Economic analysis

A surefire made-in-Canada way to lose $650 billion

Here’s a stock tip Valeant investors should have heeded: If a company that’s not a bank becomes the largest in Canada, run!
Dollar Markets 20160104
FILE-- A tote board displays the closing figure for the TSX for the year in Toronto, in a Dec. 31, 2012 file photo. Stock markets around the world got off to a bad start in the first day of trading for 2016, sparked by a sharp drop in China that triggered a new "circuit breaker" mechanism that closed trading early to limit losses. THE CANADIAN PRESS/Frank Gunn

A tote board displays the closing figure for the TSX in Toronto THE CANADIAN PRESS

Valeant, the Quebec-based drug company, has claimed a lot of victims in its plunge from stock market star to investor scourge. Former CEO Michael Pearson, who built Valeant into what briefly became Canada’s most valuable company, is gone. The head of the storied Sequoia mutual fund, Robert Goldfarb, retired after his big bet on the company led to steep losses. Meanwhile Bill Ackman, the hedge fund manager (and now a Valeant board member) who regularly touted the stock on its way up, has taken a US$2 billion hit on the way down.

But those individual losses pale next to the vast wealth destruction wrought by Valeant’s collapse. Since it’s share price peaked last summer, at which point its market capitalization (the total value of its outstanding shares) surpassed Royal Bank of Canada’s, Valeant has seen more than $100 billion erased from its stock market worth.

How could Valeant go from being Canada’s biggest company to total train wreck so quickly? There are some good theories here. The full tale of its troubles will be revealed in time, and possibly in court.

But here’s the thing: Valeant’s market turmoil is simply the norm in Canada for any non-bank company that becomes the largest stock on the TSX.  Since 2000 seven different companies have bumped aside a bank—almost always RBC—to take the top spot, and each one has gone on to suffer massive stock market declines afterwards.

It’s often described as a curse afflicting any company that becomes number one (I discussed that notion in a column about Valeant last July) but it’s only when you tally it all up that the full scale of wealth destruction can be appreciated. From the peak of their market worth to now, those seven former stock market champs have combined to wipe out a staggering $655 billion in shareholder value.

wealth destroyers

To put that evaporated wealth in perspective, it’s equal to 38 per cent of the market cap of the entire S&P/TSX Composite Index today, and is greater than the value of Canada’s 10 largest companies combined. (Performance excludes dividends.)

Each company has its own boom and bust story. As the chart shows, the behemoth that was Nortel (RIP) accounts for half the total wealth vaporized by the bank-beaters over the last 15 years, a reminder of just how astronomically large that company was at the bubbliest heights of the dot-com era. (Nortel first overtook RBC in the mid-1990s and held the title until September 2001.) BlackBerry’s fortunes soared through 2008 as it cemented its dominance of the newly emerging smartphone market, only to be crushed by the Apple iPhone. Encana, Barrick and Potash Corp., meanwhile, all rode the commodity boom. In the summer of 2008 Potash was giddily being called  “pink gold” and the “Google of fertilizer”  on Bay Street, but within a few months it had lost 74 per cent of its value and remains near its financial crisis low. Manulife’s decline took longer. Its market value soared after merging with U.S. insurer John Hancock in 2004, and it jockeyed with RBC for most-valuable-company status over the next couple of years. Then the financial crisis hit and Manulife’s market cap tanked—the company’s share price is down 60 per cent from its pre-crisis peak and remains one-quarter below where it was at the time of the merger.

In fact, the only exception to the rule that it’s the kiss of death (or at least, a harbinger of supreme disappointment) to beat out RBC for the top spot is when that feat is achieved by another bank. Both Scotiabank and TD Bank have at times surpassed RBC in value.

This all raises the question, what the heck is going on?

Aside from the individual examples of exuberance behind each company’s rise, Laurence Booth, a professor of finance at the University of Toronto’s Rotman School of Management points to how shallow Canada’s stock market is as a culprit—with a dwindling number of big, growing companies replenishing the market as others are bought out or merged, it becomes easier for one booming company to distort everything. “There’s been a hollowing out of the Canadian economy and the problem with that is as soon as anything gets hot, it tends to become a big part of the TSX,” says Booth. “That’s indicative of a thin equity market.”

The unbearable lightness of the TSX also makes it particularly vulnerable to the bandwagon effect, says Booth’s colleague at Rotman, finance professor Eric Kirzner. Retail investors usually get blamed for piling into hot stocks, but Kirzner says institutional investors are just as guilty. When a company like Valeant begins to dominate the S&P/TSX composite index and drive its performance, as it did last year, money managers will load up on it for fear of missing out. “There’s comfort in the consensus,” he says. “If you hold the same thing as others and things go badly, at least you’ve got lots of company.”

Whatever the case, the next time a company’s market value soars past the banks and it gets crowned Canada’s biggest company, investors should think twice before piling in. It very well might be Canada’s next big wealth destroyer.