t think high yield investments are in the kind of bubble territory of the aforementioned examples, I do think caution and common sense is needed.

For example a number of independent power producers (IPPs) in Canada trade at mid-teens EV/EBITDA** multiples solely because of their dividend yields (5-6%), yet there is one IPP I’m aware of that doesn’t yet pay a dividend and trades at 12x EV/EBITDA (and used to be in single digits). This kind of valuation disparity solely on the basis of a dividend shows the kind of frothy waters yield investors currently occupy.

* The above companies were selected for illustrative purposes only and are not intended to convey specific investment advice

**Enterprise value/Earnings Before Interest, Taxes, Depreciation and Amortization is a valuation multiple used to measure the value of a company.

Get more information on Trimark Canadian Small Companies Fund.
Learn more about the Trimark Investments team.
Trimark Canadian Small Companies Fund, Series A provided the following performance returns as at November 30, 2012: 1-year, 10.43%; 3-year, 10.58%; 5-year, 3.90%; 10-year, 8.13%.


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2 responses to “Question: High yield is in fashion, but will it run its course?

  1. Hi Dave, thanks for reading. My answer to your question turned out quite long and I think it makes for a good topic for another blog post. Please stay tuned for my answer on the blog.

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