“Canadian Capital Compounders” is what this author calls these stock market beating Canadian stocks
Robin Speziale | April 27, 2017 | SmallCapPower: I’m a growth investor. Growth at a Reasonable Price (GARP). Which means that I’ll invest in a company trading at 30 P/E if its EPS growth rate is 30% or greater, for example. I say this because most so called ‘value investors’ would just balk at that 30 P/E and move on. And I especially love finding capital compounders; those stock market beating Canadian stocks in the small-cap and mid-cap space that eventually grow into large-caps, on the foundation of their exceptional wealth creating ability, fueled by expanding book value per share, earnings per share, and free cash flow per share.
The challenge, though, is finding these capital compounders when they’re small. For example, I’m certain some of you probably found Fairfax Financial Holdings when it was a smaller, yet largely unknown company, trading at $175 per share in the year 2000. But most investors at that time were probably thinking about stocks like Bombardier, Loblaw, and CIBC; those large caps with less runway for growth but more analyst coverage, as well as retail investor awareness. But as Peter Lynch said: “The person that turns over the most rocks wins the game.” By the way, if you did invest in Fairfax Financial Holdings Limited (TSX: FFH) shares in 2000, well done, because you’re up 235%, beating the TSX’s 64% return over that same period, as well as the performance of those aforementioned stocks.
The list below is of 25 exceptional Canadian capital compounders, many of which I hold in my own stock portfolio. They’re all still publicly traded on the TSX. I don’t include past top compounders like Paladin Labs, which under Jonathan Goodman’s leadership, was close to a 100 bagger (100x)… in other words delivering a 10,000% cumulative return. $1.50 invested in Paladin at its founding was worth $142 nineteen years later. Amazing. And so are these companies:
To name a few of these exceptional Canadian capital compounder stocks today: Dollarama, Constellation Software, Alimentation Couche-Tard, Savaria, MTY Food Group, CCL Industries, and Lassonde. It’s important to note that you won’t see any oil & gas or mining companies on this list. I call companies in those sectors “capital destroyers” over the long run. They’re cyclical ‘price takers’, meaning their prospects are dependent largely on commodity prices.
To the average stock picker, not all of these 25 companies will be known, but their returns, nonetheless, have been market-beating, all compounding at rates higher than the S&P/TSX’s long term 9.8% compound annual return. The average compound annual return among these 25 stocks is 26%. With a range from 10.3% (Logistec) to 82.4% (CRH Medical). And these figures don’t even include dividends; just capital appreciation. I like to think that there’s a strong correlation in the long run between a company’s return on capital and its share price performance. The average ROIC of these 25 capital compounder stocks is 16% (that’s a five-year average).
Some of these 25 companies still likely have considerable runway to grow. Whereas others don’t, because of the law of large numbers. Obviously, a company cannot compound at the same high rate forever. For example, Brookfield Asset Management, which is a large $48 billion company.
So, what are the commonalities of these 25 capital compounder stocks? It would be great to use this knowledge to find the next compounders…
I’ll first reference Chuck Akre’s “three legged stool” – the three foundations of “Compounding Machines,” as he calls them:
“The first leg of the stool has to do with the business models that are likely to compound the shareholders’ capital at above-average rates, combined with leg two, people who run the business who are not only exceptional at running the business but also see to it that what happens at the company level also happens at the per share level–and then leg three, where because of the nature of the business and the skill of the manager there is both history as well as an opportunity to reinvest all the excess capital they generate in places where they earn these above-average rates of return.”
And to Chuck’s last point, “reinvesting all the excess capital…”, we know that CEOs really have 4 choices in deploying capital: invest back in their business, acquire/ integrate new businesses, buy back shares, and/or issue/or raise a dividend. Outstanding companies do the first three incredibly well; re-invest in the business, acquire/integrate great companies, and buy back shares over time. In my opinion, and this isn’t true in all cases, but companies that issue high dividends have conceded that they can’t deploy that cash as effectively to earn high rates of return. This is true of most large-caps.
So, to conclude, these 25 Canadian Capital Compounders; which have all beaten the market, are:
- Free cash-flow generative, high return on capital businesses (16% ROIC – 5 year average);
- Run by exceptional, and shareholder-oriented, managers who;
- Effectively deploy capital, to grow their business, and continually deliver high rates of return for their shareholders (26% Compound Annual Return average)
Some of these exceptional managers are: Larry Rossy (Dollarama), Mark Leonard (Constellation Software), Stanley Ma (MTY Food Group), Alain Bouchard (Alimentation Couche-Tard), and Bruce Flatt (Brookfield Asset Management).
But perhaps most importantly, these companies have sustainable competitive advantage, whether that be through the industries in which they operate, their operating models, distribution network, niche products/services, regulatory advantages, patents, technology, and brand/goodwill, etc. Not only does competitive advantage allow these companies to compound shareholder wealth for a long period of time, but they have strong and enduring balance sheets capable of funding growth, and avoiding crashing in economic downturns. Indeed, these 25 capital compounders seem to have staying power, as their public life is 15 years on the market, with hopefully more years of out-performance to follow.
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Robin Speziale is the national bestselling author of Market Masters, which is available in-store at Chapters, Indigo, Coles, and Costco, as well as on Amazon.ca. He lives in Toronto, Ontario. Learn more about Market Masters. Contact Robin at r.speziale@gmail.com
Disclosure: Neither any of the principals at Small Cap Power, nor their family members, own shares in any of the companies mentioned above.
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