The 5-Bs

In my last Blog (Beware of Market Jargon), I referred to value, growth, defensive and cyclical stocks. In this blog, I will attempt to explain the differences between them, and why I believe you should own the 5-Bs.

Let’s start with growth stocks. Everyone wants to own a growth stock. Why wouldn’t you? Or, to put it another way, why would you invest in a company that is not growing or at least not capable of growing? Simply stated – you wouldn’t, but how do you measure that growth and what are the risks involved? The focus here is on earnings growth and not on share price growth because that usually follows.   

So, how do you grow earnings? I will skip early stage development because this is usually the period when a company might lose money and accumulate some debt in the process. These types of investments can be successful for sure but they should be considered speculative until they are proven.

Earnings growth comes from two main sources: organic growth (increase in top line revenue, better operating margins and lower overhead costs including debt service charges), and acquisition growth (when a company buys another company and consolidates operations to improve efficiencies and increase profits). Competition plays a big role in this including the company sector and, of course, the quality of the management team. The economy also has a huge influence because, depending on what cycle we are in, it could favour one company or sector over another.

Pure growth stocks are shares in a company that tend to grow in share price at a rate significantly above the average growth for the market. These stocks generally do not pay dividends. This is because the issuers of growth stocks are usually companies that want to reinvest any earnings they accrue in order to accelerate growth in the short term. When investors invest in growth stocks, they anticipate that they will earn money through capital gains when they eventually sell their shares.

Pure defensive stocks, on the other hand, are the shares of companies that have continual demand for their products, so they tend to be more stable during most business cycles than 'risk on' or 'growth' stocks. This means they usually provide consistent dividends and stable earnings regardless of the performance of the stock markets. Utilities, real estate, consumer staples and communication services are part of this group.

Cyclical stocks are either in favour or out of favour depending on the market cycle. In periods of economic recovery and ensuing growth following a recession, these stocks typically do very well only because they have been in the doldrums for so long. Think of oil & gas, metal, lumber and, depending on what is happening with inflation, precious metals (aka gold stocks). These are what I call the boom or bust stocks. They can do well but never for long. On the other hand, financials, industrials, materials and consumer discretionary stocks are also cyclicals but are far more stable during their “off-season”.  

Value stocks are usually identified as growth stocks that are trading well below companies of the same size in the same sector. You have to be careful here because the market is seldom wrong and there is usually a good reason for this discount, which is why they can remain out of favour for far longer than you think.

So that brings us to the 5-Bs - BIG, BASIC, BORING, BRAND-NAME BUSINESSES that consistently reward investors who hold them with healthy growing  dividends and reliable share price increases over time.  Unlike the “blue chips” term first used in 1923 to describe high-priced stocks trading on the Dow Jones, blue-chips today refer to stocks with a high price tag, but more accurately to stocks of high-quality companies that have withstood the test of time, In Canada, that constitutes the S&P/TSX 60.

The 5-Bs are even better than the companies on the S&P/TSX 60 because they must meet or exceed each of the following screening filter checkpoints:   

• Market cap of over $1 billion
• Annualized dividend growth rate over 5 years greater than 2.5%
• Dividend yield higher than the current rate of (real) inflation
• Annualized share price increase over 5 years greater than 5%

The one exception we make for companies that don’t meet the current dividend yield criteria is that their 5 year earnings per share growth rate must be higher than 10%.

As you might expect, the 5-Bs which constitute the core of our Canadian equity model portfolio are made up of only a small number of utility, real estate, financial, telco, industrial, consumer staples and energy stocks that deliver solid total returns with far less volatility than the overall market. More importantly, by holding them, you can sleep at night.

David J. Angas, CEA
Senior Vice President, Financial Advisor
Family Wealth Counsel Advisor Group/Raymond James Ltd.

The views are those of the author, David Angas, and not necessarily those of Raymond James Ltd.  Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decision.  Raymond James Ltd. is a Member - Canadian Investor Protection Fund.