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Why one stock is a buy, one’s a hold and one’s not a sell

Picking profitable stocks is no easy task in this market. A Canadian advisory gives us a case study of three stocks facing tough times.

Let’s assume you’re still buying stocks. You’re convinced that, current circumstances notwithstanding, stocks bring in greater returns over time than any other investment.

A number of stocks have perked up in the intermittent market rallies, but their charts still look like the down slope of a rollercoaster.

So you look at what analysts call a company’s “fundamental” strengths — its balance sheet, its earnings, its market share, its management.

And yet, many a company that does things right can’t make headway in an economy where the weak tend to drag down the strong. So how do you shop in this treacherous market?

For a sort of case-by-case primer, we turn to one of the oldest stock picking advisories in Canada, The Investment Reporter.

We look at three stocks. One is a buy despite going through a rough patch. One is a hold because it’s going through an even rougher patch.

While the third, which is having a really bad time, is not a sell — and might even be a buy for some investors.

All of them, we should mention, are on the advisory’s list of “Key stocks,” a group of equities it identifies as core portfolio holdings.

No can of paint

For those who don’t know the company, Richelieu Hardware (TSX-RCH) is not a hardware store. You can’t walk in and buy a can of paint.

It is a manufacturer and distributor of specialty hardware — kitchen and bathroom cabinets, doors and the like. And it’s been very successful for many years.

In fact, this is one of the few Canadian firms that has gone into the American market and done very well, largely by acquiring U.S. firms that complement its business.

But the recession has caught up with it. How could it not have, given the state of the housing market?

So after a long run of success, its earnings fell. This happened in the first quarter of fiscal 2009 — and it came after 13 consecutive years in which earnings rose year-over-year in every single quarter.

How should investors react to this distressing news? Buy the stock, says The Investment Reporter.

Sharing the pain

One of Richelieu’s greatest strengths is its enviable balance sheet. Even though its sales fell and its cash flow slipped in the first quarter, the company retained more than enough to cover capital spending, dividends and share buybacks.

In fact, the company could pay off its total debt and still have enough to cover all the above items. If the advisory has a bone to pick with the company, it is that it has kept its annual dividend at 32 cents a share, rather than raising it.

Richelieu keeps a careful eye on costs, and the advisory notes with approval that it has frozen officers and managers’ salaries. That’s called sharing the pain instead of taking the money and running.

The advisory regards this as a classic case of a company that will succeed because it does the right thing come rain or shine.

A triple whammy

This advisory also has a high opinion of the management of AGF Management (TSX-AGF.B). But the company is one of Canada’s largest sellers of mutual funds, not the greatest business to be in these days.

AGF has been hit with a triple whammy. Fund assets under management shrink as the stock market goes down, while the same weak markets lead people to sell. Plus, many investors shift their holdings into money market funds, which means lower profits.

The trouble AGF faces is that even the best-managed fund company can’t reverse trends in the market by its own efforts. The trouble investors face is the state of the dividend.

The company has raised the dividend every year since 1997, but the yield of nearly 12 per cent suggests that “the market must expect the firm to cut its dividend,” says the advisory.

AGF is taking steps to cut costs and raise revenue, and it has survived many market cycles. But it’s still a hold, says the advisory. Buy it when it recovers, especially if it continues to reward shareholders.

Cost-cutting mode

Transcontinental Inc. (TSX-TCL.A) had a terrible first quarter. Unlike AGF, which was bound to suffer in this crisis, this giant printing firm didn’t necessarily look like it would get clobbered in the recession.

It holds many lucrative contracts (it does all the flyers for Shoppers Drug Mart, for instance). It just extended its contract to print the Globe & Mail through 2028. It will print all of Rogers Communications’ magazines for six years, and so on and so on. And more contracts are on the way.

But when you have a long list of customers, some of them are going to be cutting costs at your expense when a recession hits. Commercial printing, direct mail and advertising can all be pulled back before companies get to more drastic cutbacks.

That’s what has happened, and now Transcontinental finds itself in strict cost-cutting mode. Its cash flow fell by a hefty 35 per cent from the year before.

Should investors bail? No. “As new contracts start and costs drop, we expect a recovery,” says The Investment Reporter. “So now is no time to sell.” In fact, adds the advisory, if you can accept some risk, buy more for long-term gains and a dividend yield of 4.5 per cent.

In this advisory’s view, each of these companies is suffering from circumstances over which it has little or no control. Investors must ask one simple question — will a company with a strong track record be just as good, or even better, when the race gets back up to speed?