Financial Jungle

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So you think you’re a hotshot daytrader? Let’s see if you can walk the talk.

My colleague recently forwarded me a link to this cool website called Inspectd, where you can trade real stocks with fake money. While the Internet is already littered with hundreds websites that offer similar features, Inspectd is unique in that you can “fast forward” your time-horizon to ascertain your daytrading skills in a matter of seconds rather than waiting for weeks or months. From the website:

Inspectd.com allows you to test your stock market skills against over 20 million actual historical charts. We’ll show you a random stock from a random date in the past, and you try to guess whether it rose or dropped. We’ll even give you $100,000 in play money to test your skill. But beware: it’s addictive!

My little test drive was a wild one indeed. The monopoly money zigzagged from $100k, to $50k, to $130k, to $65k, to $171k, to $40k, to $100k and finished shamefully at $35k. My biggest let down was SAM. It lured me into a deceiving uptrend just prior to slipping precipitously by 36%. Maybe you have better luck than I, but I’m going back to my day job tomorrow. Let me know how you did.

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Just because the financial sector is ruing Bear Sterns’s stunning collapse doesn’t mean all dividend investors are in dire straits. Smart investors who are surviving this bear market are diversifying into sectors that don’t correlate with the financial sector. Something like the largest pipeline operator in the country, TransCanada (TRP), should fit the bill, because it’s partially immune to both subprime and recession.

TransCanada is a huge conglomerate, but its 2 family jewels are pipelines and energy. Its “network of more than 59,000 kilometres (36,500 miles) of pipeline taps into virtually all major gas supply basins in North America.” The company is also one of North America’s largest providers of gas storage, and a key power plant operator with interests in approximately 7,700 megawatts of power generation.

The pipeline stocks tend to pour in vast amounts of positive cash, but they’re not traditionally known for their growth. However, things are about to change with a glut of crude and natural gas coming on steam in and around Alberta over the next 6 or 7 years. The problem is that the real demand for energy isn’t in Alberta; it’s in Southen U.S. And if crude gets clogged up in Alberta, all producers suffer a phenomenon known as apportionment, where a shortage of pipelines is preventing cruel oil from being shipped to places where it can command top dollars. With producers and refineries crying at both ends of the pipe, companies like TransCanada and Enbridge can come in to relieve the congestion. And to profit handsomely, of course.

Pipelines, are what some people call, a business with strong economic moats. Building a pipeline is tough work. It’s notoriously expensive, complex, and you must wait maybe 2 or 3 years to reap the rewards. On top of that, management must jump through many regulatory hoops, and duke it out with relentless oppositions such as First Nations, farmers, environmentalists and workers unions. The bright side is that all these Mount Everest tall hurdles tend to chase away rookie entrants wishing to duplicate the service. That’s great for long-term shareholders looking to protect their dividend streams.

Here is a map from TransCanada’s annual report showing off their pipelines which span from Canada down to Mexico. Over at the lower right (1) is the recently acquired $3.4 billion 17,000km long ANR gas pipeline system. Next is a 50% ownership in the $5.2 billion Keystone Pipeline (2), which is TransCanada’s venture into the oil pipeline business. This 3,500 km pipeline is currently under construction, and is expected to deliver 590,000 barrels of crude per day. Operation will begin in late 2009. North Central Corridor (3) is a $983 million expansion to the existing Alberta System gas pipeline. The two dotted lines (4) are the proposed Northern Pipelines: the Mackenzie Gas Pipeline and the Alaska Pipeline.

We always think of pipeline stocks as slow moving mammoths, but the company is firing on all cylinders with its numerous growth initiatives, such as the Keystone projects, northern pipelines and expansion to their Alberta system. TransCanada, along with arch-rival EnBridge, are in the most prosperous economical environment possible despite US slipping into a recession. Back-of-the-envelope math suggests that TransCanada is investing at least $11 billion in key pipeline and power projects between 2007 and 2010. (I know I’m underestimating this.) That’s a staggering figure relative to TRP’s $20 billion market cap. In 2008 alone, management forecasts overall capital spending to be $2.9 billion.

Here’s an image of their power plants and gas storages. The key excitement in this area is the refurbishment of Bruce A Units 1 and 2 (9) which is expected to add another 19% of additional megawatt of output in 2010. A couple of other initiatives include the Portlands Energy Centre (11) and Halton Hills Generating Station (10) generating 550MW and 683 MV respectively when they’re complete.

Valuation

At 16 PE, TransCanada isn’t exactly a bargain when compared to the 13.9 historical average. (Financials are still the cheapest.) But the business is investing heavily these days to accelerate revenue, cash flow and earning growths. Given their improved growth profile, I believe buying at historical average PE is a reasonably attractive entry price, or ~$33 with 4.3+% dividend yield. TransCanada closed higher on Thursday at $38.06. I’m keeping an eye on this one.

Disclosure: I have positions in TransCanada, EnBridge and Inter Pipeline Fund.

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Dividends4Life recently tagged me to write a post on My Top 3 Investing Mistakes. This series, originally launched by The Dividend Guy, is blasting through the blogosphere.

As the saying goes, “when you lose, don’t lose the lesson.”

1. Over Trading - After graduating from university in 1998, I found myself in a position to day trade $5,000 in a Royal Bank Action Direct account. I split my money 5 ways to buy high-tech stocks, and paid $29 per transaction; that’s $58 squandered away to buy and sell a stock. So, it didn’t take me long to realize that gluing my nose to the screen all day long was a high stress, zero-sum and money-losing game after fees. Which is why I’ve adopted dividend-investing as my preferred approach. It’s not intense. It’s positive-sum. It’s cheap since you buy and hold.
2. Allowing Emotions To Cripple My Judgment - One of my friends accused me of being too logical, and I agreed with him. But, I was kind of proud of it at the same time. I figured I was pretty good with numbers, and my pointy Vulcan ears would always keep my mind cool during financial upheavals. Of course, all bets were off when I started losing thousands in my trading portfolio. The story isn’t unique. I know this teenager from an investment forum who claimed to have been investing in stocks since 9 year-old — using fantasy money. Little did he know, the little pinch in losing monopoly money pales in comparison to losing real money that he may have saved for months or years. Obviously, I don’t have a heart of steel, but at least now, I understand what investment strategy works best for my psychology. At the end of the day, it doesn’t matter if you a dividend-investor, an ETF investor, a mutual fund investor, a real estate investor or a combination everything; the way to prosper in the market is to stay in the market in good and bad times.
3. Not Thinking Independently - I used to think scouring investment magazines, forums, blogs, and newsletters looking for top stock picks was considered doing my due diligence. But time and time again, I found myself drowning in a myriad of contradicting and unfounded investment advice. Many investment articles are written with inherit conflicts of interests. For example, hooking investors into buying stock-picking subscriptions, or favouring certain stocks in order to attract investment banking businesses. Even well intentioned wisdom by revered investors like Warren Buffett can be dangerous if not interpreted in the right contexts. But that’s another story. Ultimately, nothing beats absorbing investment literatures with a pair of unbiased eyes. Echoing sentiments of others is a recipe for long-term disasters.

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One of the greatest investing dilemmas I reckon with is ethical investing. Loading up on sin stocks doesn’t exactly align with my moral conscious. After all, most people like me have issues buying controversial companies like Lockheed Martin that thrive in times of war. But giving up these little devils doesn’t bode well with generally accepted investment principles such as diversification and return. Pull up a chart of S&P 500 and Lockheed Martin, and you’ll be surprised at Lockheed Martin’s low correction with the index, as well as its marvelous long-term out performance.

In his My Stocks Must Pass The Goodnight Test article, John Heinzl “vowed never to invest in such a vile product again.” The offending product he’s hissing at was tobacco. He recounted an accident where a driver was pronounced dead from a heart-attack that was possibly induced by cigarette consumption. A few weeks after the incident, John sold all his shares of Altria, the largest tobacco company in the United States, with approximately half of the U.S. cigarette market.

I personally don’t own any cigarette stocks, but I must confess; it’d be very tempting to wake up tomorrow and find all cigarette stocks on a fire sale. Not to mention, cigarette stocks have historically been most generous at puffing dividends at shareholders.

How do we measure the sin scale of a stock? Where do we draw the line to discern evil stocks from the ethical ones?

It’s interesting to note that prior to John Heinzl’s horrific car crash experience, he was content to hold Altria for their lucrative dividends. Tom Connolly of the Connolly Report also refuses to buy tobacco stocks because his sister died of lung cancer. That begs the question what if you own a stock that’s hurting everyone else except the people you know. Does that justify investing in a tobacco stock? Should it take a dramatic life experience before we evaluate the morality of a stock?

I also ponder how much of our perceptions are influenced by the media. We often don’t hear enough of the other evils that don’t illuminate as brightly on the radar screen. If you think tobacco stinks, how about oil? Last I heard, our energy consumption is punching holes in our ozone layer leaving irreversible damages to our precious environment. While the Earth is being worn down, the real causalities are the wildlife habitats and our future generations. Too bad for them, their mourning doesn’t garner nearly the same attention as tobacco. If we can somehow systematically measure sins in concrete and quantifiable units, I’m sure you’ll agree that cigarette, booze and gaming stocks are like little baby angels when standing next to these oil devils.

As Canadians, our love affair with energy stocks is best exemplified by the whopping 29.1% sector weighing on the TSX, beating financials to the top spot. Chances are, if you’re an equity investor, you’re probably heavily vested in energy stocks. To make matters worse, even if you’re not investors, the unconscionable is foisted upon you. An interesting fact is that in 2005, the Federal and Provincial governments collectively inhaled $7 billion in tobacco taxes. So much for trying to remain pure in our virtues. See the pavement you drive your car on? It’s built with cigarette money.

Although it’s virtually impossible to construct a completely ethical portfolio, looking at my core holdings, I’m relieved to say that my portfolio is relatively light on the sin scale.

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In his new book, Retire Rich From Real Estate, Dr. Marc Andersen doesn’t teach you how to flip your way to overnight sensational success. Get-rich-schemes only enrich those authors, who otherwise, couldn’t score big in the tortuous world of real estate investing. Marc is none of that. Rather, he advocates the safe and steady approach to real estate riches by using tips and tricks stemming from 2 decades worth of investing experience.

In his introduction, Marc highlights a dire U.S. Census finding where just 4 out of 10 private landlords were profitable in the year surveyed. In another study, 1 in 3 owners would not buy the same property again if given the chance, and less than half reported a profit on their investments. “The average investor in real estate is not successful and continues to make the wrong investment decisions,” Marc warns, because unrealistic assumptions are dumping investors to the poor house. However, don’t let this dampen your spirit.

To help place yourself in the top tier of all property owners, Marc outlines a series of practical guidelines in his book, which is filled with lesser known techniques (at least to me) on how to identify bargains, deal with realtors, calculate cashflow, finance the investment, screen tenants, manage properties, and much much more.

Probably the most important subject is on cash flow. The primary culprit that sinks property owners into financial hardships is the optimistic assumptions used when estimating cash flows. Is the 5% projected vacancy conservative? Will your renovation remain within budget? Is the existing landlord artificially inflating rent revenues by accepting risky tenants? Is the landlord artifically lowering expenses by neglecting maintenance? Marc recommends artificially fellow landlords in the neighborhood to ascertain the neighbourhood’s market rent. Good point. Some sellers will attempt to dress up their financial statements just prior to a sale. Always “verify, verify, verify,” and never accept financial figures from seller’s agent at face value.

The topic on valuing properties based on CAP rate is also neat. Investing based on CAP rate is akin to investing in dividend-paying stocks based on yield. Generally speaking, the lowest CAP rate has the best growth potential. Meanwhile, the highest CAP rate has little or no growth prospect. A happy medium is 1-2% above the prevailing mortgage rate so you get a balance of both good cash flow and reasonable growth. For example, ING Direct is offering 6.25% on 10-year fixed, so investors should strive for a 7.25% to 8.25% CAP rate. (I’m not sure if ING Direct charges a premium rate on rental properties.)

Sample lessons

• “For Rent” sign on the lawn is a cheap and effective way to find tenants.
• Think like a landlord, not a homeowner. Buy on highly visible areas rather than the one that’s tucked deep in the neighborhood.
• Landlording is the most unpredictable business because it deals with people. Always enforce lease agreements with descriptions of the lease, deadlines, and consequences.
• Flat paint types are easier to touch up without repainting the whole wall.
• Offer fast closing and hassle-free “as is” purchase as incentives to lower prices.

What I want to see in future editions

• Sample letters to tenants on evictions, warnings, new rules, late rents, and rent increases.
• Sample dialogs on negotiating for lower/higher sales prices, lower mortgage rates, and higher rents.

All in all, I think for anyone serious about becoming a property owner, Retire Rich From Real Estate is an essential book that is furnished with real-life solutions to circumvent real estate investing hazards.

Also check out reviews from Thicken My Wallet and Million Dollar Journey.