You weren’t the first one to come up with that investment idea, Buffett’s favourite number, and TSX stocks that have cut dividends – The Globe and Mail

The Irrelevant Investor’s post “Unintended Consequences” is primarily about moral hazard, but it includes an anecdote about buying stocks that I want to discuss in more detail.

The author mentions two stocks – video conferencing provider Zoom Video Communications and remote medical adviser Teladoc Health Inc. – that are ideally positioned for the ongoing quarantine. He writes, “First-level thinking says that Zoom and Teladoc will benefit from the lock down, so we should buy their stock. Second-level thinking says that everyone already knows this, so maybe we shouldn’t.”

I see this all the time. Investors recognize that a company is benefitting from a trend and then blindly buy it as if they were the first ones to have the idea. In the case of Zoom, the stock is trading at 1,925 times trailing earnings (not a typo) after climbing 115 per cent year to date.

A trader might be able to make a profit on Zoom by buying it, staring constantly at the share price, and selling when the momentum fades. But for investors with longer time horizons, it is almost certainly too late – the stock is too expensive.

At the base level, successful investing involves buying the strongest, fastest-growing future stream of earnings and dividends at the lowest possible price (in terms of valuations). Zoom will likely see remarkable profit growth this year – but what about the year after that? Almost 2000 times trailing earnings is almost certainly too high a price to pay in light of that uncertainty.

There is always a balancing act between price and future growth prospects. There is a price where any asset, no matter how poor the quality, is a promising investment. Conversely there is also a price at which any asset, no matter how great, should be sold.

— Scott Barlow, Globe and Mail market strategist

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The Rundown

Three situations where you should totally keep your money out of the stock market

The bull market that ended abruptly in late February has left us with some bad habits. Strong returns from stocks, coupled with low rates on savings vehicles, led some people to put money in the markets when it should have been in something safe, such as guaranteed investment certificates or savings accounts. Rob Carrick provides three examples that come from recent reader contacts. (for subscribers)

Warren Buffett loves this number – here’s why you should, too

Bargain hunters might want to pay attention to an often-overlooked number – retained earnings – among the beaten down rubble in the stock market, says John Reese. He explains why this favourite metric of Warren Buffett is worth paying attention to, and screens for stocks that score highly. (for everyone)

Investors bet giant companies will dominate after crisis

An economic downturn almost always favors giants like Microsoft, Apple and Amazon, the country’s three biggest companies. But the demand for their shares has only been amplified by a crisis that seems almost tailor-made for their future success. Their combined value rose more than three-quarters of a trillion dollars over the past month — more than the cumulative gain of the bottom 300 stocks in the S&P 500. Matt Phillips of The New York Times tells us more. (for subscribers)

Can gold love a coronavirus crisis?

Gold loves a crisis, the old adage goes. And with prices up 13 per cent this year to their highest since 2012 and many predicting further gains as investors search for safe places to put their money, it looks true for the coronavirus crisis so far. But, as individuals and countries alike see a drop in income, traditional gold consumers in India and China are buying less and central banks are cutting purchases. Without them, gold’s run higher may be hard to sustain. Read more in this analysis from Reuters (for subscribers)

Also see: Why inflation is not about to soar (despite what the gold bugs say)

Equity valuations rebounding, with bleak earnings a wild card

The sharp rebound in equities has pushed widely used measures of valuing U.S. shares to their highest level in years. Strategists say price-to-earnings ratios could go higher still given monetary stimulus, but huge uncertainty around earnings this year because of the economic fallout from the coronavirus makes for challenges in valuing shares. Read more from Reuters. (for subscribers)

Others (for subscribers)

TSX stocks that have cut dividends since the start of the coronavirus crisis

Here are the returns of every TSX Composite stock since markets bottomed last month

Wednesday’s analyst upgrades and downgrades

Tuesday’s analyst upgrades and downgrades

Number Cruncher: Six TSX companies at risk of having their credit downgraded to highly speculative

Number Cruncher: Fifteen Canadian stocks that prioritize cash flow

DoubleLine’s Gundlach says U.S. stocks to take out recent lows

Horizons warns investors to avoid two of its oil ETFs

Globe Advisor

Is cannabis still a long-term play worth considering?

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Ask Globe Investor

Question: The yields on preferred share exchange-traded funds look very appealing. The BMO Laddered Preferred Share Index ETF (ZPR), for example, yields about 6.7 per cent, and the iShares S&P/TSX Canadian Preferred Shares Index ETF (CPD) yields about 6.1 per cent. Do you think their dividends are sustainable?

Answer: I’m skeptical. The reason preferred yields are so high is that preferred share prices have tumbled (prices and yields move in the opposite direction). And one reason prices have tumbled is that the market is dominated by rate-reset preferreds, whose dividends are adjusted every five years based on a predetermined yield spread over the five-year Government of Canada bond yield.

With the coronavirus flattening the global economy and central banks slashing interest rates, the five-year bond yield has plunged to a near-record low of about 0.44 per cent (as of Friday afternoon). That’s a problem because, if bond yields remain low, companies that reset their preferred dividends over the next few years could reduce their payouts.

We saw this the last time government bond yields went for a skid. ZPR, for example, was paying 5.3 cents a month in dividends at the start of 2014. By September of 2017, ZPR’s monthly payout had dropped to 3.5 cents – a 34-per-cent haircut.

The ugly action in the preferred share market suggests investors are fearing a repeat performance. Through the first three months of 2020, the S&P/TSX Preferred Share Index posted a total return – including dividends – of negative 22.8 per cent. The drop may also reflect general worries about the economy and the financial health of certain companies.

I’m not saying preferred shares are necessarily a bad investment right now or that the dividend reductions will be as severe this time; the shares might turn out to be a good bet if the world gets back to normal and bond yields rebound. Indeed, preferred prices have recovered from their lows in late March, signalling that some investors see opportunity.

But higher yields come with higher risks, and the risk right now is that some rate-reset preferreds will reduce their payouts at some point in the future. So keep that in mind if you’re tempted by the high yields of preferred share ETFs.

–John Heinzl

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What’s up in the days ahead

Tim Shufelt will take a closer look at small caps, which were hit harder in the downturn and haven’t recovered as much in the rebound.

Click here to see the Globe Investor earnings and economic news calendar.

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