Sunday, September 24, 2006

Single Best Investment - some of the rules

I recently reviewed the book, The Single Best Investment, which provided a framework for investing in stocks likely to outperform the market over lengthy periods of time.

I am going to provide a synposis of some of the rules that the author suggests to find suitable candidates using this dividend-and-value-oriented approach:

  1. Company has to be financially strong, minimum B+ Value Line rating, or BBB+ S&P credit rank;
  2. Dividend yield at 150% of the S&P500, but hopefully at 200%+;
  3. Yield has to be expected, and shown to have grown over 5-10 years, at at least 5% annually (twice the expected inflation rate);
  4. Dividend payout ratio less than 50% (except for utilities and REITs);
  5. Company should have at least moderate earnings growth of 5-10% annually (both historically and going forward);
  6. Price/Sales ratio below 1.5, and hopefully less than 1.0;
  7. Price/Earnings ratios lower than the market, AND must less than the reciprocal of the long-term bond rate;
  8. Book value ratios should be lower than the market, and;
  9. Growth of cash on the balance sheet is a big positive.

There are, of course, other rules and suggestions, but I'd suggest to you that these encompass the heart of the book and suggested technique.

Since almost all of these rules as stand-alone situations have been shown by various academic studies to produce some level of market outperformance, combining them is obviously going to provide a platform for outstanding results with enhanced safety of capital.


The Confused Capitalist

Saturday, September 23, 2006

A low-maintenance simple portfolio

I am advising an older person on their portfolio allocation for the stock market portion of their investments. Although he's not as old as the still long-term investor, 105 year old Albert Gordon, he's still looking to the future.

And that's smart, because, given his heredity, he may well have another 20-30 years left. And the only thing that'll provide adequate long-term growth over that time, is participation in the markets. I've convinced him that mutual funds aren't the best ticket today, but he still needs broad diversification at his age. So we're looking to some ETFs to fill his ticket.

Readers here know my belief in the power of dividend-paying stocks to produce out-sized market returns, with lower volatility and risk. This has been well-documented in a variety of books, large and small market studies over lengthy periods of time, covering a variety of market conditions. Thus, most of the selections I suggest for this Canadian investor, will fit the mold of having dividend-paying attributes as prime amongst their selection criteria.

Because of potential tax implications, we'll seek suitable Canadian products where available.

We are going to use just four ETFs, a quartet, but this will provide ample diversification by geography and will eliminate individual stock risk. Given that they are ETFs, they will also eliminate so-called "style drift". Finally, we'll use products that use rules-based fundamental indexing where possible, to enhance returns and reduce risk.

Claymore Investments has three of the four products we'll need. Because he's Canadian, it's suitable to try and get returns denominated in Canadian funds if possible, on the basis that cost of living swings might mirror market activity. So here are the products I've suggested:

Claymore Canadian Dividend & Income Achievers (CDZ). Weighted to emphasize stocks that both have a relatively high yield, and also have a good track record of raising their dividends. It tracks the Mergent Canadian Dividend Income and Achievers (fundamental) index. Over the past five years, the index has posted a 15.1% annual gain, versus the S&P/TSX Index return of 11.1% annually. Over ten years, it posted an 18.1% annual return, versus an 11.0% return for the S&P/TSX Index. The underlying holdings are around 55-60 stocks typically. I'm suggesting a 40% weighting for this ETF.

Claymore US Fundamental Index, C$ Hedged (CLU). This ETF also tracks another fundamental index, which tracks the top 1,000 US securities by fundamental value, using the following four factors: cash dividends, free cash-flow, total sales, and book equity. This ETF is also attractive from my point of view, in that I think the US dollar will be lower in 10 years than now, but this ETF hedges against currency changes, meaning that we'll only trap the underlying changes in the index. Over five years, this index has returned a 7.0% rate annually, versus a -3.2% S&P 500 annual return (as converted to Canadian currency). The underlying holdings are around 1,000 stocks. I am suggesting a 20% weighting for this ETF.

Claymore BRIC (CBQ) is the final Claymore product, that portfolio manager Roger Nusbaum has also written about. This ETF isn't fundamentally indexed, but is designed to mirror the BNY BRIC Index, which tracks ADRs from Brazil, Russia, India and China, all powerful emerging economies. Over time, this should be a strong growth component, but one which will also be volatile in nature. This index has returned 33.2% annually over the past four years, versus the more widely known MSCI EM Index, which has returned 19.7% annually over the same period. The ETF has 75 underlying stocks with above average concentration in the first ten stocks, with about 53% of the value held therein. This isn't currency hedged or denominated in Canadian dollars, but this could be a plus if these currencies gain strength against the Canadian dollar over the next decade. I am suggesting a 20% weighting for this ETF.

Finally, for the fourth ETF, I'll suggest a product that trades on the American exchanges, a Wisdom Tree ETF product that tracks the Wisdom Tree International Dividend Top 100 Index (DOO). This is also a fundamental index, based on dividend yield of large and mega cap international companies. Currently, about 80% of the companies in the index are domiciled in Europe, with about 20% in Australia, Singapore and Hong Kong. The index has returned 16% annually over the past five years, as denominated in US Dollars. Conversion to Canadian currency over that time would have considerably diminished these returns to about 8.5% annually (which is still respectable, although not outstanding). While the currency issue may be slightly negative over the next decade, I don't think it's going to weigh down returns like it did over the past five years, or like it might for an unhedged US stock situation going forward. I am suggesting a 20% weighting in this ETF.

Well, that's it. A relatively simple portfolio, with ample geographic representation, and wide corporate representation. The one noteworthy thing about this portfolio is that it's definitely weighted to the financial sector, but I've never considered that a particular problem, since I consider this sector as the backbone of the entire economic system. My theory here is that if this sector suffers some sort of serious long-term decline, so will virtually every other sector of the economy.

Finally, the other noteworthy aspect is the ability of high-dividend paying stocks to resist market downturns, something that might make this particular portfolio even more attractive; certainly, it makes it easier to sleep at night.

In summary, I consider that these four components will produce robust and relatively reliable returns over the medium to long haul, all with overall reduced risk because of the weighting towards the various fundamental indexes.


The Confused Capitalist

Monday, September 18, 2006

More low PEs and sweet dividends

Portfolio sweetness: a well above average chance for portfolio outperformance!

With the number of articles I've written over the past while about dividends and low PE ratios, I thought I'd continue the trend.

A fairly recent report issued by RBC Dominion Securities identified a list of stocks that met a trifecta of tests for outperformance: relatively low PE ratio, relatively high dividend yield, and positive dividend growth over the past five years. The following S&P 500 companies were included in the report:

  • Bank of America, BAC
  • Pfizer, PFE
  • KB Home, KBH
  • Cincinnati Financial, CINF
  • Fannie Mae, FNM
  • Conoco Phillips, COP
  • DR Horton, DRI
  • Home Depot, HD

Note that these stocks all have a dividend yield above 1.5%, with most above 2.5%, and a PE below 20 (but most are below 13).

The report also included some Canadian TSX-listed stocks, including:
  • Russel Metals, RUS
  • Reitman's Canada, RET.A
  • Teck Cominco, TCK.B
  • National Bank, NA
  • Rothmans, ROC
  • Power Financial, POW
  • Bank of Nova Scotia, BNS
  • Encana, ECA

An investor could do a lot worse than look at these stocks as a great starting point for core holdings in a conservative stock portfolio.


The Confused Capitalist

Saturday, September 09, 2006

Book Review: The Single Best Investment

I recently completed reading The Single Best Investment: Creating Wealth with Dividend Growth, by investment manager Lowell Miller. The dust cover additionally describes the book as "The Classic/Revised & Updated".

The subtitle describes how the wealth is to be created: by finding reasonably-priced (perhaps even so-called "cheap" stocks), reasonably-yielding dividend-paying stocks, that have a history of raising their dividends over time.

As readers to this blog know, I am a fan of both buying stocks with below average PE ratios, and with good (and rising) dividend yields as a way to outperform the market (which is the essense of the approach recommended in this book). This is also something I've written about here, here, and here. So this is an approach that I personally recommend as suitable for practically any type of stock-market investor.

This book is useful for both beginning investors and those with more experience, particularly experienced investors weary of the "next great stock" approach. Mr. Miller does teach the keys to finding the right kind of stocks, that will allow an investor to "sleep easy", knowing that the stocks chosen using this approach are likely to be far less volatile than the market in general, and to have great staying power over the longer term. All with the likelihood of achieving achieving above-market-average rates of return. What more could most investors want?

Of course, this also provides the opportunity to hold these stocks outside of tax-sheltered accounts for long periods of time, thereby reducing both transaction costs, and capital gains. Another wonderful benefit.

Finally, the book isn't filled with lots of technical jargon and is a nice easy read.

However, having sung the praises of this book I also have to note a few a warts with the book. Although it's stated as an "updated" version, there are places in the book where it's not clear what time frame is being talked about: now, or examples which were current when the orginal version was published (about 10 years ago). Also, some of the examples are also dated, and it could have been very useful for the author to show how, for instance, five or ten stocks recently purchased in the portfolio he manages, fits into this approach. A few changes to the book could have resulted in a great book showing a a great approach, rather than just a good book with a great approach. Overall though, these warts aren't enough to really detract from the overall content and message of the book.

In the end, this is a book I definitely recommend this as a good addition to any investors library, with a very solid approach, and with very high off-the-shelf usefulness. I'll definitely be lending this book to my teenagers to read and for them hopefully to practice the approach!

Finally, I would like to thank and acknowledge the publicist (Jo Treggiari of The Print Project) for providing me with a complementary copy of the book.


The Confused Capitalist

Monday, September 04, 2006

Distill Your Investment Choices

A recent story from the excellent Avner Mandelman of Giraffe Capital reminded me, once again, of one of the reasons I became a "focus" investor.

Mr. Mandelman relates a story of a old classmate asking for Giraffe's top ten stocks in 2003. Although Giraffe already ran a focussed portfolio of just 25 stocks, Mr. Mandelman agreed. One year later, the former classmate sent back the results of just those 10 stocks: those ten stocks actually doubled the overall performance of the already focussed portfolio (see link for overall 2003 performance).

Mr. Mandelmans point is to dive into your own stocks to both cull the weaker positions, and to add to those positions holding the best promise.

In fact, I also had a virtually identical experience when I ran the Global Walkers Investment Newsletter in the mid-to-late 1990s. I had two model portfolios, one of which ("The Top Ten"), which was a subset of a moderately larger (typically 20-25 stocks) portfolio. While both portfolios trashed the TSX index (its benchmark) over the two year period I ran them, the Top Ten, like Mr. Mandelmans experience, also doubled the broader model portfolio.

So I concur with Mr. Mandelman: don't be afraid to look in your own backyard for some of the best stock ideas out there. After all, there's already been considerable distilling (hopefully) of your ideas to arrive at those. Just a little further distillation can yield fabulous results!

A foolish diversification is the hobgoblin of little minds, adored by mutual fund managers, brokers and fitful investors alike.

(With all due apologies to Ralph Waldo Emerson)


The Confused Capitalist