(Runtime: 7:00. Read the audio transcript.)
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Successful equity investing starts with understanding the underlying business rather than simply buying what appears cheap, says Ken O’Kennedy of Dixon Mitchell.
Speaking on the Soundbites podcast, Ken O’Kennedy said he endeavours to understand “the DNA of a business,” which he describes as its durable competitive advantages and management’s ability to allocate capital effectively.
“As an investor, you have to really understand what you own and why you’re owning it. And especially the why you’re owning it part,” he said. “The why you own it leans on the qualitative side of understanding the business and its particular situation versus purely looking on the numbers.”
O’Kennedy admits that his philosophy of seeking high-quality cash-flow compounders has been under pressure lately, as Canadian markets have rewarded commodity exposure and, to a lesser extent, defensive yield, while in the U.S., capital has flooded into AI infrastructure beneficiaries.
“Those two things have been a fairly big disruption for us over the past 12 months,” he acknowledged.
Nevertheless, he maintains that from a fundamental perspective, the value of any investment is simply the present value of its future cash flows. That sometimes requires patience as companies spend strategically to build competitive advantages.
He cited Amazon as an example of a company that invested heavily in its shipping network before that was the norm.
“They were losing money, but they were building a moat over time, which eventually led to rising cash flows,” he said. “But you had to be able to look through that, and that’s not always easy.”
O’Kennedy said he currently sees the best opportunities in international markets, followed by Canada and then the U.S.
“We see international as the best combination of valuation — which is also a function of growth — and business quality,” he said. “We’re finding high-quality franchises at more reasonable valuations than U.S. peers in similar industries.”
He highlighted Spotify, which has been introducing new AI-enabled products that should drive growth.
In Canada, the opportunity set includes select financials, some industrials and infrastructure-like businesses, especially where management teams are focused on allocating capital to grow value over time.
Among the names he likes are TD, Royal Bank, National Bank, Brookfield Infrastructure, Boyd Group and Element Fleet.
“These are attractive Canadian businesses with high-quality business models,” he said. “Some of these companies are facing some kind of temporary cyclical or sentiment headwinds, but are showing good or resilient unit economics, and also have good growth runways ahead of them.”
In the U.S., the leading businesses have experienced a decade of multiple expansion, and the recent AI-driven momentum has compressed forward returns.
He likes Berkshire Hathaway, Visa, Domino’s Pizza, as well as a relatively new name for the portfolio: aircraft parts manufacturer Heico Corporation.
“This is an interesting company with one of the strongest competitive advantages in the portfolio,” he said.
He is cautious about the current scale of AI infrastructure spending — on everything from chips to connectors to HVAC, power supply and infrastructure construction — while large areas of the broader market are ignored.
“There’s a lot of very high-quality names with low volatility that are trading at or near their long-term lows in terms of relative valuation,” he said. “All the free cash flow from the hyperscalers is going here. Plus, they’re raising money in bond markets … But we don’t see that as sustainable over the long haul.”
Rather, he wants to focus on companies with good prospects for compounding free cash flow.
He sees fixed income as a good diversifier and ballast for the portfolio, providing a source of ready cash when there are market dislocations.
“Over the last two months, we’ve increased our bond allocation from about 20% to 24%,” he said. “We’re just preparing ourselves, so if we get a large beta event we’re going to be able to tap liquidity to deploy money into equities.”
O’Kennedy said equity investors in the current moment need to understand where their exposures are — especially with the AI momentum driving capital speculation.
“Eventually this will moderate, and there will be a reset,” he said. “That’s historically when we’ve been able to deploy capital post-speculative bubble.”
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This article is part of the Soundbites program, powered by Canada Life. The article was written without sponsor input.