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Canadian Strategy Snapshot: Small Cap Challenges and Opportunities

 

Bottom Line

Similar to the US, there is no denying the recent outperformance of small stocks relative to their larger cap brethren over the last few quarters. While the outperformance is certainly encouraging after the consistent underperformance over the past few years, we are skeptical about the sustainability and believe it is likely premature to shift weight toward smaller capitalization names. Yes, earnings are set for a strong rebound in the coming quarters, however underlying fundamentals are more “mixed”, especially relative to the large cap universe in our opinion. As such, we are cautious on small caps more broadly and believe investors should focus on bottom-up stock picking relative to relying on industry, sector, asset class and stylistic driven conclusions.

Main Points:

  • Canadian Small Caps Post Solid Outperformance From Oversold Levels

    • Overall, small cap stocks have been in a decade long underperformance trend versus large cap stocks and recent outperformance is more likely a reversion from oversold levels, in our opinion.

  • Small Cap Earnings Have Likely Troughed, But Set to Lag Large Caps

    • While earnings and sales are likely to post a solid rebound over the coming quarters, we believe the small cap universe continues to face greater challenges than the large caps.

  • Small Cap Stocks Offer Value, But Beware of Value Traps

    • Despite relatively low earnings multiples, other valuation metrics show small cap valuations more in line with large cap names, suggesting investors should beware of value traps.

  • Profitability Challenges, Cash Preservation Mode and Returning Cash to Shareholders

    • Sharp drop in profitability, cash preservation strategies and cash preference toward distribution over investing suggest growth challenges ahead.

  • Many Opportunities Exist, but Focus on Stock Selection

    • Near record performance and valuation dispersion suggests stock selection is essential.

Implementation Strategies: Small Cap Canadian Equity Portfolio

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Brian Belski Chief Investment Strategist



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