Craig Jerusalim in the the Moneyletter

November 2015 / First Report Volume 39, Issue No. 21 THE MONEYLETTER® STRATEGIES FOR SUCCESSFUL INVESTING

MARKET STRATEGY Dutch Shell plc; and equity issuance, including initial public offering activity, is heating up. The interesting outcome is that, To maximize your risk-adjusted returns, don’t mix investments following each scenario, stock and emotions. With a quality portfolio, you’ll be able to ... markets moved in the opposite direction to the headlines’ senti- ments. After bearish Scenario #1, the S&P/TSX returned a positive SLEEP 15 per cent, only to give back almost all that positive return in the months following bullish Sce- nario #2. One obvious take-away WELL could stem from one of Warren Buffett’s famous quotes, “Be fear- Craig Jerusalim ful when others are greedy and greedy when others are fearful.”? Investments and WHEN IT COMES TO INVESTING, claim we’ve entered a “corrective Emotions Don’t Mix particularly in today’s heightened phase” in the markets; crude oil I would argue that practicing state of volatility, the average prices have dropped 20 per cent Mr. Buffett’s credo is a challenge. investor is often more influenced over the month; the Greek govern- Everyone wants to believe they by their emotions than their brain. ment debt crisis is fuelling con- have investment discipline and To prove this theory, I’m going to cerns of a greater euro zone crisis; control over their emotions. They paint two true scenarios that have the Ebola virus epidemic is sweep- believe they can act contrary to occurred in the past 24 months. ing across Western Africa; and sentiment. Instead, I advocate a SCENARIO #1: contentious issues in Syria, Iran, much simpler approach that avoids BEARISH HEADLINES Russia and Ferguson, Missouri are the need to identify pivotal market all reaching boiling points. inflection points. My approach is to The front page of a financial SCENARIO #2: avoid market timing altogether. As newspaper screams out, “MAR- BULLISH HEADLINES an alternative, invest in high-quali- KET TANKS 600 POINTS THIS ty companies most likely to survive WEEK!” Investment pundits pro- The following month, the same virtually any market trough, but front page says, “MARKETS RIP- also positioned to thrive during the Craig Jerusalim, MBA,CFA, is a Portfolio PING HIGHER.” Consumer con- normal course of market growth. Manager on the Canadian Equity Team at CIBC Asset fidence is soaring; the S&P/TSX The World’s Worst Management Inc. He man- ages the CIBC Canadian Composite Index has recently Market Timer Equity Fund and co-man- experienced a “Golden Cross1”; Here’s another (fictitious) ages the following: the CIBC Monthly Income merger and acquisition activity is example of why market timing is Fund, CIBC Global Month- ly Income Fund, the Renaissance Diversified Income frothy—including a $70 billion not worth the economic or emo- Fund and the CIBC Wood Gundy Investment Consulting Service Canadian Diversified Income Strategy. bid for BG Group from Royal tional risk. I have a friend (whom

The MoneyLetter can be found at www.adviceforinvestors.com I’ll call Steve), who is literally the not ubiquitous within the invest- become the lowest-cost producer world’s worst market timer. He has ment community, it is important to in its industry. Competitors would invested $1,000 in the S&P/TSX explicitly define what is meant by a take years to replicate Gildan’s cost every year for the past 25 years. high-quality company. Most com- structure, and Gildan could put However, he only invests when the mon definitions of quality refer to excessive pricing pressure on com- outlook is rosy, confidence and companies that demonstrate earn- petitors during the time needed to commentary is most bullish, and, ings stability and consistency. How- close that gap, given Gildan’s head inherently, the market has reached ever, my more robust definition of start. Therefore, Gildan is likely to its all-time high for the year. quality includes earn- Low His one saving grace is that he ings stability, but also Leverage never sells. He keeps his money in incorporates four High the market, allowing it to work for additional traits: high Profitability Disciplined & him even when “others are fearful.” margins, low lever- Consistent Management One would imagine that Steve’s age, strong manage- performance would significantly ment teams, and Low lag the returns of the market. How- growth at a reason- Variability ever, because Steve is not making able price (“GARP”). Growth at a the amateur mistake of both buying Any company can Reasonable Price at the top AND selling at the bot- exhibit high mar- tom, his performance is only gins or high profitability in any maintain its cost advantage in the slightly worse than the market one quarter or year. However, in short-to-medium term. overall. Steve’s 25-year compound- order for those margins to be con- A company that has a strong ed annual return is approximately sistently maintained, a company balance sheet, or low financial five per cent, versus the market needs to possess a sustainable and leverage, is gifted with both flexi- return of just over six per cent. defendable competitive advantage. bility and optionality. All compa- Maximizing Otherwise, competitors will enter nies, good or bad, encounter rough Risk-adjusted Returns the market and erode any excess patches or experience unexpected Now, the goal is not only to meet returns. adverse events. If a company has a market returns, but to exceed those GILDAN: LEADING relatively low level of debt, returns on a consistent basis over IN ITS INDUSTRY chances are the company won’t be time. Investing in a well-diversified forced into doing something unde- portfolio of high-quality companies For example, take Gildan sirable at an inopportune time. The allows investors to sleep well at Activewear Inc. (TSX-GIL). company has enough flexibility to night, while still participating in Gildan has invested hundreds of avoid issuing equity at a low share market growth. It is a strategy that millions of dollars over many years price level or having to sell core looks to maximize risk-adjusted to automate its manufacturing assets at a market trough. returns. Since the term “quality” is process and drive down costs, to Low debt levels also provide

MPL Communications Inc., 133 Richmond Street West, Toronto, ON M5H 3M8 prudent companies with optionality band services are essential, so stop- THE HARD PART: when their peers hit rough patches. ping these services is not an option. IDENTIFYING These high-quality companies can It’s a case of “if you can’t beat ‘em, INFLECTION POINTS then make strategic and accretive you might as well own their stock!” acquisitions at market troughs, posi- STRONG LEADERSHIP The easy part of the process is tioning themselves to thrive once IS ESSENTIAL identifying these characteristics. the market recovers. The energy sec- The hard part is scrutinizing the tor is a good example of this con- The fourth tenet is seeking management teams and identifying trast. Companies that had high debt companies with strong manage- inflection points when a company levels when crude prices fell were ment teams, exemplified by con- loses some of these qualities or, forced to sell off their best assets to sistent track records of success. I conversely, proves it has emerged pay down debt. It was the high-qual- like to see a pattern of under- as a high-quality company. At ity companies like Suncor Energy promising and over-delivering CIBC Asset Management, one of Inc. (TSX-SU) that were ready and results. Most importantly, manage- our competitive advantages is our waiting to snap up premier assets at ment must always follow through in-depth fundamental analysis that attractive prices. with its promises and commit- strives to uncover mispriced CONSISTENT AND ments. Holding management opportunities. Site visits, expert PREDICTABLE teams responsible for their actions networks, management meetings, EARNINGS MATTER is why I consistently meet with and proprietary long-term finan- leadership teams face-to-face. I cial modelling are some of the The next characteristic that I like gain insights into the intricacies of tools that help us make the best to see is low variability, or high their businesses, and also pick up investment decisions within the predictability, in earnings. I feel changes in tone and outlook. context of our style discipline. more comfortable owning compa- A conservative management To recap, market volatility is nies with recurring earnings or team, such as ARC Resources expected in today’s hypersensi- large backlogs of business so there Ltd. (ARX-TSX), always seems to tive, lightning-speed information isn’t a concern about the source of be able to exceed expectations. It era. However, you can hopefully next quarter’s revenue. Good exam- sets targets that it knows it can beat, sleep a little easier at night when ples of these types of companies and leaves buffers for those unex- your portfolio or mutual fund is include utilities like Fortis Inc. pected circumstances that occur in filled with high-quality compa- (TSX-FTS), telecommunication all industries from time to time. nies with defendable competitive companies like Telus Corp. (TSX- GARP advantages, strong balance sheets T) and Rogers Communications Finally, I want to invest in com- and seasoned management teams Inc. (TSX-RCI.B), and definitely panies that are growing. That is, prepared to take advantage of any the large Canadian banks. If one of growth in their top-line revenues, adverse situation. My two young the Canadian banks ever “misses” which funnels down into bottom- children at home may sometimes its quarterly expectations, it is usu- line earnings, cash flow, and ulti- wake me at night, but my invest- ally by a nickel or dime on a per- mately, free cash flow. Companies ments let me sleep in peace. ▼ share basis. These stocks don’t typ- with excess free cash can create 1 A “Golden Cross” occurs when the 50-day moving average moves above ically swing from large gains to value for their shareholders by the 200-day moving average. large losses, other than as a result investing in the business, making 2 S&P/TSX Composite Index return of an infrequent event like the great strategic acquisitions, opportunisti- The views expressed in this article are the personal views of the author and should not be taken as the views financial crisis. cally buying back shares and of CIBC Asset Management, Inc. or Canadian Imperial Bank of Commerce (CIBC). This document has been The telecommunications compa- growing the dividend. I want to prepared for the general information of our clients and does not constitute an offer or solicitation to buy or sell nies are another group with very pay a reasonable price for that any securities, products or services and should not be construed as specific investment advice. The informa- high levels of visibility and low lev- growth; otherwise, I won’t realize tion contained in this document has been obtained from sources believed to be reliable, but we do not represent els of volatility in their earnings. I a return on my investment. This that it is accurate or complete and it should not be relied upon as such. All opinions and estimates expressed in hate paying my Rogers bill each style is often referred to as GARP this document are as of the time of its publication and are subject to change. CIBC Asset Management Inc. is a month, but their cellular and broad- or Growth at a Reasonable Price. member of the CIBC Group of Companies.