Before entering the investment industry over 16 years ago, I had the opportunity to work with one of the best housing economists in Canada at the Canada Mortgage and Housing Corporation (CMHC). Alex Medow was the Ontario Economist for CMHC at the time and I had the pleasure of working an internship as his Economic Analyst in 2000.
The housing market in the late 1990s was by no means frothy compared to today, however, most bank economists and forecasters in Canada continued to forecast weak housing starts. Time and time again, those bank economists and forecasters were wrong. Housing starts continued to grow and Alex was usually on the correct side of the call with his projections of continuing growth in housing starts.
His analysis showed that housing starts were driven by two major factors that were favourable at the time: (1) affordability (income-to-expense ratio, with interest rates being a large factor that drives the mortgage expense portion), and (2) population growth (that was underpinned by a strong Canadian immigration policy).
Alex’s differentiating method of making the correct call was simple, but so difficult for many analysts, forecasters and investors to grasp. Ignore the noise, and listen to the data.
Ignoring the noise, and listening to the data stuck with me and was emphasized by my other mentor Scott Lamacraft. I was fortunate to work as Scott’s Research Associate when I started at Sprott Securities Inc. in early 2001. Scott was also Head of Research when I started, and he was promoted to CEO later in 2001.
When I started at Sprott in May 2001, the Nasdaq had already lost 59% compared to the tech bubble peak in March 2000. Most analysts and forecasters were throwing their hands up and claiming that valuation didn’t matter in the tech bubble, and those same forecasters had no idea how to value companies when those stocks were down over 50%.
In the midst of a nasty bear market, Scott was adamant that we continue to focus on the value of a company’s assets to measure our downside risk scenario and use earnings potential as our upside scenario. In our case, Scott was covering energy services and industrial companies. For the energy services companies, Scott focused on the replacement value of the drilling and service rigs that the company owned (along with any other meaningful assets such as real estate).
This was a valuable lesson so early on as an investment professional attempting to value how much a company’s stock is worth. Earnings forecasts are always our best educational estimate of how the future will unfold, and the earnings multiple can often be a subjective approximation of how valuable a company’s earnings stream, economic moat or other competitive advantage might be compared to other companies or industries. However, the true asset value of the company should always be in focus in an effort to ignore the noise and gauge your downside risk.
While we believe we are in an extended equity bull market that could last another several years, we continuously reflect on the true asset value of the companies we hold. Corrections happen all the time in a healthy bull market. Ignore the noise, and listen to the data.