Gordon Pape's Picks for a Value Portfolio

08/06/2020 5:00 am EST

Focus: STRATEGIES

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

Value stocks — with low price-to-book values or low p/e multiples — often trade at bargain prices relative to the market, observes Gordon Pape, a Canadian stock specialist and editor of The Income Investor.

Generally, these are useful stocks for income investors. Typically, they are in defensive sectors and the higher-than-average yields make them a good source of cash flow. Here are some stocks that meet the criteria:

Emera Inc. (EMA) has grown from a small Halifax-based utility to a significant North American player, with assets in Canada, the U.S., and the Caribbean.

It now supplies about 2.5 million customers with electricity and natural gas and has $34 billion in assets. Some of the companies it owns include Nova Scotia Power, Tampa Electric, Emera Caribbean, and New Mexico Gas.

In the first quarter, Emera reported adjusted earnings attributable to shareholders of $193 million ($0.79 per share), down from $224 million ($0.95 a share) in the same period last year. The stock has a p/e ratio of 15.07. The quarterly dividend is $0.613 ($2.452 a year) to yield 4.5%.

Formerly TransCanada Corp., TC Energy Corp. (TRP) is a pipeline and storage company that also has interests in power generation. It operates 93,300 km of natural gas pipelines and storage and 4,300 km of oil and liquids pipelines.

It’s the company behind the construction of the on-again, off-again Keystone XL pipeline that, if it is ever completed, would carry 830,000 barrels a day from the oil sands to Gulf Coast refineries. It also owns 48.4% of the Bruce Power nuclear plant, which supplies about 30% of Ontario’s electrical power.

The company reported first-quarter net income attributable to common shares of $1.15 billion ($1.22 per share) compared with net income of $1 billion ($1.09 per share) for the same period in 2019. TC Energy reported that it had suffered minimal negative impact from the pandemic. The stock pays a quarterly dividend of $0.81 per share ($3.24 per year), for a yield of 5.4%.

Any time you can buy shares in Canada’s largest bank — Royal Bank of Canada (RY) — with a yield of almost 5%, you should grab it. It’s the kind of bargain that won’t be around long.

Canada’s Big Five banks are solid. Yes, their profits will be cut by big jumps in loan loss provisions, and we may not see any dividend hikes this year. But in the long run that will be just a blip. These banks came through the financial crisis of 2007-09 without needing any government bailouts. They’ll survive this crisis too.

The bank reported a 55% drop in second-quarter earnings, to $1 per share, fully diluted. Provision for credit losses rose to $2.83 billion, up by $2.4 billion from the same time last year. Also, lower interest rates reduced the bank’s net interest margin (NIM), the difference between interest income and the amount of interest paid out to depositors.

The quarterly dividend is $1.08 per share, so earnings did not cover the payout during the quarter. If that trend continues for a lengthy period, a dividend cut is not out of the question, but it looks improbable at this time. The p/e ratio at a price of $93.72 is 12. The yield on the shares is 4.6%.

In fact, all the big banks have low p/e ratios right now. TD is at 10.62 with a yield of 5.2%; Scotiabank has a p/e of 9.14 with a 6.4% yield; Bank of Montreal has a p/e of 9.84 and a yield of 5.7%; and CIBC weighs in with a p/e of 10.26 and a yield of 6.23%.

Royal has the highest p/e and lowest yield in this group, but I prefer it for its size and strong performance over many years.

It’s surprising to find one of the leaders in the race for a coronavirus vaccine in the value category, but Pfizer Inc. (PFE) qualifies with a p/e ratio of 13.45 and a yield of 3.8%.

On July 22, Pfizer and its German partner, BioNTech SE, announced they had reached a deal with the U.S. government to sell up to 600 million doses of their COVID vaccine, assuming it receives approval from the U.S. Food and Drug Administration.

Washington will pay US$1.95 billion for the first 100 million doses. The price for the remaining 500 million doses was not announced. Analysts estimated that the deal could result in windfall revenue of US$15 billion for Pfizer if it goes through. Tests so far have been positive.

First-quarter results saw a decline in revenue and profits, which contributed to investor concern and held back the share price. Revenue was down 8%, to just over US$12 billion. Adjusted net income was also down 8%, to US$4.5 billion (US$0.80 per share).

The company said that it was able to maintain its manufacturing operations around the world at or near full capacity as the pandemic took hold but experienced an impact on its sales and marketing activities. The shares pay a quarterly dividend of US$0.36 per share (US$1.44 per year) and it does not appear to be at risk.

There are many other value stocks out there that are worth considering for your portfolio. But be wary of “value traps.” These are stocks that are trading at extremely low levels but whose prospects of turning the business around are poor. Stocks with an inflated yield often fall into this category.

In short, value stocks are a good way to add cash flow and growth potential to an income portfolio. But be sure to choose companies with strong turn-around potential and limited downside risk.

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