These 3 Stocks Are in My Investment Sweet Spot

Let’s talk about one of my favourite things to see as an investor, a setup that has yielded some of my most profitable investments ever.

This setup combines both growth and value investing into one nice little package, essentially forcing investors to find expanding companies at something of a bargain price. As you’ll see, the rule doesn’t work unless the bottom line is expanding.

And the best part is it’s ridiculously simple.

Here it is. What you want to look for is stocks that:

• Have grown both the top and bottom lines over time

• Yet the stock has done absolutely nothing during that time period

That’s it.

Wait. That’s it? But that rule is too simple.

The simplicity is part of the beauty, but I’m also not suggesting you find this situation and do zero additional research. You still need to analyze a company’s strengths and weaknesses, and handicap its ability to grow over time.

Let’s look at a quick successful example, and then I’ll highlight some current examples. Manulife (TSX:MFC) shares struggled for years, and the stock did pretty much nothing for eight years from 2015 to 2023. In 2015 the stock traded for just over $20 per share… and in 2023, the stock was still trading at just over $20.

Many investors declared it a value trap and moved along.

But earnings told a different story. Manulife earned $1.48 per share in normalized earnings in 2015. The bottom line had more than doubled by 2023, with normalized earnings checking in at $3.47 per share. The dividend also more than doubled (increasing from $0.57 to $1.46 per share), and the company’s book value grew from just over $16 to almost $25 per share in that time — and that was despite paying an increasingly generous dividend.

The underlying business was steadily getting better, but the stock wasn’t reacting. That’s a wonderful setup.

I’ve shared this piece of wisdom a few different times on the ol’ Tweeter app, and I tend to get one piece of feedback above all others — this isn’t possible today. The market is too high, it’s efficient, etc., and this setup doesn’t exist.

These folks couldn’t be more wrong. Here are three Canadian dividend stocks that have exactly that setup today.

Rogers Communications

Rogers Communications (TSX:RCI.B) has been busy over the last few years. It tried to take over Cogeco, failed, had some major boardroom drama, and then it tried to take over Shaw. That effort was successful. Oh, and apparently it just added a big stake in Toronto sports teams?

Geez, these guys really have been busy.

All these moves (except for the MLSE transaction, it hasn’t closed yet) left Rogers with a bunch of debt and even more cash flow. Rogers has told investors it will generate about $3B in free cash flow in 2024, which works out to about $5.60 per share.

Compare that to 2018, when Rogers generated $1.7B in free cash flow. That works out to a hair over $3 per share.

That’s right… Rogers has almost doubled its free cash flow on a per share basis since 2017, and revenue is up about 50% too. The stock must be up pretty substantially, right?

Uhhh…. not really. In fact, Rogers’ shares are down from just about every level in 2018. Shares hit a 52-week low in February, 2018, at just under $60. These days, they’re around $55.

I can hear the naysayers now… there’s a mobile price war! Soon Rogers will be giving plans away it’ll get so bad! Yawn. That’ll get better, Rogers will continue to pay down debt, and free cash flow will grow. Just like it has for the last handful of years. It just takes patience.

If Rogers isn’t your cup of tea (their dividend growth is weak to non-existent, I’m the first to admit), then check out Quebecor (TSX:QBR.B). They’ve grown earnings even faster and the stock basically hasn’t done a thing since 2019.

Enghouse Systems

Enghouse Systems (TSX:ENGH) is a mission critical provider of software for industries such as contact centers, video communications, virtual healthcare, public safety, and the transit market. It’s a growth-by-acquisition play that is sitting on a large cash balance, waiting to make the next move.

Even without deploying its $260M war chest, Enghouse is growing. Revenue was up 17.6% in its most recent quarter, and earnings per share increased by almost the same amount. The company gushes cash, has zero debt, and pays a generous 3.3% dividend.

And yet, the stock has struggled of late. It’s down more than 50% versus all-time highs, and the stock is negative over the last five years. It’s fallen by about 15%.

I like to value Enghouse on a free cash flow basis, since it has large depreciation and amortization expenses from its many acquisitions. Free cash flow in fiscal 2019 was $79M, or $1.43 per share. In 2024, analysts expect the company to generate $114M in free cash flow, which works out to $2.06 per share.

Free cash flow is up 44% on a per share basis over the last five years, yet the stock is down by some 15%. What a beautiful setup. 

I’ll also point out that Enghouse is quite reasonably valued. Once we strip out the cash on the balance sheet, the company is worth $1.5B. It’ll generate about $114M in free cash flow this year. That puts us at just 13x free cash flow, which is a pretty attractive valuation. Especially for a consistent grower like this one.

Gibson Energy

Gibson Energy (TSX:GEI) is a stock I’ve featured a few different times on the premium side of this newsletter. It’s a energy infrastructure operator that operates oil terminals, rail loading and unloading facilities, gathering pipelines, and a crude oil export facility in Texas.

The company had a come to Jesus moment in 2017, and vowed to restructure its business to something that had very little underlying commodity price risk. It has done that, and is now the proud owner of a pretty enviable set of assets that collectively generate a lot of free cash flow — all without much commodity risk.

Just like they set out to do.

Gibson uses distributable cash flow as a substitute for earnings. In 2019, midway through its transformation, it generated $2.09 per share in DCF. Over its last 12 months that number increased to $2.53 per share in DCF — and it should go up over the next year as more assets come online.

Despite earnings increasing by some 25% over the last five years — with more to come — Gibson shares are flat in that time period.

Gibson has a few warts. The debt is a little too high for my liking, and a new CEO comes with some uncertainty, although one of the very first things the new boss did was purchase 69,000 shares, an investment which set him back some $1.5M. You’ve got to like that level of commitment. The company also has plans to reduce debt over time, and it just filed for permission to repurchase what it likely views as undervalued shares.

And for the dividend growth crowd (i.e. all of us), Gibson delivers there, too. It has hiked its dividend each and every year since 2020. And with a current payout ratio in the 65% range, this 7% yielder checks off both the high yield and safe dividend boxes — with a little potential growth thrown in.

Bonus stock

Algoma Central (TSX:ALC) — a boring specialty shipper I profiled on this newsletter a few weeks ago — also qualifies here. The company has steadily improved its earnings over the last decade, increasing the bottom line from $1.22 per share in 2014 to $2.00 per share in 2023. Yet the stock has traded sideways, with shares below where they were back in 2014.

With growth potential coming from additional ships coming online, I think this boring stock is a long-term winner. Plus, you get paid a 5% dividend to wait — a dividend that has both gone up over time, and is supplemented by periodic special dividends.

The bottom line

Ultimately, I’m a buyer of businesses. I want businesses with barriers to entry, with reasonable balance sheets, and that grow over time.

And because I’m a value investor, I want to pay a reasonable price for these businesses. That’s why the stock market is so wonderful — I can take my pick of companies and wait for them to trade at bargain prices.

One easy way to help ensure you get a bargain price is by checking the current price with one a few years ago. If the current price is lower and the business earns more, then that’s generally a pretty good setup.

In fact, that’s a key part of what I do over on the premium side of the newsletter. I want reasonably priced companies that can grow earnings and increase dividends, yet trade at attractive levels.

I scour the depths of the Canadian market looking for these names, and then present my research to DIY investors looking for a little additional help.

Just $200 per year gets one of Canada’s top dividend stock analysts on your side. Upgrade today!