January 4, 2018

Thursday was yet another wonderful day for stock investors. Especially U.S. stock investors.

The S&P 500 was up another 0.4%. The Dow was up 152 points or 0.6% as it cruised through the 25,000 point milestone without even slowing down to acknowledge that feat and closed at 25,075. Toronto was up 0.25%.

A notable gainer was TFI International up 2.4%.

Most investors in stocks have been enjoying excellent gains of late. Their only complaint might be that those with exposures to Cannabis or certain crpyto currencies have done even better.

I feel like the gains are coming rather too easily and quickly and we should not expect the party to continue without end.

The four Cannabis stocks that I am keeping an eye on were down roughly 10% on average today after the white house announced that federal agents could still prosecute cannabis users in States where it is “legal” because it remains illegal under federal law. That basically put a damper on expectations for the Canadian companies selling into U.S. markets. It seems to me too, that the TSX was recently concerned about listing any Cannabis company that was doing business in the U.S. due to legal issues. This news could heighten the concern of the TSX. Overall, the fact that these stocks fell only about 10%, which only gave back approximately the gains of the previous day, perhaps reflects the strength of the appetite for these stocks.

Costco was down 0.8% today even though it reported absolutely stellar December same-store sales growth. I have Costco rated as a (lower) Sell which seems sort of harsh for such a powerful company. But perhaps the market action today reflects that even great companies can get over-valued at times. Still, I was surprised to see a drop after those great December figures came out.

A New Corporate Performance Indicator

When I look at the book equity of a company, I always take some note of the proportion of the book value that represents original shareholder money and the proportion represented by retained earnings. If a large portion is retained earnings then that is proof of profitable operations in the past.

Usually, but not always, a negative retained earnings figure indicates a history of losses. An exception to that rule can occur when a profitable company has paid out all of its past earnings as dividends or for share buy-backs (which reduces both retained earnings and original invested shareholder money). Dollarama is such a case.

I have calculated a new performance indicator (that I have not seen elsewhere) by breaking out the equity market cap value of companies into three components:

1. Original shareholder invested money – raised by seed financing, public offerings of shares, money received on the exercise of stock options and also the value received when shares are issued in corporate takeovers. This amount has often been reduced when a portion of share buybacks (or in some cases dividends) is considered to be a return of original shareholder invested money.

2. Retained earnings including accumulated comprehensive earnings which has often been reduced by dividends and share buybacks.

3. The residual which is the amount by which the market value exceeds (or in some cases trails) book value which is the sum of components 1 and 2. The market should logically value a company at a higher level than book value when that company is expected to generate returns higher than those “required” by investors. (Just as a bond paying an above market yield will trade above par value.)

As an example, the equity market cap of TFI International can be broken out as 24% (remaining) original share owner investment, 20% retained earnings and the remaining 56% of the market cap represents the premium the market has found to be appropriate over and above the book value.

This is not a perfect indicator but it does illustrate that TFI has a history of profitability and that some of the profits have been retained. It also illustrates that the market believes that TFI can continue to achieve book value ROEs that are higher than investor required returns and that therefore a premium value over and above book value is appropriate. Basically, these figures indicate that TFI International has done what we would want any company to do: It took in investor money, and made profits that are high enough to deserve its shares to trade at a premium to the invested/retained capital. Not every company can make that claim.

I will provide more details of the results of this analysis in a forthcoming article.