Profit from dual-share Canadian stocks

Members of Pat McKeough’s Inner Circle enjoy a double benefit when it comes to taking advantage of our investment research. They get to address investment questions directly to me and my research associates; AND they get to see all other members’ questions, and our answers (of course, we eliminate any personal information).

Aside from specific investments (such as U.S. and Canadian stocks, income trusts or exchange-traded funds), Inner Circle members ask us a wide range of other kinds of investment questions, as well. So you can get a sense of how the service works, I’d like to share an example of the type of question an Inner Circle member might ask. I hope you enjoy and profit from it.

Q: Pat, I’d like to buy Canadian Tire stock. I note the company has two share classes. Which class is the better buy?

A: Canadian Tire Corp., Toronto symbols CTC.A, $55.73, and CTC, $66.49 (Shares outstanding: 81.6 million; Market cap: $4.6 billion), has two classes of shares: the common shares (symbol CTC) carry one vote per share and the class A shares (symbol CTC.A) are non-voting. Investors can buy either class of share. We cover Canadian Tire in our Successful Investor newsletter.

Most Canadian stocks with two share classes, including Canadian Tire, have a “coattail provision” in place. This provision aims to ensure that both share classes have equal rights in the event of a takeover. So, if you hold non-voting or subordinate-voting shares, you won’t miss out on a takeover bid. For example, Canadian Tire’s non-voting class A shares would carry one vote per share in the event of a takeover offer, just like the common shares.

Canadian stocks: Voting shares have certain advantages over non-voters

If a company’s two classes of shares trade for roughly the same price, you’re better off buying the voting shares. That’s because the voting shares may move substantially higher than the non-voting shares if a shareholder who is trying to take control of the company accumulates a large number of shares. In addition, voting shares sometimes trade above non-voting shares because certain institutions refuse to buy non-voters, or only buy them in limited quantities.

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Canadian stocks sometimes combine their voting and non-voting shares into a single share class to make themselves more attractive to investors (particularly institutional investors) who dislike non-voters. When that happens, the voting shares may get a 10% to 20% premium over the non-voting shares in return for sharing control of the company. So, if you can buy the voting shares of a dual-share company for less than, say, a 5% to 10% premium over the non-voting shares, it can be a worthwhile investment.

Note that most Canadian stocks with two share classes have far fewer voting shares outstanding, and they trade far less actively than the non-voters. (In the case of Canadian Tire, there are 3.4 million common shares outstanding and 78.2 million class A non-voting shares outstanding.) However, for long-term investing, having a vote is more valuable than a high level of liquidity, since the voting shares will tend to trade at or above the non-voters.

That’s why we recommend that you buy the voting shares when they trade at roughly the same price or less than the non-voters.

In the case of Canadian Tire, however, the class A non-voting shares sell for 16% less than the voting common shares. They also yield 1.5%, compared to 1.3% for the common shares. We see the class A non-voting shares as the better choice.

How investor fears about dual-share Canadian stocks can lead to bargains

Some investors feel that dual or multiple share classes concentrate too much power in the hands of insiders and consequently expose outsiders to added risk. Some companies with multiple share classes do abuse outside investors. So do all too many companies with a single class of shares.

Over the years, we’ve had great success with a number of companies that have two or more share classes. Often, you can invest in these companies at a lower ratio of price to asset value or earnings power simply because some investors prefer not to invest in them.

We, of course, only recommend stocks if we see the insiders as people of high integrity. In that case, there is little extra risk in investing in a company with multiple share classes. On the other hand, if the insiders are inclined to cheat you, they will find a way to do so, regardless of the company’s share structure.

If you have investment-related questions, or if you’d like to ask me about stocks you’re considering buying (or selling), you should join my Inner Circle service. Click here to learn more.