The Fundamental Case for CanonApril 13, 2015
By Knowledge Leaders in
Last week we received a good question from a client asking for our thoughts on Canon, the well-known maker of office machinery and cameras. Excepts from our response are below.
From a relative strength perspective (relative to the MSCI ACWI), Canon has been in a well-defined long-term downtrend for the last four years. It is currently challenging the downtrend line and shows promise of breaking it as the stock has put in one higher low and one higher high. We would consider this potential change of trend to be in the earliest of stages and would generally look for more signs of accumulation (usually some sort of basing, or sideways action) before jumping in. We like to share good experiences with other investors and typically would wait for more evidence that the old investors who have had a loathing experience with this stock are out of the way.
From an absolute perspective, the chart formation looks much more appealing. It is in a well-defined trading range spanning back to some point in 2011. As you are aware, point & figure charts do not incorporate time as an element of chart construction, just volatility, so all we can say is that the top of the trading range is defined by that cluster in 2011 from coordinates B0:B3. There is a well-defined base of support between G:F, and the stock just registered a triple top buy signal. On the downside, the trading range is quite narrow, suggesting potential upside of only about 25%, and it is already running into some intermediate resistance that is likely to cause the stock to check up at D, just like it did twice in 2013. The “box” size represented in our charts is 2.5%, so I calculated the potential upside from the current position to the top of the range as roughly 10 “boxes” (10*2.5%=25%). Even though the trading range is quite narrow at this point, that cluster of resistance back in 2011 isn’t all that substantial and will soon drop off of the chart. We only look at four years of chart history as we consider historical support and resistance for individual stocks dating back further than four years to be much less relevant than nearer term levels. Very rarely have current holders of a stock been the same as holders of a stock more than four years ago, and so current investors have likely not been a part of any of those formative support and resistance levels dating back more than four years.
From a fundamental perspective, Canon is strong, and the best in its group of companies. It ranks in the 69thpercentile of all companies in the MSCI ACWI Index for quality. It’s balance sheet is superb, but all of its quality metrics are solid.
The valuation case is a little harder to make, but Canon is by no means expensive relative to other stocks as it scores in the 55th percentile (a higher score is better even for valuations). It falls down on valuations relative to earnings growth and cash flow growth (thing PEG ratios) mainly because growth has been weak or negative, but is relatively inexpensive on a normalized basis and relative to its own historical valuation levels.
Here are the absolute valuation levels for the group. Of note, all stocks in this group trade for under 10x cash flow, which we would consider to be a low multiple given the fairly high operating strength of these companies.
The above tables were all showing the actual reported statistics. When we look at all of the intangible investments Canon has made, the fundamental picture gets even better! Below are the same tables as above, except looked at through our intangible adjusted lens.
Canon still the best in class for quality:
Canon ranks a little higher than before in terms of valuations:
And from an absolute valuation perspective, the entire group is downright cheap. All of these stocks can be had for under 4x cash flow and at or below book value. It is rare when an entire group of stocks looks this cheap six years into a bull run.