Market Call: Martin Cobb's outlook on U.S. & Canadian Equities

Key Concepts

AI Narrative: The prevailing investor sentiment and focus on Artificial Intelligence as a driver of market performance.
Return on Capital: A financial metric measuring the profitability of an investment relative to its cost.
Valuation: The process of determining the current worth of an asset or company.
Discount: When a stock or market trades at a lower valuation compared to its peers or historical averages.
Apathy: A state of investor indifference or lack of interest in a particular stock or sector, often leading to compressed valuations.
Mr. Market: A metaphor from Benjamin Graham representing the irrational and emotional nature of the stock market, which investors should exploit rather than be influenced by.
Flywheel Business Model: A business strategy where success in one area drives success in another, creating a self-reinforcing cycle of growth.
Economic Moat: A sustainable competitive advantage that protects a company's long-term profits and market share from competitors.
Greater Fool Theory: The belief that one can buy an overvalued asset and sell it to someone else (a "greater fool") at an even higher price.
Spin-off: The creation of a new, independent company from a division or subsidiary of an existing company.
M&A (Mergers and Acquisitions): The consolidation of companies or assets through various types of financial transactions.

Market Overview and Investor Sentiment

The market is currently experiencing a "tug of war" between the persistent AI narrative and the reality of strong underlying earnings growth in various sectors. While the AI narrative has driven significant performance, investors are becoming more circumspect, potentially due to concerns about valuations and return on capital for some AI-related companies. Martin Cobb, Senior Vice President, Equities at Lawrence Steinberg Wealth Management, notes that while some AI entities are not making money, the overall market sentiment suggests a degree of optimism that might be "baked into investor expectations, maybe too much."

Historically, November and December have been strong months, but September and October have typically been weaker. This year, however, saw good performance in those months, leading to high expectations entering November. The TSX is on track for another 20%+ year, and the S&P 500 is poised for its sixth double-digit return in seven years. Cobb suggests that investors may be getting "too enthusiastic," leading to the recent market fluctuations.

Investment Strategy: Seeking Apathy and Long-Term Value

Cobb advocates for an investment strategy that avoids market noise and focuses on the long term, drawing inspiration from John Templeton's advice to look for opportunities where the outlook is "the worst" to find bargains. He prefers to focus on what "no one is talking about" – businesses that continue to operate effectively but have fallen out of investor favor, leading to compressed valuations and attractive buying opportunities for a multi-year view. The key is to "avoid the noise, looking long term and trying to take advantage of Mr. Market not being formed by him."

Company-Specific Analysis and Recommendations

Take-Two Interactive (TTWO)

Key Points: The company's valuation is heavily reliant on the success of Grand Theft Auto VI (GTA VI). GTA V, released in 2013, is one of the best-selling titles of all time. However, there is "not much else" in Take-Two's portfolio that generates significant revenue. The company has been loss-making for the past two years due to the absence of a major hit title.
Technical Terms: "One hit wonder" refers to a company heavily dependent on a single successful product.
Argument: The stock is "more than fairly priced in" for GTA VI's success. The risk-reward is not favorable, as the company needs a highly successful and timely launch of GTA VI to meet expectations.
Real-World Application: The complexity and cost of developing modern video games are highlighted by the 13-year development cycle for GTA VI, with significant investment required to ensure quality and avoid glitches. The video game industry now "dwarfs" the box office in terms of annual sales.

CNQ (Canadian Natural Resources Limited)

Key Points: The company is attractive due to its business fundamentals rather than oil price forecasts. CNQ was free cash flow positive even when oil prices were below $39 WTI in 2022. It exhibits strong capital discipline, clear communication regarding debt repayment, and has made strategic in-fill acquisitions.
Argument: CNQ is a "very well positioned, low cost, reasonable growth entity that generates a lot of cash flow, has excellent stewards of capital, and will pay a growing dividend over time." The current apathy around oil stocks makes it an attractive opportunity.
Technical Terms: "Break-evens" refer to the minimum price at which a company can operate profitably. "WTI" (West Texas Intermediate) is a benchmark for crude oil.
Data: The IEA (International Energy Agency) forecasts a potential glut for next year, but their historical track record on oil price forecasts is questioned.

Waste Management (WM) and Waste Connections (WCN)

Key Points: These companies possess "wonderful assets" that are nearly impossible to replicate due to landfill permitting challenges. They also have capabilities in recycling and incineration.
Argument: While these are quality businesses with economic moats, their valuations are often "rich," trading at high multiples (e.g., 40 times earnings for Waste Management) with low earnings yields (2.5%). Cobb would "love to get on sale" if there's a market dislocation.
Technical Terms: "Economic moats" are competitive advantages that protect a company's profitability.
Data: Waste Management typically trades on 40+ times earnings, resulting in a 2.5% earnings yield. Dividend yields are not high due to limited free cash flow for distribution.

Telus (T)

Key Points: There are discussions about Telus's ability to continue paying its high dividend (9% yield). The payout ratio is considered too high, especially if the Dividend Reinvestment Plan (DRIP), which saves the company $800 million annually, is excluded.
Argument: The market is signaling a potential dividend cut, which Cobb believes "would make sense." He notes that investors often "cheered" when BCE cut its dividend. While management's decision is key, pressure to cut is likely increasing.
Technical Terms: "Payout ratio" is the proportion of earnings paid out as dividends. "Dividend Reinvestment Plan (DRIP)" allows shareholders to reinvest dividends to purchase more shares.
Quote: "There's no free lunch in dividends."

Tesla (TSLA)

Key Points: Cobb views Tesla as both a car company and a technology company, valuing it accordingly. He estimates the car company aspect to be worth around $100-150 billion. The remaining valuation is attributed to its solar business, robotics, and AI ambitions.
Argument: Cobb cannot value the technology side at the market's current valuation. He believes the probability of Tesla achieving the profitability in its other businesses to justify its current valuation is not in investors' favor. He considers it "one of the most overvalued stocks in the market."
Technical Terms: "Greater fool theory" is invoked, suggesting investors are betting on someone else paying a higher price in the future.
Perspective: Cobb prefers not to play the "hype and speculation" game associated with Tesla, finding the risk-reward unattractive.

Interfor (IFR)

Key Points: Interfor is a large lumber producer (4.5 billion board feet). The stock has seen a recent jump following an announcement from Ottawa about support for steel and lumber.
Argument: Cobb is "not a fan" of lumber companies like Interfor, considering them "low quality businesses" and "price takers." While politics and tariffs can provide short-term boosts, they are not fundamentally great businesses. He notes they have loss-making years and significant debt.
Alternative Recommendation: For a 5-10 year hold, Cobb suggests Stellar Jones, which uses lumber products for enhanced wood products for residential use, railways, and pools, calling it a "much better business, much greater compounder, higher returns on capital over time."

Blackberry (BB)

Key Points: Blackberry has transformed into a software company, moving away from hardware. It possesses some good software products.
Argument: Cobb considers Blackberry an "also ran" in the technology space, despite Canadians' pride in the company. He would "rather look for something that's cheaper, like an OpenText, or perhaps something that has a little more of a moat in terms of software, a little bit competitive advantage."
Perspective: He would take his money out of Blackberry and invest elsewhere, not being convinced of its differentiated offerings.

Saputo (SAP)

Key Points: Saputo was an "unloved stock" due to losses in its US food service division, which is more commoditized and used to be its most profitable segment. Industry conditions have been tough, with overcapacity in the cheese market and a struggle to recover from the pandemic's impact on food service.
Argument: The company has been implementing "self-help" measures, and margins are starting to pick up. Industry conditions remain challenging, but the stock is now discounting a recovery.
Data: US consumers are consuming record levels of cream and butter, driving milk demand, while the cheese market faces overcapacity. Saputo's US food service division used to achieve 10% operating margins but has been into losses.
Valuation: The stock has moved from 11-12 times earnings to 17-18 times forward earnings, indicating a shift from "glass half full versus glass half empty" sentiment.

Smith & Nephew (SNN)

Key Points: A medical device company specializing in knee/hip replacements, sports injuries, soft tissue issues, and advanced wound care. It operates in an oligopoly with other major players like Stryker, Zimmer Biomet, and DePuy.
Argument: The stock became attractive after a "very poor pandemic" as elective surgeries were delayed. Cobb sees it as a "discount for domiciliary" compared to Stryker, trading at roughly half the multiple.
Data: The industry has about 5% growth. Smith & Nephew trades at 15-16 times earnings, while Stryker trades at 26-27 times forward earnings.
Perspective: Cobb sees significant upside both operationally and in terms of investor valuation.

Electronic Arts (EA)

Key Points: EA has been bid for by a consortium funded by Saudis and Jared Kushner, with an expected settlement in the second quarter. It is considered the "most utility-like" of the video gaming companies, with a diversified portfolio unlike Take-Two's reliance on GTA.
Argument: At the time of recommendation, EA was trading at a significantly lower multiple than Activision Blizzard, which was acquired by Microsoft at double EA's price. This presented an opportunity to buy an attractive company that could eventually be acquired.
Data: The deal offers about 4% annualized upside, or 8% in the market today.

Cenovus Energy (CVE)

Key Points: The acquisition of MEG Energy by Cenovus is considered a "sensible deal" as it allows the commodity company to "stick to its knitting" by acquiring assets it knows well.
Argument: With a constructive oil price environment and reasonable operator, companies like Cenovus and CNQ are expected to serve investors well over a five to ten-year horizon through free cash flows, dividends, and growth.
Data: Cenovus is trading around $24.61, with a high earlier in the month at $25.89.

BlackRock (BLK)

Key Points: BlackRock has grown from a "relative minnow" to a significant player, particularly with its iShares business. It offers a wide range of products and has been effective in managing fee pressures through scale.
Argument: BlackRock is a "great asset gathering business" that handles industry pressures better than most. It is well-managed and strategically positioned to remain a "behemoth" for years to come.
Perspective: Cobb likes BlackRock as an entity, acknowledging the pressures on the asset management business but believing they are handled effectively.

Morocco Gold and Silver (Potential Investment)

Key Points: Morocco is considered a sensible location for mining operations, with a history of running phosphate mines and a stable rule of law.
Argument: Cobb is "fairly constructive on the gold price longer term," noting central bank buying and retail investor interest through ETFs.
Caution: Investors should be mindful of position size, as gold and gold-related vehicles are speculative assets.

Costco (COST)

Key Points: Costco's business model is described as a "flywheel effect": scale leads to low supplier prices, which are passed to consumers, driving footfall and revenue, further increasing scale. Membership fees provide an annuity. Kirkland Signature private label products are a significant revenue driver.
Argument: Cobb believes there is "no better business model in retail." The company is well-positioned for continued growth, with 900 stores globally.
Data: Costco fixes its gross margin between 12-13% annually. Kirkland Signature sales are twice the size of Coca-Cola.
Valuation: While it "always looks expensive," a forward multiple in the high 30s is starting to pique Cobb's interest.

Thomson Reuters (TRI)

Key Points: The company provides data for legal and finance sectors, forming the backbone of many enterprises. It appears to have a strong economic moat.
Argument: Cobb has consistently found the valuation "uncomfortable" despite recognizing the business's strengths and its acquisition of the Refinitiv business. He believes drawdowns should be celebrated if the business remains attractive and growing, offering an opportunity to buy more.
Perspective: Thomson Reuters is entering a camp where its valuation is compressed, presenting an opportunity in the current market environment.

AIA Financial

Key Points: Cobb prefers Sun Life and Manulife due to their asset management businesses and growth in Asia. He notes that pressures on the asset management business remain intense.
Argument: He prefers Manulife and Sun Life for their exposure to growing savings rates in regions like Asia.

Small to Mid-Cap ETFs

Key Points: There are numerous ETFs offering exposure to US or global small and mid-cap equities.
Recommendation: Look for reputable providers, keep ETF charges below 30-40 basis points, and avoid paying for active management within ETFs.
Perspective: While small and mid-caps used to trade at a premium, the gap is closing. Diversifying from mega-caps is a valid strategy, even considering S&P 500 ETFs that exclude the "Magnificent Seven" stocks.

New Top Picks

Kenvue (KVUE)

Key Points: A spin-off from Johnson & Johnson with well-known consumer brands like Tylenol, Listerine, and Nicorette. The company is trading at an attractive multiple compared to peers like Procter & Gamble and Colgate-Palmolive. Kimberly-Clark has made an offer for Kenvue, which is mostly an all-share deal.
Argument: Cobb likes Kenvue on a standalone basis and believes the blended company with Kimberly-Clark will trade at an even lower multiple, offering significant upside. The brands are considered essentials that are not threatened by AI.
Technical Terms: "Portmanteau" refers to a word blending the sounds and meanings of two others. "Spin-offs" are a key interest for Cobb.
Data: The blended company is trading at 14-15 times earnings and could reach a 20 times multiple.
Synergies: Potential synergies exist in manufacturing and sales, leading to increased bargaining power with customers.

Starbucks (SBUX)

Key Points: The company is undergoing a turnaround effort led by Brian Niccol, focusing on improving the US customer experience and addressing menu complexity and wait times. China, a significant profit contributor, is being managed through a joint venture.
Argument: Evidence suggests the US business is stabilizing, and the company can regain its community feel and drive revenue growth. The goal is to return to mid-teen operating margins and $5 per share in earnings.
Perspective: Cobb believes Starbucks has a strong market position and can achieve its turnaround goals by simplifying operations and focusing on customer needs.

CN Rail (CNR)

Key Points: The stock has fallen significantly over the past five years, but the underlying business remains strong and irreplaceable. The company has navigated various challenges like tariffs, wildfires, and labor disputes for over 100 years.
Argument: There is apathy around CN Rail and CPKC, making them attractive. Cobb believes the current "bad news" is already priced in, and the risk-reward is compelling for a long-term investor.
Data: The stock is trading at two-thirds of the multiple it commanded two to three years ago.
Quote: "When you buy companies you can have good news and cheap share prices, but you can't have them at the same time."

Conclusion

Martin Cobb's analysis emphasizes a contrarian approach, favoring investments in companies that are currently out of favor or overlooked by the market. He stresses the importance of long-term investing, focusing on quality businesses with strong economic moats and attractive valuations. While acknowledging the influence of narratives like AI, he prioritizes fundamental analysis and the potential for value creation through strategic acquisitions, operational improvements, and disciplined capital allocation. The current market environment, with its high expectations and potential for overvaluation in certain sectors, presents opportunities for astute investors to identify undervalued assets.