Investor’s Digest of Canada – Best Buys from Michael Sprung

Investor’s Digest of Canada – Best Buys from Michael Sprung

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While volatility since winter “may or may not be indicative of a protracted market downturn”, it does signal shifting investor priorities, suggests Michael Sprung, founder of Sprung Investment Management in Toronto. He is a chartered financial analyst who serves as president and one of the portfolio managers at his namesake boutique investing firm.

Elaborating on the shift, Mr. Sprung explains, “I’d very much describe the last year as price-driven markets.” That is, investors largely put money into companies simply on the basis that their shares were rising, thus further inflating prices. Expressed as price-to-earnings, the portfolio manager notes that the major technology companies and other, more speculative corners of the economy (such as medical marijuana) had driven most of the increases over the last couple of years up to January, despite relatively negligible or even negative earnings. Investors during the period chose to bet on future growth.

Investors Digest Canada Best Buys Michael Sprung

Investor’s Digest of Canada – Best Buys from Michael Sprung

By contrast, the recent ups and downs are “forcing people into more higher-quality securities,” says Mr. Sprung. “It’s going to be much more of a ‘show-me’ kind of a market where people are going to want to see the road to earnings and the road to profitability,” he predicts before adding, “Quality of earnings is going to become much more important.”

The analyst advises against holding shares of the major technology companies, as well as stocks in emerging industries, given their room to fall.

He further recommends that investors avoid taking long positions in fixed-income investments, especially as interest rates rise and capital moves to other areas of the market in anticipation of growth. “We are very short in almost all of our fixed-income investments.”

Generally speaking, the larger economic outlook remains healthy, with a caveat. Mr. Sprung recalls that before the pullback in winter, “Everybody was talking about synchronized global growth from an economic point of view.”

Key to this rosy prognosis was simultaneous growth in both emerging and developed economies. In fact, the consensus expected better worldwide economic expansion this year than in the last five. However, Mr. Sprung admits, “A lot of that future will be dependent on the global trade issues.”

In Canada, the picture is also sound. “The country is very well-positioned to participate in a global economic recovery,” says the analyst. If NAFTA (North American Free Trade Agreement) negotiations are positive, closeness to U.S. growth further sweetens prospects back at home.

The analyst argues that the energy sector offers the best domestic potential for share prices to rise. After years in the doldrums, the energy sector is rising again. Because of the previous slump, many oil and gas names offer good value to shareholders, Mr. Sprung argues.

“Those that have had stronger balance sheets and better management have been able to take advantage of some of the opportunities that have come up.”

Reflecting this view, his first “best buy” pick is Vemilion Energy Inc. (VET-TSX, $44.97; VET-NYSE, US$34.92).

The oil and gas company is very well-diversified with operations in Canada, Australia, France, the Netherlands, and more.

Vermilion is able to generate free cash flow at current energy prices and its balance sheet is “very solid”, enough to recently hike up its dividend by seven per cent to $2.76 a share annually.

“Given their position, this is a company that has proven itself to be very savvy,” says Mr. Sprung. He praises Vermilion’s investment in Spartan Energy Corp. assets on “very, very advantageous terms” and points out that its Australian presence means it can serve emerging markets in the Far East. “It is one that people should seriously consider.”

Both Vermilion and Alaris Royalty Corp. (AD-TSX, $17.45), Mr. Sprung’s second “best buy”, boast very high dividend yields, at six per cent and 9.3 per cent (as of April 24), respectively, meaning that shareholders can look forward to being paid nicely even if the wait for price gains turns out to take longer than hoped.

The analyst says of Alaris, “It’s a company that’s selling at a compelling valuation.” He explains that shares took a lasting hit because of issues at several underperforming companies in the Alaris stable. (The company makes capital investments in other firms in exchange for ownership of preferred shares.)

Its lofty dividend yield stoked further share-depressing fears of a cut. However, only five out of 16 Alaris partners were underperforming, and Alaris has already largely resolved the underperformers’ cash flow problems, according to Mr. Sprung.

“As they deploy more funds going forward, they will create more cash flow and there will be more dividend increases possible,” he predicts, leading the market to notice the positive trend coming into play.

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