Stock Market Updates from 5i Research - Mar 18, 2021

Barkha Rani Mar 19, 2021

Flash Report 

We have a flash report update of 11 companies on our coverage list, many of which recently reported earnings. With an anticipated economic recovery, the prospects of many names in this report look bright going forward and for that we reason we have maintained most of our ratings. However, we have downgraded the rating for one company.

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Company Updates

Xebec Adsorption Inc (XBC)

The company announced full-year 2020 revenue guidance of $57 million. This was far lower than the initial $70-80 million guidance provided by management. Upon this news, shares saw a 34% drop on the news and are now down over 40% since the announcement. The lowered guidance and related contract issues are something to watch but the swing in share prices looks overdone relative to the actual impact on results. With an earnings release on March 25, we would prefer to wait at this stage for a bit more information and reassess at that time.

Market Update

Market volatility has eased as investors adjusted their exposures from higher growth names to cyclical and value stocks in the context of an upwards move in bond yields and a faster than expected economic recovery. Nearly a third of the US population has already been vaccinated and expectations are bright with some estimates anticipating US GDP to reach pre-COVID levels by next quarter. The rollout of the vaccine has been slower in Canada, but as it relates to market sentiment, we continue to see a similar theme of a rotation from high growth tech to cyclical and value names.

In 2020, a lot of investor capital moved toward industries like tech while stocks in other sectors (especially cyclicals) suffered. Looking ahead, there is a wide pool of opportunities in different pockets of the economy that will likely see a recovery trading at attractive multiples that could add some alpha to an investor's portfolio. Here are some things we think investors should consider when looking for these names:

Growth companies will not stop growing

Corrections in high growth are often a reminder for investors about how much high growth they are comfortable with in their portfolios. However, we are of the view that high multiples can be justified if the growth is there and it is reasonable to believe a company could achieve that growth. The point is, just because there seems to be a rotation to value or cyclicals, it does not mean growth stocks cannot outperform. An investor who bought into a high growth company in 2020 should continue to ask if that growth story changed from then and until now. This is where time horizon comes in. Investing in a stock with a high multiple not only means one needs to have higher risk tolerance, it also implies that an investor may need to be patient before realizing a significant return. 

Value or growth? Why not both?
In investing, it's never all or nothing. Just as an investor would have taken on more risk to go 'all in' on high growth tech stocks in 2020, it would also be risky to shift one's entire portfolio to value or cyclical stocks. Just as there were 'mini-bubble' growth stocks, there are also many low P/E value traps out there as well. An investor can benefit by owning both value and growth names for diversification and of course, valuation multiples are not the only thing one should look at. 

Look for market leaders with strong balance sheets and a competitive position
Companies with strong fundamentals and leadership positions tend to come out of a recession even stronger and are better equipped than their peers to take more market share. We generally find these types of companies to have a higher probability of greater returns, even if paying a slightly higher multiple. Of course, a company does not have to have a leading market share to be a good investment. We would also look for companies that were showing above-average growth in revenues and profits prior to the pandemic.

Look for companies that were proactive during COVID quiet period
Companies that have characteristics of the point above were likely also proactive during COVID to get ahead of the competition. Examples are retail companies that have done a significant rehaul to their e-commerce presence, revamped their IT systems to significantly reduce operating costs, significantly enhanced product offerings or distribution channels to get ahead of competitors, or have significantly improved their balance sheet to take on acquisitions. 

A lot of recovery may already be priced in
As can be observed from the markets, a lot of recovery stocks have done well lately with expectations of a near-term economic recovery. However, some names may already be pricing in full recovery to pre-COVID levels of earnings and beyond. Today, it is common to see cyclical names with much higher price multiples than most of the company's history. This then becomes a game of how determining how much upside there is left for an investor in the near to mid-term, which ultimately can have an effect on long-term returns if a valuation is too rich. Further, current recovery expectations may not reflect a scenario where the economy recovers slower than the market expects, so this may result in higher valuations being tested yet again, but for recovery sectors. 

The "recovery trade" may be short-lived
This ties in to the point above. The idea is once markets have 'completed' the rotation (i.e. investors have finished reallocating capital from growth to value or the economy stabilizes, there will likely be less "torque" left from buying recovery stocks. Additionally, we would not expect the same type of explosive growth we saw with tech in 2020 given the unique circumstances of COVID and how it accelerated certain growth trends. While "trades" tend to be shorter-term in nature, we also do not think it means one should not look out for cyclical companies as long-term holds.

As always, it is important to avoid letting the fear of missing out on a trade derail one's overall investment strategy. Arguably, this has been especially difficult in a global pandemic that has caused seismic shifts in the balance of the markets. However, we continue to believe that by making small adjustments to a diversified portfolio of companies with strong fundamentals and a good understanding of one's investments, investors should do just fine over the long-term.

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