Glenn Fortin, vice-president and U.S. equity specialist at Beutel Goodman & Co. Ltd., says that the powerful year-end rally in the U.S. equity market has made for slim pickings for value investors.
This spurt, he says, helped propel the market to a strong showing over the last 12 months to the end of January. Over this period, the S&P 500 Index produced a high total return of 20.04%. This compares with the total return for calendar 2016 of 11.96%, reflecting a weak start to 2016. Turning to the valuation on this index, it recently traded at a price/earnings multiple on a trailing earnings basis of 25 times, and 18 times on the basis of forward earnings estimates.
"The U.S. equity market is expensive by historic standards," says Fortin, and it is tough to add new positions to the U.S. equity portfolio. "At Beutel Goodman, we are essentially bottom-up stock pickers looking for great businesses that trade below their intrinsic value."
Fortin says that there are isolated new opportunities in the U.S, market, such as in the health-care sector. Also, there is relative value to be found in the financial-services sector "by focusing more on the non-bank fee generators among our existing holdings."
As a result of this shortage of new names, Fortin says that "our strategy has been to have larger weights in high-conviction names, reflecting both our additions to those names and stock-price increases." Also, he says, the portfolio has had low turnover.
Fortin notes that investor sentiment in the U.S. equity market turned more positive after the Nov. 8 election of Donald Trump to the White House. Investors, he says, focused on Trump's pro-growth strategies and moved into economically sensitive stocks and those likely to benefit from rising interest rates and a reduction in government regulation.
Reinforcing this investor enthusiasm, the U.S. economy has been showing strong signs of improvement, says Fortin. "There has been a steady stream of positive data." For example, he says manufacturing, which had contracted in the summer of 2016, has rebounded and employment numbers have strengthened. "Job creation numbers have come in ahead of expectations."
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| Glenn Fortin | |
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Fortin and colleague Rui Cardoso co-manage portfolios of large-and mid-cap U.S. equities, including the U.S. equity portion of balanced funds. Included in their mandate is Beutel Goodman American Equity, which has received the top 5-star Morningstar Rating for its risk-adjusted past performance. The U.S. portfolio has 25 names and the top-10 holdings account for more than half of the portfolio. The portfolio is benchmarked against the S&P 500 Index.
"All our holdings continue to generate strong free cash flow, have good balance sheets and adopt capital-allocation policies that strike the right balance between corporate needs and shareholder returns," says Fortin.
At the end of December, sector-overweight positions in the U.S. equity portfolio included health care at 17.1% (13.6% in the index) and financials at 17.3% (14.8%). Information technology at 21.9% of the portfolio was a slight overweight relative to the S&P 500 Index at 20.8%. (Information technology is the largest sector weight in the index.)
In health care, the focus, says Fortin, is on companies with strong franchises, good cash flow, strong market positions and those whose business model is more reliant on scale and innovation, rather than on pricing.
Fortin reports that he and Cardoso added one new position to the portfolio in the fourth quarter of 2016: 
AmerisourceBergen Corp. (ABC). In the health-care sector, this company is the largest drug wholesaler in the United States. This industry is an oligopoly, says Fortin, in that the largest three players account for 85% of the market. "There are high barriers to entry, substantial economies of scale and an increase in drug utilization."
Furthermore, AmerisourceBergen is a strong cash-flow generator and "has a culture of returning money to shareholders in the form of increasing dividends and share buybacks." In the last five years, says Fortin, the company has reduced the number of its shares outstanding by 20%. The stock was a top-10 holding in the portfolio at the end of December.
A pharmaceutical company and another top-10 holding is Eli Lilly & Co. (LLY). The company, says Fortin, produces both human pharmaceutical products and treatments and animal health-care products. Under the helm of a "disciplined" management team, Eli Lilly focuses on being the leading player in the diseases it targets, Fortin says, such as diabetes. "In addition to its legacy products, the company has an attractive pipeline of new drugs and treatments coming to market." The company, he says, is a strong cash-flow generator and returns money to shareholders.
| AmerisourceBergen Corp. | Eli Lilly & Co. | |
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| Feb. 27 close | $91.73 | $83.06 |
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| 52-week high/low | $94.50-$68.38 | $83.78-$64.18 |
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| Market cap | $19.9 billion | $91.6 billion |
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| Total % return 1Y* | 6.4 | 15.6 |
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| Total % return 3Y* | 12.0 | 14.4 |
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| Total % return 5Y* | 20.8 | 18.9 |
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| *As of Feb. 27, 2017. All figures in U.S. dollars Source: Morningstar |
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Turning to the U.S. financial-services sector, Fortin noted that it was one of the best performing sectors in the equity market after the U.S. election in early November. The strength in this sector was, he says, a reflection of both investor expectations of rising interest rates, which benefit these stocks, and of the potential for less regulation of financial-services institutions under the Trump administration.
In keeping with their strict sell discipline, Fortin and Cardoso trimmed their holdings in two bank stocks. They are JPMorgan Chase & Co. (JPM) and BB&T Corp. (BBT), which is a regional bank. "These stocks had reached our target price," Fortin says.
Their value discipline requires the managers to sell one-third of their holding in a stock when it hits their target, and then analyze the fundamentals to decide whether to retain or sell the remainder of the holding. These two bank stocks remain in the portfolio.
Fortin reports that the proceeds of these two sales were deployed in Ameriprise Financial, Inc. (AMP) and American Express Co. (AXP), two other existing names in the portfolio. "Although Ameriprise is classified as a life-insurance company, says Fortin, some 70% of its earnings stem from its wealth-management arm."
In all, he says, these two financial-services companies are less capital-intensive than the banks. In addition, "they produce returns on equity in excess of 20%, have strong balance sheets, are predominantly fee-based, and return a high percentage of their free cash flow to investors. Finally, "the valuations on the stocks are still attractive."
In information technology, the team continues to focus on enterprise-software companies, says Fortin. "Once their software is embedded in their customers' computer systems, there are extremely high switching costs." Here Fortin is highlighting Amdocs Ltd. (DOX) and Symantec Corp. (SYMC).
Amdocs is a "global leader in billing software for the cable and telecom industry," Fortin says. "Unlike some high-growth technology companies, Amdocs is a slow but steady grower." The company is a strong cash-flow generator and returns the bulk of its free cash flow to shareholders, he says.
Symantec continues to be a large position in the portfolio, says Fortin. The company sold its data-storage unit, Veritas, "so as to focus on Symantec's security-software business." Last year, Symantec acquired the cloud-based security-software company Blue Coat, Inc. "Blue Coat's CEO Greg Clark has taken over the helm at Symantec as its CEO, in what is essentially a reverse takeover," says Fortin. In addition, he says, there is ongoing restructuring of Symantec's sales force, which will support profit-margin improvements longer term."
