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(B)(N) Fair Value In The S&P TSX 60

December 18, 2013
Fair Value

Fair Value? What’s that?

Essay. There isn’t anything in economics or finance that can help us to say that a stock price is “fair” or “fair value” and without knowing what is “fair”, we can not possibly know what is “undervalued” or “overvalued” or more cogently, what might go up in price while we own it and what might not or is less likely too.

For example, economists only know that a “fair price” is formed when “supply” is equal to “demand” and there is, therefore, no opportunity for a “risk-free” arbitrage profit which would obtain if demand exceeds supply because the supply is at one price (a lower price) and the demand merits another (a higher price), and in the opposite case, if supply exceeds demand, because the supply is at one price and it can’t be sold at that price.

Finance takes a different approach and says that the “fair value” of a stock, now, is the discounted value by the rate of inflation of the future cash flows. Yes, that is correct (please see below) but what is it? Specifically. Because we have no idea of either the future rate of inflation or the future cash flows and why are “stock prices” so volatile and uncertain on a daily basis?

We left all of that behind us in grade school where we first heard of it, but unfortunately it’s still being taught from Wiarton to Wharton and that’s all they know and it explains a lot of why the poor will always be with us because although the principles are sound and cogent, neither is actionable (CBC News, December 17, 2013, High school students falling behind in financial literacy).

Take Action

Taking Action!

To succeed, we need to take action and for that we need to re-shape the metaphors, not radically, but a little.

We should tell our students that an “investment” is just and only the “purchase of risk” and the “risk” is that we might not get our money back when we need it or we might not get it back with the same purchasing power that it has now. And that’s what we bought and that’s all that we own absent our “money”.

That accords well with the “financial” definition of “fair value”. The value is fair because our money in the investment is no worse than our money as cash but no better unless there is some kind of a payment to us for spending our money on the investment. And the “payment” is that we might obtain a hopeful but not necessarily guaranteed return above the rate of inflation which can be described more succinctly as a hopeful but not necessarily guaranteed non-negative real rate of return.

That’s fair too in the context of “the purchase of risk” because investments that guarantee a non-negative real rate of return as the “payment for risk” when there isn’t any can only be bought from the government as, for example, Real Return Bonds (RRBs) or Treasury Inflation Protected Securities (TIPs) but even governments can’t issue too much of those because there are economic costs such as recessions and depressions and unemployment or deflation that we will all pay if they do.

Efficient Frontier (B)(N) Boundary Open

Efficient Frontier (B)(N) Boundary Open
Courtesy: The RiskWerk Company Glossary

successful or effective arbitrage is also a guaranteed payment for risk and it is routinely seen as a payment for the investment activities and services of the investment banks, broker/dealers and market-makers – that’s their job and they should be paid for it.

But we can also establish an “arbitrage” in our portfolios of stock investments (in this case, although the principle holds for government and corporate bond investments as well) by crafting conservatively managed portfolios of stocks that – as a portfolio – “tend not to lose in value” which we have called the Perpetual Bond™ (B).

One might say, however, that the Perpetual Bond™ is “unfair” because it routinely outperforms every market, every year, but that’s our job and not unlike the job of successful investors who craft arbitrage by taking large or controlling interests in individual firms. Please see Exhibit 1 below.

Exhibit 1: Aggregate Market Returns – December 12, 2013

Aggregate Market Returns - December 12 2013

Aggregate Market Returns – December 12 2013

With reference to Exhibit 1, we note that the S&P TSX 60 companies paid an aggregate dividend yield of 3.2% and $39 billion to their shareholders this year and provided a market return of +5.3% substantially under-performing the other major North American markets, but that the Perpetual Bond™ obtained a similar dividend yield and a market return of +24.6% and currently has an investment but not ownership or controlling interest in just thirty-two of the sixty companies in the S&P TSX 60.

The “arbitrage” is established by the thirty-two companies that we have in our portfolio (B) and the twenty-eight that we don’t (N) and it could be contrasted to the Dow Jones Industrial Companies in which our numbers are currently twenty-seven in and only three out, numbers which may change as more or fewer companies trade at or above the “price of risk“.

The Perpetual Bond™ is, of course, a managed portfolio and returned +24.6% for the year on a cash only basis but, with reference to Exhibit 2 below, the thirty-two companies that are a (B) now have done well all year and are up +14% in aggregate based on their market values; and the twenty-eight that are an (N) now have lost minus (13%) of their market value and produced negative earnings of minus ($8.4 billion) even though they still paid dividends of $7.9 billion.

Exhibit 2: Arbitrage in the S&P TSX 60 – Fundamentals

Arbitrage in the S&P TSX 60

Arbitrage in the S&P TSX 60

We also note that the aggregate [P/E]-multiple of the (B)-companies is just 15× so that in “econo-speak” or “pundit-gab”, they are undervalued and on quite a different page, we can also show that there is an excess of demand over supply for these companies and that the “price of risk” is the “fair value” for a “stock price”. Please see Exhibit 3 below.

Exhibit 3: Fair Value for a Stock Price – The Price of Risk

Fair Value For A Stock Price - The Price of Risk

Fair Value For A Stock Price – The Price of Risk

The current (B)- and (N)-portfolios are compared to their market values since 2011 and their aggregate “price of risk”.

And a similar chart obtains if we select the (B)- and (N)-portfolios in 2011 or two years ago so that “survivor bias” is not an issue.

One of the implications is that the “undervalued” companies of the (B)-portfolio are “undervalued at high prices” and that the “overvalued” companies of the (N)-portfolio are “overvalued at low prices” and there are well-known remedies for both situations.

For more information and additional references to the theory, please see our recent Post, The RiskWerk Company Glossary.

And for more on what risk averse investing has done for us this year, please see our recent Posts on The S&P TSX “Hangdog” Market or The Wall Street Put or specialty markets such as The Dow Transports & Utilities or (B)(N) The Woods Are Burning, or for the real class actionLa Dolce Vita – Let’s Do Prada! and It’s For You, Dear on the smartphone business.

And for more stocks at high prices, The World’s Most Talked About Stocks or Earnings Don’t Matter – NASDAQ 100.

And for more on what’s Working in AmericaBig OilShopping in America or Banking in America, to name just a few.


We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond
Alpha-smart with 100% Capital Safety and 100% Liquidity
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to


Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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