Sunday, January 20, 2008

Cleaning up behind "Easy Al" (Greenspan)

If the economy was a ship, then Easy Al guided the world's largest economy within spitting distance of the shoals. Now, everybody else has to try and make sure that it doesn't crash into those shores, wrecking secondary havoc elsewhere.

The Bank of Canada is widely expected to lower its interest rate at its next meeting on January 22, in response to the slowing US economy and liquidity issues. Because Canada's largest export market is softening, having our currency float through the roof would hurt many Ontario-based manufacturers who count on this market. So we too are in the position of having to lower our interest rates, even though this is against the other relatively strong fundamentals elsewhere in the country. This, undoubtedly, will cause trouble further down the road, as in the stagflation that money manager and financial columnist Avner Mandelmann says has begun to visit its plague on the US.

While it's unfortunate that this will happen, viewed through the lens of alternative realities, which could include a depression, suffering through 10 years of stagflation seems infinitely better.

For Canada, the picture is different. Public finances are on the soundest footing in a generation, and all attempts should be made to maintain that. Accepting that American troubles are real but different, we should not follow the same asset inflation mistakes made there, by allowing our credit to become too cheap. Policy-makers and central bankers must put their heads together to make humus out of manure, so that Canada can take advantage of this situation, and not blindly follow the Americans down the manure-laden stagflation trail.

Perhaps first among these actions is lowering the cost of credit at a very slow pace, to a far lesser degree than that seen in the US. Secondly, as the cost of credit is lowered once again, perhaps accelerating our own national debt repayments would give us additional flexibility down the road.

We experimented with stagflation in the 1970s - perhaps we can try experimenting with a strong currency for a change.

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Friday, January 18, 2008

7.1%? Are you kidding me!!?

Picture: Kruschev (famous table pounder at the UN)

Well, 2006 seemed like the year I pounded the table for emerging markets. If you'd listened to me - heck, if I'd taken my advice more seriously - my portfolio and yours would be turning into serious dough by now.

I have a feeling that this year I'll be pounding the table about the banks.

Less than two weeks ago, I wrote about an eight stock portfolio containing three banks - stocks that Warren Buffett had recently added to his position in. Since then, two of the three stocks have fallen in price and the dividend yield has correspondingly increased. These three stocks, recent prices and yields are:

Wells Fargo (Bank) - WFC -$26 - 4.8% dividend yield

US Bancorp (Bank) - USB - $30 - 5.6% dividend yield

Bank of America (Bank) - BAC - $36 - 7.1% dividend yield

I can get a 7.1% yield on a bank stock - the largest bank in America by market capitalization -that's just announced a buyout of a troubled financial institution. 7.1%? Are you kidding me!? I say these banks offer fantastic value at these prices.

Do you really think the banking team would have even considered this buyout if they thought there was any potential they'd have to cut the dividend? Because that's what a 7.1% dividend for a major business institution implies: that a dividend cut, a la Citigroup, is in the works.

Unlike Citigroup, however, Bank of America is still buying. Does that sound like a troubled institution to you? 7.1%? You must be kidding.

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By comparison, the ETF "SPY" (S&P500) was trading at $132, and a 2.1% yield.


The Confused Capitalist

Credit Crunch: Canadian Banks On Sale

Pictured: A different kind of crunch.

The global credit crunch seems to be affecting a lot of bank share prices, including many Canadian banks who have relatively little exposure to the sub-prime slime (CIBC excepted).

One analyst recently pointed out that 10 year Government of Canada bonds were yielding around 3.8%, and that the average weighted dividend yield of the six big banks was around 4.5%. The analyst pointed out that this was as large a spread as he could ever recall.

I too think that the banks offer tremendous value at current prices and yields. I look at it this way, if the credit crunch turns really bad, it's not just the banks that will suffer. There will really be no hiding out anywhere if things turn nasty. Having said that, I don't expect it, and therefore suggest that the current environment is great for buying banks stocks.

Of the Canadian ones, I like four of the six that have avoided most of the sub-prime problems and have dividend payout ratios around 40%.

These include the Royal Bank ($47, DivYield 4.2%, 42% Payout Ratio); my personal favourite, the Bank of Nova Scotia ($45, 4.1%, 40%); the TD ($64, 3.6%, 36%); and, to a lessor extent, the National Bank ($47, 5.3%, 39%). I think that buying a basket of these shares now, will look very good in two to five years. Odds are that the dividends will have been raised nicely over the period, and the shares are quite likely to have been repriced higher as well.

By comparison, the XIU ETF (broad Canadian market) is trading at $74 with a 2.1% dividend yield.

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Tuesday, January 15, 2008

Sub-Prime Slime Dirties CIBC

One of Canada's five big banks, CIBC, announced on Monday that it would be re-capitalizing its balance sheet with the sale of $2.75 billion in new equity. The bank, which has a penchant for poking itself with a sharp stick every two to three years, has already written off $3.5 billion in sub-prime exposure, which handily exceeds the $2.5 billion write-offs from the Enron fiasco.

The shares will sell at a headline price to the main investor group at $65.26 for the well-heeled billionaire, pension funds, and life-insurers who'll soak up about half the issue, and $67.05 for the great unwashed masses. After an additional 4% commitment fee is further soaked up by the main investor group, this reduces the actual price to $62.65 off of the $65.26 headline price, which is a steep reduction from the $72 level which the shares were trading at prior to this announcement.

Reaction from analysts has been widely positive, who generally point out that it's better to go to the equity well once, and dip heavily and deeply in case of further trouble. Most analysts appear to think that a good portion of the new equity won't be entirely needed for further write-downs.

Canada's best business writer, Derek DeCloet, thinks however, that the remainder of the new equity will be useful as all banks head back to their core roots - making loans with their own capital, as investors continue to shun repackaged loans of all sorts.

CIBC shares have been trashed by the market over the sub-prime mess; the further $2 drop to $70 since the equity infusion announcement means that their shares have now lost some 35% since achieving their 12 month high in May 07.

While conservative CEO Gerry McCaughey has, in my opinion, done a good job since his appointment, one can only wonder what stick CIBC will pick up and play with next year.

Saturday, January 12, 2008

Would Morningstar like this portfolio?

Recently, I profiled a portfolio that looks like it could do well to help fund a financially secure retirement, based on borrowing against your home, and using dividends to make the payment.

Today I joined Morningstar, and looked up the rankings for all of those stocks. Some of their key rankings involve their assessment of overall business risk, the moat of the company, the overall rating (out of five stars), and their estimate of fair value. Now, due to their business model, I consider Morningstar ratings to be of higher quality than that churned out by the average investment house.

Of the eight stocks in the portfolio, only three of them have an overall "three star" (average) rating (Progress, Reynolds and Verizon), with GE having a four, and the rest at five stars. This suggests an above-average portfolio, overall.

The average ratio of current stock price to their indicated fair value is just 80%, with only Verizon over 100% (109%), and all the rest are at 92% or below. This suggests that, as a group, there is room for significant capital growth going forward. The best buy of the group on this ranking is Bank of America, which they estimate is trading at just 55% of their fair value estimate.

All of the businesses exhibit "average" business risk, except for Reynolds (above average) and US Bancorp (below average).

Five of the businesses are defined as having a "wide" moat, while the same three stocks that got an overall three star (average) rating had their moat defined as "narrow". According to information Morningstar publishes, only about 10% of their coverage universe achieves a "wide moat" definition, with about 45% achieving the next highest "narrow moat" ranking, and the balance defined as "no moat". This suggests that this portfolio is far more secure than average in this criteria.

In summary, I'd say that the portfolio is above-average quality in three of these four important categories, while still no lower than average in any category (average in overall business risk).

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Wednesday, January 09, 2008

Buying a Dividend Machine

Photograph: Cash-Flow Machine.

It's easy to say, but often tough to do: buy something popular, before it's popular. As Yogi Berra was once reputed to have said, "It's easy to make money in stocks; just figure out which ones aren't going to go up, and don't buy them"

However, research has repeatedly shown that buying stocks that return money to shareholders, through dividends and/or share buybacks, consistently outperform the market, usually by a wide margin (2% or more).

The best buys however, are usually those whose cash returns to shareholders are just beginning to turn upwards, and those that operate in a protected or oligopolistic environment.

Cable and cell companies fit the bill in terms of limited competitors, and two stocks whose fortunes appear to be ascendancy are Rogers Communications, and Shaw Communications.

Both trade both in Canada on the TSX (RCI.B and SJR.B) and also on the US exchanges (RCI and SJR) respectively.

After a several decades of infrastructure build-out and crushing debt, Rogers is emerging as a cash-flow machine. According to a survey of analysts, as reported here, Rogers is predicted to increase dividends from $1.00 annually to $1.60 later this year, to $2.40 is 2009 and $3.20 in 2010. Morningstar provides some further information, here (note, however, that the dividend information is out of date, as it has been recently raised).

What is also interesting here, is that if the consensus dividend projections are correct, it suggests that the stock may well also be revalued significantly higher by 2010. Compared to its recent price at around $41 (Canadian) with a 2.4% dividend yield, very few quality stocks in Canada yield much over 4.5%. Assuming that the $3.20 in dividends by 2010 is correct, this suggests that the stock may well be valued by the market in the low $70 range at that time, with the distinct possibility of something higher.

Similarly , according to a story here, Shaw Communications, a cable and telephone provider expects to be able to continue churning out the dividend increases. Morningstar provides some further information, here (note, however, that the dividend information is out of date, as it has been recently raised). Shaw's recent price of $23 (Canadian) is producing a 3.2% yield, and it also appears that there may be room for significant upward appreciation of the stock price if the dividends keep getting raised.

In another story, Shaw was picked by analyst Peter Gibson at Desjardins Securities in his outperforming focus portfolio, as one of eight Canadian stocks with the potential to outperform the market. He also picked Rogers in that same portfolio.

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I expect both of these stocks to outperform the broader market over the next five years, and the current dividends (and expectation of future increases) make that prospect just the more tantalizing.


The Confused Capitalist

EFT Benchmark: Broad Canadian Market "XIU" (on the TSX) - $80.40 (Canadian)

Tuesday, January 08, 2008

Make dividends work for your retirement

If you are going to buy stocks on credit, via a home mortgage loan, now is an excellent time to consider doing so. currently shows the average national 15 year fixed at 5.08% and 30 year at 5.56%. Here's how to make those fantastic rates work for you.

Let's say that you and your wife have poor retirement prospects (never saved any money) and are both now 50. By purchasing strong dividend- paying stocks, you can actually build a substantial positive cash-flow by retirement.

By screening for large-cap stocks, with strong dividend history, we can assemble a moderately diversified portfolio, with strong dividend history. Here's a selection of eight large-cap S&P500 stocks with a five year history of increasing their dividend over time - by an average of 8.5% annually. (Name - Industry - Stock Symbol - Recent Price - Dividend Yield)

  1. Wells Fargo (Bank) - WFC -$27.68 - 4.35%

  2. US Bancorp (Bank) - USB - $29.71 - 5.61%

  3. Bank of America (Bank) - BAC - $39.90 - 6.35%

  4. Pfizer (Pharmaceuticals) - PFE - $23.23 - 5.52%

  5. Progress Energy - (Utilities) - PGN - $48.37 - 5.19%

  6. Reynolds American (Tobacco Conglomerate) - RAI - $67.37 - 5.17%

  7. Verizon (Communications) - VZ - $43.35 - 3.96%

  8. General Electric (Industrial Conglomerate) - GE - $36.04 - 3.44%

These stocks, if bought in equal amounts, would currently produce an overall dividend yield of 4.95%.

If, for example, $20,000 of each stock was purchased, then a mortgage of $160,000 would have to be taken out. Using a 30 year fixed rate schedule, the monthly payment (5.56% rate) would be $914. Against that, the first year, you would receive dividend payments of $660 monthly; a modest shortfall of $255 monthly. However, even that shortfall would likely be in name only, since the interest (roughly $740 per month during the first year) can be written off on your taxes.

Assuming the dividends continue to grow by an average of 5% annually (against the actual average five year growth of 8.5% annually), by year five the dividend income ($843 monthly) would nearly match the actual payments, before the interest write-off.

Under the same assumption, by retirement at 65, a dividend income of $1372 per month would be produced, and by the time the mortgage is paid off in 30 years, $2852. If the dividend income grows at the same pace it has over the past five years, then you'd have to revised those two prior figures significantly upwards, to $2243 and $7628 per month, respectively. Sure eases the worry of being on a "fixed income" later in life!

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As a final plus, if the stock value also grew at an average of 5% per year, then the value of that portfolio in 15 years would be $332,628 and $691,510 in 30 years.

Lest anyone think that three of these stocks - the bank stocks - are too risky - be advised that billionaire genius investor Warren Buffett has recently added to his stash in these three stocks. And uncle Warren isn't noted for buying into distressed companies.

By the way, there's also a ton of academic research showing that dividend-paying stocks produce a better rate of return over time, and are less volatile than non-dividend-paying stocks.
Right now, funding a healthy retirement is easier than you might think.


The Confused Capitalist

Tuesday, January 01, 2008

Report Card - Predictions in Review

This is the time of year when many financial columnists and bloggers review their picks, predictions and suggestions made during the past 12 months.

I'm not going to do that, since this blog specifically makes the point that investing is a longer-term process, and picking your winners and losers an average of just six months later is foolish and leads to thinking which doesn't improve your long-term results.

What I am going to do is review the 2006 predictions and suggestions I made, providing a better longer-term outlook.

This blog started in February 2006, and on Feb 19th I looked at a portfolio heavy in dividend companies, with the hope that the dividend growth over about 5 years or so, would then pay enough in dividends to make a theoretical mortgage payment used to buy those securities with. Based on history, I was looking for a 10% annual portfolio growth, with about 5% of that coming from dividends, and 5% from capital growth.

Overall, the portfolio is up 12%, plus the dividend yield of about 5% annually, which is producing a return pretty much bang on. The dividends have also grown, from 4.75% annually of the initial portfolio value, to 5.08% annually now. Call that a win overall.

Incidentally, with long-term mortgage rates now in the 5.3% (15yrs) to 5.8% (30yrs) range, now is an excellent time to revisit that same strategy, although I expect the portfolio might well get stuffed today with many more financial firms, given some of their perceived difficulties and consequent high yields. Read the entire Leverage Series.

Emerging markets was a popular theme for me, calling them good value in March/06, May/06 and October/06. Buying the most-popular emerging markets ETF, "EEM", you'd be up anywhere from 45% to 55% depending upon your entry point. The S&P 500 moved up only 10-15% over that same period. Call that a clear victory.

I also suggested in March/06 that uranium producers had a long tailwind in their industry, given decades of under-mining the resource and shortages to come. The world's largest single uranium producer, Cameco ("CCJ") moved up by just 5% since then, against a 14% increase in the S&P500. However, since then, Cameco has also been plagued with production problems, which has likely impaired its stock price. Still, call this a loss.

In early March/06, I also warned that I felt the US currency would continue its descent, and later re-iterated this call in April. Since the initial call, the US dollar has lost 18% when measured against its largest competitor currency, the Euro. Call this a win.

Also in March, when many were suggesting that Berkshire's Warren Buffett had his better days behind him, I suggested it would be too early to count an extraordinary investor like him out. Since then, Berkshire shares have risen by 63%, rising from $87,400 to $142,200. Call this a win.

In mid-March, I felt that the oil-boom in Alberta Canada, was going to continue to positively impact their real estate sector, and suggested three companies who would likely be prime beneficiaries. Since then, these stocks have risen by an average of 42%, against Canada major stock index, the S&P/TSX60 (represented by the ETF "XIU" on the TSX) which has risen by 20% since then. Call this another win.

In late March, I suggested that inflation was on the upswing (a win), and that as a result of this, US homeowners would be wise to lock-in their variable rate mortgages (ARMs) to 15 or 30 year fixed rates, as rates will be higher in 2-3 years, and much higher in 5-7 years. While the jury is technically still out, long-term fixed mortgages were in the 6.25% range then. The freeze-up in the credit markets has resulted in the Fed dropping its rates, and 15-30 year fixed mortgages are now in the 5.3% (15 yrs) to 5.8% (30yrs) today. Call this a loss.

In April/06, I suggested that constructing a simple, sensible, long-term portfolio was as simple as "1,2,3 - A,B,C". That portfolio used just six ETFs, tracking both domestic and international markets. The portfolio gave consideration to value type investments, as well as growth through a 25% holding in emerging markets. It was also much more balanced internationally than most investors holdings, with 60% of its holdings outside of the US market. This portfolio has returned 22%, against an 11% increase in the ETF "SPY" (which tracks the S&P 500). Call this a clear win.

In April, I also suggested that the US market had reached its peak for quite a while to come - since then the S&P 500 has risen by 14%. Call this a clear loss.

In April/06 I also said that Canada's Ontario land-title provider Teranet (TF.UN), would likely jump upon its IPO issue to reflect a lower yield. While that did happen, it also fell subsequently on some poor results. Call that one a draw.

Looking back now, it seems like an easy call to say that the US residential real estate was going to get trashed, but then, not so many were certain of that. I made calls on this sector in March/06 saying it was too hot and re-iterated that again in June/06. In July/06, I twice advised against investing in home-builders or related stocks, warning that "it won't be pretty out there in two to four years". This warning came despite some sensible bloggers, notably Geoff Gannon and Bill of No-Do-Das, suggesting they looked like good long-term investments. Depending on which point you use, the home-builders ETF "XHB" has fallen by as much as 55% since then. Call this a can of "whupp ass" victory.

In September/06, I suggested another simple ETF portfolio, this time for Canadian investors, using just four ETFs. This one would have half of the portfolio invested outside of Canada, with the balance in the country. That portfolio is up 37% on a local (Canadian) currency basis, compared to a 22% improvement in the country's major index (S&P/TSX60). Call this another clear win.

Finally, in November/06, I suggested an investment in the leveraged split shares of LSC and ALB (trading on Canada's TSX) exchange representing several Canadian insurers and banks respectively, looked like good value. Since then then have fallen by an average of 2%, against the S&P/TSX60 increase of 13%. Call this a clear loss.

Well, that's about it - the way I read this is that I got almost all the major calls right - that is, the portfolio suggestions, the ETF builders (e.g. emerging markets, etc.), currency calls, and the real estate meltdown. And while I was right on the inflation rate indications (upward), I didn't anticipate the Fed dropping rates due to the credit market freeze up. And I also missed on a few individual stock predictions. However, I would say that my biggest miss was calling a US market high in April 2006. Overall, though, I'm pleased with how the suggestions have turned out.

I hope that my 2007 predictions and suggestions look as good in 2009 as these ones generally have.

PS (Jan 6/08): I now also recall a 2006 year end survey by Birinyi Associates who run the Blogger Sentiment Poll, asking which S&P500 stock did I think had the potential for the greatest increase over the year. I selected Coke, "KO", which closed on the trading last day of 2006 at $48.25 and the last day of 2007 at $61.37, for a 27.2% increase. By comparison, the ETF "SPY" (representing the S&P500) gained just 3.2% over the same period. Call that also a clear win.

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