Financial Jungle

I received a few emails from readers singing the dividend investing tune and craving for more out of this blog. As much as I enjoy these praises, most of the ideas don’t originate from me. I certainly don’t live long enough to survive all the experimental mistakes and live to tell about them. Instead, I mimic dividend investors who have succeeded before me: Stephen Jarislowsky, David Dreman, Tom Connolly and bunyip. But the person who really spring boarded my endeavor into dividend investing is Scott M.(a.k.a scomac).

If you don’t know who scomac is, you owe it to yourself to dig up all the little nuggets he left behind in the Financial Webring and Canadian Business forums. In particular, scomac graciously shared this stock picking template, which I adopted and morphed numerous times over the past 2 years to suit my own investment style. His disciplines have also influenced many forum members/bloggers including Brad911 and Investor99.

To my immense delight, Scott visits my humble blog and even agreed to answer a few personal questions! Thank you Scott!

1 ) I remember reading a prior post of yours that you’re semi-retired. What exactly does that mean? How long have you been semi-retired? Are you working your dream job? How do you spend your spare time?

I would interpret semi-retirement to mean working when you want to, as much or as little as you want to and for reasons other than the need of employment income. I have been semi-retired for a little over three years. If working your dream job means not having to do anything, then I’m probably there.

We have a small farm, so that takes up some of my time, but not as much as it used to since our “herd” now consists of only one dog and one cat. Beyond that, I enjoy cooking, cycling, gardening, golf, skiing and….writing.

2 ) At what point financially did you decide it was time to phase in to retirement? Did you wait until your portfolio income covers your essential living expenses?

I just sort of fell into retirement. There was no grand plan. I had originally intended to go back to school and take some training so that I could enter the financial services industry as an advisor. I took the courses, but haven’t bothered to look for work. I doubt I have the personality for that gig. After I had been “semi-retired” for a year or so, we discovered that we had more than enough income as a family unit to continue living the lifestyle that we were accustomed to.

3 ) You’re a pretty young fellow. 47 if I remember correctly. If you were to travel back in time — but without the hindsight of market peaks and valleys — were there anything that you could’ve done to speed up semi-retirement even earlier?

I wouldn’t have done anything differently. The real wealth generator for me was a concentrated investment in personal business assets rather than the traditional savings and investing methods that are discussed in financial forums. We only began investing in the equity markets in a big way in the last 10 years or so.

4 ) You’re a regular at Financial Webring and Canadian Business. Do you think these financial forums are good training grounds for young people looking to shape their financial philosophies? Or, are they better off cutting out these intoxicating noises and sticking with good financial books, such as Personal Finance for Dummies?

I would advise young people to stick with a few good financial texts rather than spending endless hours on financial forums. I don’t want to downplay the value that these forums can have, but it would be difficult, if not impossible for novice investors to separate the good from the bad. They pretty much have to rely upon experienced forum members to correct any errors, poor guidance or miss-information that is posted. This is handled quite well at some forums, but it can be hit and miss at others. Just because an individual can make a convincing case for following a certain course of action, it doesn’t mean that it is the right path for the reader or even the alternative with the greatest probability of success.

My suggestion for a young person looking to get a good basic grounding in personal finance would be to read the following classic texts:

• “The Four Pillars of Investing” by Wm. Bernstein
• “A Random Walk Down Wall Street” by B. Malkiel
• “The Naked Investor” by J. L. Reynolds

5 ) It’s easy to get carried away and spend over 2 hours each day on forums. For someone thinking of participating in a financial forum, what should one do to make the experience more productive?

Limit your time. There’s more to life than sitting staring into a computer screen. If there are some specific things that you want to know about, then don’t hesitate to ask the questions. Remember that the only silly questions are those that aren’t asked. If you stick to specific areas of discussion that apply to your situation and avoid the heated opinion threads, you will likely find that your time spent was well worth it.

6 ) Forum participants often scoff at the “talking heads” from BNN, but come on! Although buying based on the top picks segments isn’t a sound investment strategy, it’s smart to augment their research with ours. And I’m not ashamed of being the first to admit, some of my favourite BNN guests include Norman Levine, Laura Wallace, David Driscoll, Gavin Graham, Bruce Campbell, Ross Healey and all the guys from Sentry Select. Do you have any superstars on your list?

Those individuals that take a balanced, prudent approach are those whose opinions I value the most. Ask yourself which one of these characters you would hand a blank cheque to and you will quickly discover whose advice is worth acting upon. From your list of individuals, the person that I would most likely have to manage our investments would be Norman Levine. Paul Gardner, of Avenue Investment Management, has been quite helpful to me on a personal basis on the fixed income side of our portfolios.

6 ) I believe you’re a hybrid stocks/ETFs investor. Tell us about your investment philosophy. What types of stock and ETF whet your appetite?

That’s correct. You can’t be an expert at everything is an old adage that I take to heart with investing. So, with that in mind, I select individual securities where I feel comfortable and use broad market ETFs to gain exposure to other asset classes.

I can be best described as an income investor. I’ve never been completely comfortable with investing solely for capital gains and having to rely on the greater fool theory where someone else will take my shares off my hands at a higher price. I like to be paid to hold investments and then the market value of these securities isn’t nearly so important to me (unless I’m buying or selling).

Our portfolios, in aggregate, are set-up to mimic a pension plan portfolio, so you could say that we engage in “core and explore” investing with the goal to have only about a third of our investments subject to active management with the other two thirds held in passive investments such as ETFs, a laddered bond portfolio and a few dividend paying stocks. The actively managed third could contain pretty much anything that I deem attractively priced from junk bonds to commodities. At the present time, I’ve been accumulating preferred shares, REITs and O&G shares.

7 ) Which tools do you use to research your potential investments? How do you determine the attractive entry prices?

Over the years, I’ve simplified my approach to researching a potential investment. If I’m not familiar with the company then I will spend a fair amount of time researching the company through resources that are available on the company’s web site and/or SEDAR. Once I’m familiar with a company, I’m quite satisfied to use the free historical data that is correlated on MSN Finance. For ETF research, my first stop is always ETF Connect. All of our various portfolios are tracked on the portfolio tracker at Globe Investor Gold. Globe Investor Gold is also my first stop for business news and I will periodically use the advanced stock/bond/fund screener functions.

I’ve used a commercial spreadsheet in the past, but I’m just as happy doing any calculations with my HP 10BII financial calculator. I think folks can get overly confident with their estimates of future value that some of these sophisticated computer programs produce. We can’t forget that it’s an “estimate”. To determine an entry price, I will use Time Value of Money and Discounted Cash Flow calculations that incorporates dividends, book value, growth of book value, growth of dividends and a discount rate that reflects my required rate of return which is typically 15%/annum. Hopefully this provides an adequate margin of safety to mitigate downside risk. As long as the price is reasonable, I’m more concerned that the company I’m looking at has the characteristics of sustainable long term growth that I’m looking for.

8 ) What are some of the core holdings in your portfolio?

• GoC 2021 RRB
• BLDRS (ADRD, ADRE) for international equity exposure
• SPDR (SDY, DSC) for US equity exposure
• Basket of Canadian dividend payers (BMO, BNS, CNR, MRU.A, PWF, SJR.B, SLF)
• Basket of Canadian preferred shares (mixture of financials and utilities)
• Basket of REITs/trusts/small caps (AP.UN, BR.UN, CUF.UN, CWT.UN, PKI.UN, RET.A, RUS)
• Commodities (CEF.A, ESI, NXY, PCA)
• Canadian pooled funds (bond, dividend income)

9 ) The recent market collapse had rumbled along leaving many road kills behind. Are you picking up any bargains these days?

I’ve been buying on a fairly consistent basis through out January. I’ve been active buying REITs, preferred shares and select stocks most notably in the O&G sector. Astute readers may have noted that I re-entered BMO as well. This was a result of a careful examination of the balance sheet after the release of the annual financial results in December. Whether or not my purchases prove out to be bargains only time will tell, but it is my view that they offer good value at the prices I paid. In the mean time, I’ll be quite content to collect the dividends/distributions.

This post is a continuation of my original analysis on Keynote Systems.

The wait is over. I finally scooped up a few shares of Keynote Systems this morning after a stunning 25% tumble — courtesy of a downgrade by Ferris Baker Watts from buy to neutral. *

Their latest quarterly results are out and they look pretty sharp. Revenues are up 12%, and net income is break-even compared to a loss of $369 million a year ago. (Note that my calculation of net income is Non-GAAP net income minus stock-based compensation.) The company just repurchased about 1.5 million shares since November 2007, and the board authorized, yet, another 2 million shares.

Keynote Systems now only has 17.8 million shares left due to the company’s aggressive repurchase program. Who can blame them? At $9.74 (after-hour trading), it’s a highway robbery.

The stock is cheap, and I believe the arithimatic is very simple. In theory, you can go to the open market and buy the entire company for a mere $173.4 million. But, this debt-free company is worth so much more. Strip away all their employees. Strip away all their intellectual properties. Strip away all their software and computer equipments. Nevermind goodwill and intangible assets. You’re still left with:

• An empty mortgage-free headquarter that’s worth $135 million**
• A bank account with $99 million in it

That’s a total of $235 million backed by hard assets, or a case of buying one dollar for 74 cents.

Who else is saying “yes” to free money?

Another value investor, Brad from Triaging My Way To Financial Success, sent me a heads up on the bargain and picked up a few shares himself.

* Couldn’t google any explanation on the downgrade. In general, I take these ratings with a grain of salt anyway. Keynote has a potent balance sheet that enables them to buy back tons of shares; a characteristic that most analysts hate because they tend not to receive a lot of underwriting businesses from corporations who are too rich to ask for more capital.

** Estimate based on $85 millions purchase price and 6% annual appreciation since 2000.

Sometimes, we just need a hero. This is even more so in the universe of dividend investing, which by nature is a contrarian style. Let’s face it. Dividend investors are always pooh-poohed in a cocktail party because they never share your misery in a market slide, nor your pizzaz in a market frenzy. Want to become a successful dividend investor? Forget about winning the popularity contest.

Instead, follow Warren Buffett’s proverbial mantra:

Be fearful when everyone is greedy and greedy when everyone is fearful.

So, does dividend investing really work? Are there real people who manage to pull this off? Of course we can always point to the foremost Stephen Jarislowsky, author of Investment Zoo, and Tom Connolly of The Connolly Report. But that’s not fair, you may quibble. They are one of a kind. How about someone a little less celebrious? Someone a little… umm… like us?

Folks, meet the retired run-of-the-mill dividend investor, bunyip, whom I met from the Canadian Business forum. Bunyip is a relatively quiet dividend investing veteran, but when this low profile investor speaks, enthralling words flow out of his mouth.

I’m delighted that he gave me the opportunity to interview him three weeks ago, just before leaving for his Central America vacation. Inquisitive readers should hang on to the lessons from his 20-year investing experience.

1) Bring us back to your foray into investing. Did you experiment with various types of style? How did you stumble into dividend investing? What appealed you?

I started investing in the early seventies and made all possible mistakes (never twice). I changed strategies several times and it wasn’t until 1992 that I invested exclusively in dividend stocks and even used to sell half when a stock doubled. Now I rarely sell anything, just reinvest all dividends. I’m retired (freedom 55) but have pension so I probably won’t use non-registered account for anther 10 years. I could have retired earlier but I enjoyed my job and after all debts were paid we had a lot of money to put into stocks.

I bought my first shares in the seventies (20 shares of Simpson-Sears @ around $40). They split 4 for 1 soon after and I used to get a dividend cheque for $10 every few months. I kept them for several years until I bought my first house and sold for a small profit. My next foray into the market was in the late seventies when I was buying small cap mining stocks on the Vancouver exchange and gold coins. Did well with the gold but rather indifferent results with the speculative stocks. It was during this period that I started to read everything I could about the markets and created a starter list of dividend yielding stocks that I wanted to own. By 1992 my mortgage was paid off and I was able to start working my way through the list. It wasn’t until I got a computer and joined TDW that I really developed my own style. At that time I would still sell half of any stock that doubled, a carry ever from the junior resource days, a strategy I came to realize didn’t make any sense. For the last 3-4 years i haven’t added any new funds as I have reach all my targets and average $3000 per month in dividends that i reinvest, mostly in stocks in which i already have a position. Now I rarely sell anything and don’t care about the size of the portfolio, just the year over year increase in the yield.

2) What personal traits are best suited for dividend investing?

Patience for sure, especially in the beginning when increases come so slowly. It is always tempting to go for a “home run” but to build a large dividend stream requires discipline, pick a strategy and stick to it. There are many stocks that have more than doubled their dividends in the last 5 years such as the major banks, ENB, FTS and IGM. I also manage the portfolios of two very old relatives and in one of their accounts it is interesting to note that the dividends paid on several stocks are now higher than the original purchase price. So start young and have patience. I was driving across N. Ontario a few years ago and looking for a radio station to help keep me awake and the only one I could receive was a CBC affiliate doing a phone in gardening show. One of the questions was “when is the best time to plant a tree”. I think the person was looking for an answer like spring or fall. The expert replied “twenty years ago”. That answer could also apply to when is the best time to buy stocks.

3) How do you research your stocks, and what characteristics are you looking for? How do you determine your entry prices? Do you sell after a strong run-up? Do you average down?

Mostly annual reports as I mostly only buy stocks in which I already have a position. Also read both National papers and Globe’s website. I look for a history of dividend increases, ideally a payout ratio of less than 60% and increasing revenues. Entry price? I don’t try and time the market, I buy when dividend revenue is sufficient to buy the next stock on my list. That being said, I’ll buy more if the stock or the market overall drops. I virtually never sell anymore and a strong run-up works against me, it makes everything more expensive. I buy all stocks at market price because all stocks I buy are very liquid and would prefer not to miss a dividend or end up paying a higher price just to save a dime.

4) What stocks are in your portfolio?

Agf.B, Aco.X, Bmo, Bns, Bce, Cm, Ema, Enb, Fts, Igm, Mbt, Mfc, Pow, Pwf, Roc, Ry, Rus, Sap, Slf, Tck.B, T, Td, Ta, Trp, Fap. Trusts- Aet, Apf, Bfc, Cix, Cos, Cne, Cwi, Eit, Mpt, Npi, Pif, Pgf, Prg, Rei, Ylo, Ep. There are several of these that wouldn’t meet my criteria today- Mbt Rus and Tck.

You may have noticed that I hold no mutual funds, just mutual fund companies. I don’t spend any money on MER or even pay for ETFs. They will eat your profits over the long term. My total expenses for a $650,000 account last year were $89.91 representing 9 trades. If this were mutual funds (well you do the math). Mutual funds have to trade often to show gains that they use in advertising, a retail investor in dividend stocks has a huge advantage. A stock that regularly increases it’s dividend and is held for the long term will come out ahead of most mutual funds in the long run.

5) What were some of your best and worst moves? If you were to travel back in time, would you do anything differently?

Best moves- Buying a lot of trusts right after Flaherty’s announcement. TRP@ 11.45 in 2000 after a dividend cut (since restored and then some). Worst- After reading a book on demographics I bought Extendicare and Louwen Group(2nd largest funeral Co in N.America). Both companies were involved in very expensive lawsuits in the US. Exe. survived but Louwen went from $40 to zip. Be diversified.

6) What are you thoughts on investing with borrowed money to enhance return?

Or enhance losses? I think it is human nature to want things to happen faster but it goes back to an earlier question. Patience. Hey but if you are successful, you’ll look like a genius.

7) How do you define financial freedom, and are you financially free?

I am financially free and have been for many years. I probably worked a few years too many because it is very difficult to say when one becomes financially free. I stayed longer so I would have a cushion but realize I don’t need that big a cushion.

I am also a jungle guy and am leaving Friday [FJ: that was 2 weeks ago] for a jungle lodge on the Costa Rican/ Panama border for 2 weeks. No phones, no computers, no stock market. I’ll probably be in withdrawal for a couple of days.

8 ) What stocks appeal you these days? What are you avoiding?

The next three I’m adding to are Fts, Td and Pwf. I’m avoiding anything to do with medicine or aviation, I have never made a cent on either though I tried often enough.

9) Any good books or websites you recommend?

I was impressed with your website. I do a lot of reading but nothing pertaining to the market as my portfolio is becoming less hands-on all the time.

Sure, you can invest in this 3-bedroom Vancouver old timer yielding a meager 3.5% to 4% CAP, but why torment yourself? Instead, you can indulge yourself with an 8.2% yield by owning these sexy office towers within H&R REIT’s portfolio:

As you may recall, the market has been punishing the Real Estate Income Trust (REIT) sector for much of 2007 and into early 2008, while the average yield is inching up each day. No one knows how long the spanking will persist, but as of this moment, the whole sector is roaming into bargain territory as many REITs are yielding well above 7%. That is far more attractive than the 3.74% offered by Canada 10-year bond, a popular yardstick to judge how attractive the REIT sector is relative to a guaranteed income investment.

I have taken an interest in H&R REIT - the largest Canadian office REIT and the overall second largest Canadian REIT behind RioCan. Today, HR.un is distributing an annualized $1.44 or 8.2% based on closing price of $17.49. That looks pretty cheap to me, and insiders agree. CEO Thomas Hofstedter and directors collectively scooped up $3 million worth of units in Nov & Dec at prices above $19. I picked up half a position at $18.05, but if we’re lucky enough, the trust will trade below $16 for a 9% yield. Otherwise, I’m happy to hold on to the half position for the long haul.

Back in 1999 when euphoric investors were dumping REITs while flocking to the ecstasy of dot-com land, HR.un traded briefly above a 12% yield at a time when 10-year Canada bond was yielding 6.25%. Outside of this anomaly, HR.un’s yield was around 10%, or a 4% premium above Canada bond. Today, the market is giving us a second chance to own this REIT at a 4.5% premium above Canada bond.

HR owns a portfolio of 35 office, 125 industrial, and 142 retail properties across Canada but principally in Ontario. Some of their well known creditworthy tenants include Bell Canada Inc., TransCanada Pipelines, Bell Mobility, Telus , Royal Bank, Public Works of Canada, Nestle, Canadian Tire, Finning International, Circuit City, Rona, Lowe’s, Shell Oil Products, Home Depot, Wal-Mart, Chapters, Famous Players, Walgreens, Sobey’s and Shoppers Drug Mart.

The trust has steadily bumped their distribution over the years, rising from $1.03 in 1998 to $1.44 today, or an annualized 3.8% growth. (They just increased distribution by 5.1% this month.) Together with the 8.2% yield, that’s a total return of 12%. Not too shabby for a hard asset class that’s traditionally weakly-correlated with the stock market. And if you’re into DRIP, HR offers a 3% bonus if you reinvest the monthly distribution to buy more units.

Real estate, by nature, is a highly leveraged asset class. HR’s average mortgage term is 10.4 years, but this is paired with an average tenant lease duration of 12.2 years with only 12.8% of leases expiring by the end of 2012. Nothing is bullet proof, but mortgage payments appear well covered. Nimble management was quick to snap up cheap buildings in a hot real estate market. New properties acquired during the first 3 quarters of 2007 cost the REIT a weighted average mortgage interest of only 5.67%, giving them an expected levered return on equity invested of 12.1%.

The only thing peculiar about HR is that their payout ratio actually exceeds 100%. The portfolio released $133.2 million of cash during the first 3 quarters of 2007, but distributed $133.7 to unitholders. This practice appears normal judging from other landlords in the REIT space. For example, bellwether REIT, RioCan has a shocking 116% payout according to a TD Waterhouse report. My only explanation is that REITs with a deeper pipeline can afford to over distribute in the short-term; RioCan has 10 properties in the pipeline versus HR’s 3.

** This is not a recommendation to buy. I’m not a REIT expert. If you have an opinion on HR or REITs in general, I’d love to hear about it.

For more info, please visit www.hr-reit.com.

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Telly recently left a comment on my Top 5 Reasons Why Dividend Investing Over ETF post expressing her skepticism that anyone can build a diversified portfolio yielding over 4% “without loading up on some income trusts which are not favourably taxed or becoming less diversified by owning only high yielding dividend companies.”

I figure it would be a fun exercise to build this high-yielding diversified portfolio, although I wouldn’t shy away from income trusts. In my opinion, income trusts are an absolute key ingredient to sprinkle over a diversified portfolio. Just because some our best Canadian cash cows are structured as income trusts doesn’t mean we should place them in the penalty box:

• Canadian Oil Sands - a 33 year life reserve of tarsand with no exploration risks like most other energy trusts.
• Consumers Waterheater - Torontans take warm showers recession or not.
• CML Healthcare - a highly profitable diagnostic, laboratory testing and medical imaging services business that is pouring out distributions from its opearational cash, and while paying back debts at the same time.
• InterPipeline - a stable and low payout ratio pipeline trust that’s not sensitive to commodity prices. I covered IntePipeline in a previous post.
• H&R REIT - any diversified portfolio must include real estate. With H&R REIT, you get a little bit of office, a little bit of retail, and a little bit of US. I’ll cover this particular REIT in a future post.

I put this hypothetical 20-stock $100,000 portfolio together based on Friday’s closing prices. I started initially with a list of 30 stocks, and then painstakingly chopping it down to 20, although I’m the first to admit that investors should stick with 30 or more just to spread the eggs around.

As many know, the TSX composite is uncomfortably concentrated in the financial, energy and materials sectors. So, one of my main objectives is to diversify away from these them and place heavier emphasis on real estate, health care, consumer and pipeline stocks/income trusts.

Incidentally, I purposely left out Russel Metals, Manitoba Telecom, CIBC, National Bank or Bank of Montreal as I’m sure many were anticipating. The only high yielding dividend stock is Rothmans, which has a tradition of raising payout and occasionally rewarding shareholders with special dividends. Not to mention the business is recession resistant. But given the portfolio’s lofty 4.69% yield, we still have the buffer to add other lower yielding stocks like Talisman, Shoppers, Research In Motion and Potash without falling short of the 4% target.

I could be tweaking this portfolio all week long, but without further ado…

*** This is just a fun post. Do not interpret this as a recommendation to buy.

All right, that’s it! Those ETF bullies have tormented us dividend stock pickers long enough. I’m retaliating. My headgear is on. My gloves are strapped. Give me your best shot.

1. Less MER - In fact, buy-and-hold dividend investors pay no MER at all. Regrettably, iShares CDN LargeCap 60 ETF (XIU.to) and TD Canadian Index eSeries seize 0.17% and 0.31% respectively. Which means, dividend investors have a 0.17% to 0.31% head start each and every year.

2. More Diversified - Most investors refer to the other types of diversification: by sectors and by geographical locations. This is a non-issue for investors with 30 or more stocks. As long as your eggs are properly spread amongst different baskets, the portfolio will achieve similar volatility as the general market. At least one study found that 90% of the unsystematic risk can be diversified away with as little as 12 stocks.

Sure, diversification does alleviate uncertainties in a portfolio due to particular sectors or countries, but there is a much bigger monster in the room, and that is market sentiment. No matter how much you slice and dice your portfolio, all sectors are still subject to market sentiment. The past few months are a testament of how every sector limps along while the market is howling over its PMS. No one can escape the carnage. The way I see it, dividend investing is the only remedy to help us cruise through the turbulence while remaining fully invested in the stock market. Just look at Bank of Nova Scotia. It’s basically the same old boring bank as yesterday, last week, last month, last quarter and last year, but its 1 year chart resembles 6-flags roller coaster. All that while, their distribution policy is steady as she goes.

So, dividend investing offers you another dimension of diversification by easing reliant on market speculations, and rewarding you with real hard cash straight from the operations of your high-caliber businesses.

3. More Tax Efficient - A $35,000 salaried British Columbian profiting from a $5,000 capital gain must pony up an extra $615 in taxes. The same British Columbian receiving a $5,000 dividend would pocket a $175 tax refund. (That’s almost enough to pick up 4 more BNS shares!) So, ETF investors must overcome both the MER and the tax refund every year.

4. Extended Investment Horizon - Due to market sentiment described in point 2, ETF investors must gradually shift their equity exposure toward bond to protect their nest eggs from market volatility. Consequently, a 25 year old ETF investor may only have a 30 to 35 year weighted investment time horizon before reaching 65. This is a double whammy for them: the investments have less time to compound, and the turnovers create tax-drags against the portfolio return. And don’t forget that bonds are taxed as regular income.

On the other hand, dividend investors can prolong a carefully crafted portfolio because dividends are never at the mercy of market turbulence. By sticking to stocks with a history of rising dividends, or businesses that provide essential goods and services, you can afford to hang on to the portfolio longer. I think the best defense is the best offence. If anyone can prolong a dividend portfolio for 40 years, the dividend compounding coupled with the preferential tax treatment will deliver enough capital cushion to hold to the stocks forever.

5. Less Market Timing - Contrary to popular belief, a thoroughly hands off approach to investing is an illusion. Eventually, a retired ETF investor will have to live off his equities. Unless he turns over 100% of his portfolio to bonds (I smell capital gain taxes), the 4% withdrawal rule is going to pinch during bear markets. If hysteria sinks the market down 15%, can he afford to devour another 4% and erode his already undervalued capital? If euphoria drives the market up 15%, should he take out a little more in anticipation of a trend reversal? You see? There are so many crucial market timing decisions. Doesn’t sound to me like a relaxing golden age.

A retired dividend investor doesn’t need to fiddle with his portfolio whether the market is sad or happy, because the dividend stream is more dependable even when the market is tumbling. And courtesy to points 1, 3 and 4, a dividend portfolio should enter retirement with a much larger base and yield, and be able to outpace inflation and cushion any unforeseen dividend cuts.

Further reading: A brief history of high yield stocks

My parents called the other day reminding me to cut back on dividend investing and start securing a house for our future. A house is a hard asset that always goes up, they reasoned, but stocks are just pieces of paper which can vapourize into thin air.

Predictably after the call, I was in no hurry to scamper to the real estate parade and satiate realtors with fat commissions. Contrary to the popular belief, hard assets do stand firm behind stock certificates: factories, equipments, pipelines, phone towers, cheese, hot water tanks, railways, trains, pills, hydroelectric plants, customers, revenues, profits, bank accounts and many more. Moreover, real estate doesn’t always go up. Suppose you bought a home in Vancouver during the peak of 1980, it would have taken 26 years to recover your money.

However, I must concede that our net worth is running dangerously low on real estate. What should we do? Perhaps we should buy stocks with real estate on the balance sheet. That’ll drive the parents crazy.

When it comes to real estate stocks, Riocan tends to balloon to the A list. That’s because Riocan is the de facto alternative for frugal investors wishing to save the 0.55% MER on the iShares CDN REIT sector index fund; Riocan commands 24.4% of the fund. The flip side of the coin is that this artificial inflated price premium is hard to justify considering Riocan’s 6.3% yield is well below the average (~7.6%), while their distribution growth hasn’t exactly raced ahead of the pack.

Rather than placing all my real estate eggs in Riocan, another option is to diversify the cash between Calloway REIT and Brookfield Properties. That way, I get exposure to both retail and office properties.

Calloway’s success is riding on the ferocious Walmart invasion into the Canadian retail market. Over 100 Calloway malls are anchored by Walmart who are contributing over 25% of Calloway’s total rent revenues. According to Andrew Guy of Sentry Select, Walmart is a tough negotiator. But having their presence serves as a super magnet attracting foot traffic and secondary tenants to the retail stores. With 125 retail properties under its belt, the trust isn’t that much smaller than rival Riocan’s 208. REIT expert, Dennis Mitchell, forecasts Calloway to surpass Riocan as the largest REIT in Canada within 2 years. There are many more reasons to like Calloway: it’s trading approximately 15% below NAV, the 6.7% yield is higher than Riocan’s 6.3%, and it’s been raising distributions at a vigorous pace. Expect more of the same from Calloway as it’s laying the foundation with 15 properties in the pipeline for development versus Riocan’s 10. Additionally, 92% of total properties are little babies, all of which younger than 13 years.

When you buy Brookfield Properties, you become a proud owner of trophy office assets around key metropolitans in North America, most notably New York. CEO Ric Clark projects a 50% increase to operating profit from the current development pipeline, but that’s before plowing their way to become the lead contender to win the Manhattan-based Hudson Yards project which should pad another 30% to 40%. The Hudson Yards project would be an image booster according to Sinclair Stewart, “[Brookfield Properties] is widely regarded as a formidable office landlord, with a portfolio of roughly 100 properties that punctuate the skylines of New York, Los Angelas, Toronto and Boston, … As a developer, however, its credentials are far less certain… The Hudson Yards would change that perception overnight, conferring instant credibility, nearly doubling the company’s development portfolio.” So far this year, the lingering concern over Merrill Lynch’s upcoming lease expiration sent the stock tumbling 50% from its peak in February. According to Dennis Mitchell, Brookfield is sporting a juicy 25% discount to NAV. BPO offers common shares yielding 2.8% of pure dividend.

Admittedly, real estate stocks are notoriously challenging to analyze due to the ever morphing balance sheets. What are you thoughts on these 2 real estate trust/stock? Do you have suggestions on how to approach real estate investing?

You can now check frequently asked questions and answers for mortgage basics information. The mortgage calculator and the amortization table help you to check the extra payments on mortgage. Several buy to let mortgages offers are very attractive for the landlords and others who are interested in real estate specially. Now banks easily provide home loans with out any home mortgage. Different kinds of credit cards are also available with loans.

You have to be a Vulcan to remain unrattled by the November blizzard that knocked the TSX index off by nearly 8%. All of a sudden, the market has become pessimistic, and rightfully so as many indicators are foreseeing a recession looming. It will suck if a recession storms in uninvited. After all, who will spoil us with dividend increases when cash flows aren’t there?

While many investors have their tongue frozen to the credit crunch pole, the conservative ones are now keeping their portfolios warm and toes-curled under a blanket of utility, consumer stable and health care stocks; ones that deliver essential products and services to the general population irrespective of the market cycle we’re in.

What are some of our basic needs? Food, water, electricity and heating. Last week, I highlighted Borelax Power Income Fund, which owns 10 power plants in Quebec and the state of New York. Staying on a similar theme, I recently invested a position in the Consumers’ Waterheater Income fund (CWI.un).

If you live in Toronto, you recognize that heat and hot water are two of the most elementary needs. CWI rents out 1.4 million natural gas-fired water heaters to 83% of residence in the Enbridge Gas Distribution network within the Greater Toronto area. A boring business, isn’t it? Which is why this investment is so exciting in my view, because mundane businesses tend to come with less baggage, and it’s easier to evaluate if they’re cheap.

CWI’s rental fees are bundled in the customers’ natural gas bills. Brilliant! Not only do they provide essential services, the fees are buried deep inside the monthly gas utility bills which everyone almost always pay in auto-pilot mode. Very few businesses are more vital and stable than CWI; S&P agrees. The trust receives a AAA credit rating and SR-2 stability rating given its conservative balance sheet and recession proof character.

CWI’s minimal capital expenditures are mostly geared toward renewing 5% or 6% of its asset base in a given year, because a typical waterheater has a 15-year lifespan. In addition, CWI has little operating risks. A partnership agreement with Direct Energy Marketing Limited means that nearly all of CWI’s service support is outsourced in exchange for 35% of the aggregate rental revenues.

What more can you ask for in an income trust? Capital expenditures are minimal, revenue stream is stable, customer base is growing, share count is in check, and bank balance is growing.

In fact, between 2003 and 2006, CWI’s vault swelled steadily from $17 millions to $39 millions without diluting shares or eroding debt-level. With the business flush with cash, CWI recently plunked down $10 millions as a 25% down payment to acquire Toronto Hydro Energy Services units for $41 million. This represents a 6% increase to the total installed waterheaters.

The growth potential doesn’t end there. According to their website:

Beyond the existing service arrangement, the Direct Energy relationship has the potential to bring new growth opportunities to the Fund. As Direct Energy expands its home services footprint, the opportunity arises to rent water heaters to these customers. In addition, should Direct Energy successfully establish a significant base of rental water heater customers elsewhere in Canada, the Fund has right of first refusal to acquire it.

Management foresees the rental rate to rise in tandem with the rate of inflation. Between that and the growing asset base, distribution should improve by about 5% a year. Each CWI unit delivers an annual distribution of $1.29. Based on Friday’s closing of $14.93, that’s a yield of 8.64%. Anything above a 9% yield for CWI is cheap in my book.

If you happen to purchase CWI, consider the tax consequence: CWI’s distributions are not as tax friendly as most other trusts. 97% is treated as interest income with only 3% is return of capital. It’s better to hold the trust in a tax-deferred account such as RRSP. Short of that, you could hold the trust in a non-registered account of the spouse in a lower tax-bracket.

It’s a sad day yesterday as I eliminated my National Bank position after holding the stock for 21 months. Of course, it’s also one of the very first four stocks I purchased when I began my dividend-investing foray (the others were Power Financial, Bank of Nova Scotia and Saputo).

While the sentimental value of National Bank made the sell button excruciating to press, I felt it was the right decision in light of NA’s large asset-backed commercial paper burden relative to its market capitalization. The mounting writedowns should persist for several quarters, distracting management’s attention away from the day-to-day operations and growth strategies. Even without the distraction, NA’s geographical reach seems to be boxed within the Quebec province. Why don’t they just go buy something? I also have skepticisms against management, but let’s no go there.

Enough of my ranting. So, where to redeploy the proceeds? The choice is obvious: TD Bank. The more I read about the subprime fiasco and TD Bank, the more I like Ed Clark. Writedowns? What writedowns? You’d think Ed Clark is taking Tylenol to cure his ABCP migraine, but no! He’s taking Viagra to extend his reach into the United States. Officially with the Commerce Bancorp acquisition, TD blossoms to become the seventh largest bank in North America while other banks are fleeing with a tail between their legs; only the highest quality banks shine eminently during financial crisis such as the one we’re in.

The story doesn’t end here. One of TD’s prime online trading competitors, E-Trade Financial, may go bankrupt because it gobbled more home loans than its cash-flow permits. This is good news for TD, because should E-Trade files for bankruptcy, customers are only protected up to the first $100,000. Half their customers are over that limit according to Sinclair Stewart of Globe and Mail. For these clients, the sensible reaction is to lunge for a quick exit, and jostle to TD Ameritrade.

Another option is for TD Ameritrade to acquire E-Trade, a potential bargain now. I like how Derek DeCloet put it:

E*Trade’s fall is stunning. In 1999, at the peak of the Internet lunacy, it was (very) briefly worth more than the Bank of Montreal. Now it’s worth less than little Canadian Western Bank. Not five months ago, two hedge funds asked - no, demanded - Ed Clark to get out of the way and let TD Ameritrade, the Toronto-Dominion Bank’s partly-owned U.S. brokerage, merge with E*Trade. Since then, the latter has lost about $8-billion in market capitalization. Where are the hedge fund geniuses now? Awfully quiet.

E-Trade is still a prestigious brand. All Ed Clark has to do is spend a few bucks ($600 millions) to bulk up its presence in the discount brokerage space. It’ll be interesting to watch how the story unfolds.

Is it possible to buy an income trust with no money down and still own it free and clear in less than 7.5 years?

While browsing the Standard & Poors and DBRS rating pages looking for income trusts with strong stability ratings, I came across the power utility trust, Boralex Power Income Fund, which is rated SR-2(stable) and STA-2(low) respectively. You won’t find the typical income trust suspects. The fund doles out distribution using internal cash flow without eroding balance sheet (debt/equity = 0.30) or diluting share count. They own 10 power stations in Quebec and the state of New York:

• 7 hydroelectric power stations (51% of total output)
• 2 wood residue (33%)
• 1 natural gas-fired cogeneration plant (16%)

These power stations have amazing longevity with a couple dating back prior to the First World War. Furthermore, each station has power purchase agreements ranging anywhere between 20 and 40 years. As long as water continues to flow on rivers and population continues to grow, Boralex will continue to electrify investors’ bank accounts. Isn’t this a simple antidote in an investment landscape whipsawed by assets-backed commercial papers and recession chatters?

The strong stability does come with a handicap, however; the trust has virtually no growth prospect, which is why a cheap entry price is so paramount. The trust traditionally trades between $9 and $10, and despite hovering around $9 recently, the 10% yield was simply not up to snuff to justify the lackluster growth. Not being deterred, I shelved the trust onto my watch list just in case bargain surfaces.

Lo and behold, the trust has since been constantly banging at my door screaming, “new 52-week low!” Even the Financial Webrings forum is picking up on the story.

Not wanting to pass up a good opportunity, I raided half a position on Friday at $6.60. You ready for this? With its annual distribution at 90 cents, the trust is yielding a generous 13.64%! Not only that, most of the distribution is in the forms of return of capital and dividend, and with only a ninth in income, the distribution is practically tax-free. Even with no distribution increases, the trust’s compounded return will still eclipse the broader market. In case you’re curious, I mortgaged my water dams with a margin loan, but this is more lucrative than buying a Vancouver property with no money down. Just for fun, I calculated it’d take 7.5 years to wave farewell to the mortgage without forking a single dime. That’s assuming a marginal tax rate of 30%, and a tax-deductible 6.25% interests from Interactive Brokers.

So why is the trust being punished? The answer likely lies in the unfavourable hydrology in the 3rd quarter. Hydrology is fickle science. Due to unusually low water level, their hydroelectric segment generated 22.8% less than historical average, even though that’s only for one quarter. It was only a year ago when the water current was exceptionally strong, while year-to-date, the segment is down only 6%.

In my opinion, investors are unjustly extrapolating this poor quarter well into future return.

The water dams look the same, smell the same, sound the same, and feel the same as yesterday, a week ago, a month ago, 10 years ago and will likely remain the same decades into the future. The only difference is they’re 40% cheaper than the 52-week high. Moreover, these hydroelectric stations represent only half the eggs in the basket. The other half is humming along just fine; the 2 wood-residue thermal power stations and a natural gas-fired cogeneration plant have revenues steaming 7.5% and 20.0% higher respectively.

Having said that, there is no free lunch here. The production isn’t guaranteed, and we don’t know if the 2011 income trust tax ruling will choke cash flow. In my opinion though, as long as the trust is held outside of RRSP, the after-tax distribution shouldn’t change much, but I won’t go into the math here. Since power trusts are generally considered stable and boring, coupled with Boralex’s conservative balance sheet and high ratings from S&P and DBRS, I feel the distribution is safe, and the higher yield offers a margin of safety in a rare event of a distribution cut.

Drooling over living off passive incomes one day?

Before plunging butt first into the sea of dividend-paying stocks, you must perform your due diligence. Get your hands on every conceivable dividend investing literatures: Dividend Growth, The Dividend Guy, Dividend Money, Dividends Matter and The Investment Zoo.

Then, you will need a few candidates to furnish your stock watch list. Not that these are all dirt cheap at the moment, but given the right entry points, these stocks will serve you well over the long-term to achieve your retirement goals.

1. IGM (3.40%) - The house always wins in casinos, and in the world of mutual funds, IGM is the house of King Kong. Every time a customer buys one of IGM’s array of equity investment products, he’s seemingly swindled anywhere between 2% to 3.5% in management fees. Much of these will eventually funneled to spoil IGM shareholders in the form of dividends. This is why I feel so guilty being an IGM investor. Can you blame me for yearning over this cash cow? The high yield coupled with the traditional dividend hikes in the teens make this one of the most formidable dividend payer in TSX.
2. Manulife (2.20%) - Another King Kong, but this time it’s in the life insurance space. Well managed by one of the most respected CEOs in Canada, Dominic D’Alessandro. Under his helm, Manulife doubled both its revenues and dividends over the past 4 fiscal years, thanks in parts to the brilliant John Hancock acquisition in 2003. The business has been so profitable, D’Alessandra accumulated over $10 Billions in the company vault to scout for other home run acquisitions. Manulife is not only big in Canada, but its operations are well diversified in the US and Asia, and currently penetrating the rapidly growing Chinese economy.
3. TD Bank (3.30%) - With the announced acquisition of New Jersey-based Commerce Bancorp, TD bank is now a true North American bank, according to CEO, Ed Clark. You have got to hand it to this guy for clutching his cash up until the last possible moment - when his Canadian bucks are near the all-time-high and US banks are in dire-straight. If I’m going to entrust my money to someone, that would be Ed Clark, who’s also genuinely composed enough to not succumb to U.S. subprime mortgages; unlike most other banks. The fact that TD sports the cheapest price/book among Canadian big backs and commands the biggest market share in online trading space give you reasons to buy and forget about it.
4. Canadian National Railway (1.60%) - One of the most diversified and efficient railroad business in North America. The CNR stock has been derailed recently by the rising Canadian dollar and ailing forestry sector, but this presents a buying opportunity for a long-term hold. Over the next many decades, CNR will continue to chug along as a big player in a space with strong economic moats. For one thing, it’s too expensive for new entrants to jostle into the railway networks. For another, oil prices will likely remain high, and that will set the stage for trains to surpass trucks as the most efficient mean of transportation. Of course, the fact that Canadian National Railway, Canadian Pacific Railway and legendary long-term investor, Warren Buffett, are all gobbling up other railway stocks is a hint that bargain hunting season had just begun.
5. Encana (1.10%) - When you invest in gas giant, Encana, you own oil and gas properties all over North America as mapped on their Corporate Profile page. This business is a money making machine who understands how to take care of shareholders. Over the past 5 fiscal years, Encana used its enormous cash flow to buy back about 22% of its own shares, while quadrupling its quarterly dividends from 5 to 20 cents. Furthermore, the recent latest record-breaking quarter has satiated Encana with $2.2 billion of free-cash-flow. If we annualize it, that’s $11.72 a share per year. Not bad for a stock trading at around $66.
6. Canadian Oil Sand (6.30%) - Canadian Oil Sand owns a 37% interest in the Syncrude project, a pure play in an oil sand that has stunning reserve life of 40+ years. Compared with the $95.93 oil, Canadian Oil Sand’s 2006 operating cost per barrel is dirt-cheap at $27.07, and it’s anticipated to mark down further due to economies of scale. So far this year, the operating cost per barrel has been $26.70. The trio of low operating costs, higher oil price and production positioned COS to raise quarterly distribution from 40 cents to 55 cents, or a cool 38%.
7. Teck Cominco (2.20%) - With Alcan being taken out, Teck Cominco is crowned as the only conglomerate mining company in Canada, and they only getting bigger with the recent acquisition of copper producer, AUR Resource. After losing a bid for nickel producer, Inco, to Brazil’s CVRD, Teck Cominco returned with a vengeance by adding copper, gold, coal and oil sand to its asset mix. Despite ponying up $4.1 billions for AUR Recourse, Teck Cominco’s balance sheet is still squeaky clean with $1.8 billion in cash. This figure is more than the $1.5 billion in long-term debt, so the company is effectively debt-free. Valuation wise, Tech Cominco is cheap according to an article by Andy Hoffman of The Globe and Mail. That’s because when broken into pieces, the individual segments are trading at lower multiples to their respective peers.
8. TransCanada (3.40%) - TransCanada is a diversified and stable utility company in an industry where all the pipelines in North America are already running at full capacity. The stock offers a safe play in the oil and gas sector without direct exposures to the underlying commodity prices. The yield is attractive, but I like it recently when it’s trading in the low $30’s. With 50 years experience and 59,000 km under its belt, TransCanada will add another 3,456 km through its Keystone project, due to complete in late 2009 or early 2010. This pipeline network will have the capacity to move 590,000 barrels of cruel oil per day from Alberta to US Mid West. It has already secured contracts to send 495,000 barrels per day with an average term of 18 years. If you’re looking for a pipeline investment with a little more yield and lesser growth, check out my post on How To Pick Pipeline Trusts.
9. Reitman (3.50%) - One of the tenets of dividend investing is to plunk your money down when good managements stumble. Fiscal 2008 hasn’t been gentle to apparel and accessories retailer, Reitmans. Unfavourable weather conditions and uninspiring rags from the Cassi experiment, a banner designed for middle aged women with youthful spirits, have torn the stock apart to a new 52-week low, thus pushing yield to a glittering 3.5%. Even though Reitmans stumbled on the recent catwalk, this debt-free retailer does have a long history of delivering superb return on equity and raising dividends. Number of outlets is expected to surpass 1,000 this year or next, and the company is poised to profit from the rising loonie. Opportune dividend investors will have a serious look to see if the valuation is compelling.
10. RioCan Investment Trust (5.9%) - You know what the real estate guys say. There are many uncertainties in the world, but there is one thing for sure. Land. They make them no more. With a few mouse clicks, you can instantly diversify your real estate holdings across Canada by investing in RioCan Investment Trust, which commands a quarter of the Canadian REIT index. RioCan, who owns 207 offices and shopping centres, has increased its annual distributions for 12 years straight. This company is known to be conservatively smart. CEO, Ed Sonshine, along with 4 other senior executives have been with the company since inception. In the first 5 years of this century, RioCan was quick to snap up undervalued properties with 9.3% CAP rate (this is unheard of in Vancouver, by the way). With real estate being high in the past few years, they sold off some non-core properties with CAP rate at around 6.3%.

Disclosure: Out of this list, I own IGM Financial, Canadian National Railway, Encana, Teck Cominco, TransCanada and Reitmans.

Disclaimer: I’m an amateur investor. If this post entertained you, I’ve achieved my goal. Please consult your financial advisor before making any investment decisions.

The timing of Canadian Capitalist’s post on Employee Stock Purchase Plan (ESPP) is impeccable, as I need to make a quick decision this week on whether to participate in my own ESPP.

I must have scorned 4 or 5 consecutive invitations to enroll in my employer’s ESPP. I work for a technology company with a very erratic earning history - the type that deserves no place in a conservative dividend-paying portfolio. Nothing against my employer, but the stock may be more suited for a growth-oriented portfolio. Another reason is I want to soften my reliant on the company I work for; losing both your job and your investment is a double-whammy.

Although I must confess, the ESPP is seducing me with a 15% discount to the market price at either the beginning or the end of the vesting period - which ever is lower. Sounds like easy money. I wonder if I should relax my investment philosophy to accommodate this enticing offering, even though I’m not keen on keeping the stock for the long haul. One strategy is to sell the shares as soon as they’re vested as I have no desire to hold the stock without the discount protection, but there is a one-month delay between when the vesting period expires and when my trading account receives the shares. I.e. there’s a risk that the stock will fall 15% during the month, which I peg at about a 20% probability of that happening. Still pretty attractive odds, in my opinion.

My heart tells me to forgo the 15% discount and buy dividend-paying stocks the old fashion way, but I hate to pass up good odds. Am I the only one with this dilemma?

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