3 Canadian Stocks to Avoid

Death and taxes are two of the few certainties in life, according to Benjamin Franklin. The same is true for investing. No matter what you read on Reddit, Meme stocks are certainly not a sure thing.

“Of course, we can improve our chances of investing success by, say, favouring low-cost, broadly diversified funds. Or by purchasing the stocks of companies with solid competitive advantages. One thing would seem to be for certain, though: Investing in stocks with unpredictable cash flows when they're trading at nosebleed valuations is a recipe for failure,” points out Morningstar.com’s director of content Susan Dziubinski.

She’s right, these are stocks to avoid. For today's screen, we're isolating stocks with extreme or very high fair value uncertainty ratings that are trading at least 50% above our fair value estimates.

But first, what is the uncertainty rating? The uncertainty rating represents the predictability of the company's future cash flows--and, therefore, the level of certainty Morningstar has in our fair value estimate of that company. We value a company based on a detailed projection of its future cash flows and discount those flows back to today's dollars using a proprietary cash flow model. The uncertainty rating captures a range of likely potential intrinsic values for a company based on the characteristics of the business underlying the stock, including such things as operating and financial leverage, sales sensitivity to the economy, product concentration, and other factors. If the range of potential intrinsic values is narrow, the company earns a low uncertainty rating. If the range is great, the company earns a high uncertainty rating.

“Is it so bad to buy an overpriced stock with high uncertainty, given that we're not highly confident in our estimate of what that company's shares are really worth? Certainly, one might argue that in the case of a high-uncertainty stock, valuation could be tossed aside and one should instead focus on something else--growth prospects, for example. Given the lack of cash flow predictability, we could be underestimating the value of these names. However, we could be overestimating their value, too.

That's why we err on the side of conservatism: We suggest that investors avoid richly priced, high-uncertainty names. If one is truly tempted to take on the uncertainty, we'd recommend doing so with only a significant margin of safety--even if that fair value is, in itself, uncertain,” Dziubinski explains.

Three overpriced, high-uncertainty stocks passed our screen, and only one of them has an economic moat or competitive advantage. Here’s the list:

Morningstar Direct Data as of June 16, 2021

Blackberry (BB) was a one-time Canadian investor darling and is now a favourite with the meme stock followers. 

“As of the morning of June 3, BlackBerry’s share price has gone up as much as 100% from its prior-week levels, with increased volatility. In our view, this is purely the result of resumed interest in the stock from Internet message boards, like WallStreetBets on Reddit, and not rooted in any news or fundamental shifts in the business. We’ve seen this play out before with BlackBerry shares, back in late January 2021 when Reddit users created a retail investor groundswell for stocks like GameStop, AMC, and BlackBerry. In less than two weeks, BlackBerry shares spiked over 300%, just to plummet over 50% in the following week. We caution long-term investors about the risk of a similarly precipitous decline to come for BlackBerry this time around,” explains Morningstar analyst William Kerwin.

His long-term thesis for BlackBerry is unchanged. “We expect 12% compound annual growth for the firm’s software and services revenue over the next 10 years as it partners with autonomous vehicle OEMs and wins new customers for its enterprise software suites. Finally, BlackBerry is still in talks to sell off a large portion of its patent portfolio, but until a deal is reached, we model a potential deal as value-neutral to our $7 fair value estimate,” he says.

Agnico Eagle Mines (AEM) is a Canadian gold miner with mines in Canada, Mexico, and Finland.

“Negative real interest rates have increased gold’s investment appeal, supporting our 2021 price forecast of $1,700 per ounce. However, when it comes to gold as an investment, today’s demand is tomorrow’s supply. As real interest rates rise, we expect investment sentiment to turn. The vacuum left by investment demand won’t be filled by other categories. Growth in jewelry, the single-largest gold demand source, will slow as a combination of government initiatives and shifting preferences slow purchases among Chinese and Indian consumers despite rising incomes. We forecast midcycle gold prices of $1,300 per ounce in real terms by 2023. Gold prices are likely to decline even before the Fed raises rates. Gold prices fell from $1,700 per ounce to $1,200 per ounce in 2013, even though the first rate hike since the Great Recession didn’t occur until December 2015,” explains Morningstar analyst Kristoffer Inton.

Like most gold producers, Agnico Eagle is highly leveraged to gold, so cash flow faces meaningful risk to fluctuations in price, so at lower gold prices, the company's cash flows would contract significantly.

“Gold mining carries many ESG risks, all of which carry medium probability and some materiality. As such, we include risks from labor strikes, disagreements with local governments and communities, and the ever-present risk of mine accidents in our scenario analysis. Risks from increased regulation of water usage and emissions released during mining are present but are lower probability,” Inton says.

Shopify (SHOP) is Canada’s current tech darling, and the only one on this list with a narrow economic moat.

“Ease of use, a large expert support community, and an emerging developer ecosystem combine to make Shopify’s platform attractive to users of all sizes. Add-ons such as Payments, SFN, Shipping, and Capital allow for upsells and provide another growth lever for the company. Shopify has been pushing more into the enterprise with Shopify Plus, which allows online stores to remain on the platform as their needs become more advanced. We think at the higher end, the company will enjoy some success, but it will face stiff competition from highly sophisticated and tightly integrated platforms from Salesforce.com and Adobe. With the buildout of the SFN, we also see the company increasingly competing with Amazon,” says Morningstar analyst Dan Romanoff.

Shopify has a very high fair value uncertainty rating. The company generally trades at high multiples relative to peers. While the firm is expected to produce revenue growth at the high end of peers and the premium may be justified, higher absolute valuation levels offer less room for missteps and therefore carry greater inherent risks.