Financial Jungle

This is the fifth post on the Dividend Increases series.

It has only been 3 weeks since my previous dividend increases post, but I feel compelled to hurry one in as Boralex Power Income Fund just announced a distribution cut from 90 cents to 70 cents, amidst external headwinds from weaker hydrology and the declining US dollar.

In 2007, BPT.un’s $42-million net cash flow related to operating and investing activities was $9-million short of the $53-million circulated to unit holders, but management has been proactive all along warning investors about the hurdles they’re facing.

Rather than masking the problems and jeopardizing the fund’s long-term health, the new distribution policy will see payout easing to $41-million a year. This is a conservative move considering the fund still has $10-million in the bank. (i.e. the cash could’ve prolonged the current payout by another year while waiting for a turnaround.) If it were an oil & gas trust, management would’ve dug themselves deeper into the hole by (a) issuing new shares, and/or (b) borrowing debts.

Here’s my original analysis on Boralex Power Income Fund:

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%.
…
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.

Obviously I was wrong about the payout being safe. Despite the relaxed distribution policy, BPT.un is still yielding an attractive 11+% based on my average purchase price, and I see the distribution chugging back up as hydrology restores to their historical average. Although I don’t think we’ll see 90 cents anytime soon unless the US Dollar is making a come back.

Disclaimer: I’m not a professional investor. It’s vital that investors perform their own due diligent, and invest accordingly.

On a brighter note, here are my dividend increases over the past 3 weeks:

• Great West - 6.4% (14% from last year)
• IGM Financial - 5.9% (13.4% from last year)
• 3M - 4.2% (4.2% from last year) More analyses from Money Gardener and Middle Class Millionaire.

There are several stable stock markets in which investing through different stock brokerage is very profitable. Several forex companies are doing online trading. The home investment or home building business is on its boom nowadays in different developing countries. If you can invest some thing then investment property is the most favorable option.

1. 80% of our net worth is our ability to earn income - Our investment portfolios extend well beyond just the securities in our brokerage accounts; our greatest asset is the ability to learn new skills and to become productive citizens of the sociaty. In my opinion, the ability to earn salaries is simply bonds on steriod. I guess you can say my name is Bond. Since 80% of our net worth has bond-like characteristics, we don’t intend to overweight bonds. Instead, we let the remaining 20% ride a diversified basket of dividend-paying stocks. Critics will point out that we could lose our current jobs tomorrow, but then we simply go find another one. Jobs are plentiful as long as we’re not choosy. The only caveat is the transition. The best way to protect against short-term job interruptions is to reserve 6 months worth of emergency cash. For long-term protection, buy disability insurance.
2. Bonds are extremely tax-inefficient - The government taxes our bond income ruthlessly at our marginal-tax-rates. We can circumvent that by hiding our bonds inside RRSP, however our RRSP accounts are too precious! We rather decorate our RRSP with high-quality income trusts (e.g. Canadian Oil Sand) and US dividend-paying stocks than squandering a penny on low-yielding bonds.
3. Bonds have miniscule real growth - The current 10-year government bond offers 3.8% yield. Subtract about 2.2% in inflation and 1.2% in income tax, we’re left with 0.4% real return. That’s a steep price to pay just to tame volatility…
4. Bonds don’t make our portfolio safer - According David Dreman, author of Contrarian Investment Strategies, “The major risk is not the short-term stock price volatility that many thousands of academic articles have been written about. Rather it is the possibility of not reaching your long-term investment goal through the growth of your funds in real terms. To measure monthly or quarterly volatility and call it risk - for investors who have time horizons 5, 10, 15, or even 30 years away - is a completely inappropriate definition. The volatility measurements provide only an illusion of safety.”

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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.

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.

One man’s garbage is another’s treasure. Sometimes it’s quite fruitful to snoop around other people’s dumpsters salvaging disgraced stocks.

Lo and behold, I may be gaping at the rottenest of all: Homebuilder stocks. The S&P Homebuilders index has been nailed and hammered over the past couple of years, and is already plummeting 20% six-months into 2007. Many Homebuilder stocks are teasing their historical low price/book ratios, but who can blame the market when you consider:

• The National Association of Realtors is reporting a nine-month worth of home inventory waiting to burn through. This is a 15-year high.
• The sub-prime fiasco is forcing lenders to tighten their mortgage lending practice, thus reducing housing demand.
• Homebuilders are lowering their prices and enticing buyers with perks in order to clear the excess inventory.
• Homebuilders are expiring and writing off their land options.

I know this may sound counter-intuitive, but bad news is good news for value investors, because the stocks have already absorbed much of these glooming expectations. (For full disclosure, I purchased a half position in DR Horton, which I’ll get to later.)

On Monday, Citigroup slapped nasty downgrades against many Homebuilder stocks:

Analyst Stephen Kim downgraded to “Hold” the shares of D.R. Horton Inc., Hovnanian Enterprises Inc., KB Home, Lennar Corp., Pulte Home Inc., Toll Brothers Inc. and Ryland Homes Inc.

What happened to the DR Horton stock? It dusted off a miniscule 1% over the next 2 sessions. Shareholders are so accustomed to pessimistic forecasts that they barely flinched after the downgrades. When the stock is already priced for disaster, the low expectations along with a higher dividend yield bolster the current price point.

Since homebuilding, by nature, is a cyclical sector, price-to-earning and price-to-sales are deceptive valuation matrices due to the fickle earnings and sales figures. A more reliable valuation matrix for cyclical stocks is the price-to-book ratio, assuming the company can hold its book value steady. Please visit MoneyCentral to appreciate how DR Horton vigorously maintained a modest equity growth even during these difficult times, and then compare what it’s trading now in relation to its historical price-to-book ratios.

Current P/B = 0.96

The question now isn’t if a recovery is looming, but when. Most of the industry experts are projecting a revival of the housing sector within the bottom half of 2008, so securing a HomeBuilder stock at this time may appear premature. However, the market tends to factor in future expectations into today’s price. Accordingly, the stock should rebound ahead of the sector. To quote Brett Arends from TheStreet.com:

[The current valuation] is a fraction of where the stocks usually trade. The last time we saw valuations this low was in late 1990, and that was in the depth of the last real-estate crash. And that time around, the shares quickly rallied — even though the housing market itself took years to get back in the swing.

There are two ways to participate in the Homebuilding sector. The diversified approach is to buy an ETF, such as XHB. The other approach, my preference, is to bypass the MER and snap up a stock directly, since Homebuilders tend to swing in lockstep with each other. DR Horton(DHI) is a reasonable choice because it is the largest US Homebuilder, and the company is buying you beer (3% dividends) while you wait for the inevitable vengeance.

DR Horton traded as high as $42 before tumbling down to $19.75. I haven’t decided when to double-down yet, but I suspect the next cyclical peak will likely surpass the previous high.

Disclaimer: I’m an amateur investor. This is not a recommendation to buy. I welcome any constructive feedback.

This is probably the most abused Warren Buffett quote I’ve read in many financial forums:

Wide diversification is only required when investors do not understand what they are doing.

For one reason or another, investors seem to interpret this as an excuse to concentrate. Let me rephrase the quote a bit.

If you don’t know what you’re doing, you ought to diversify.

Even Buffett, arguably the most astute of all investors, relies on 42 stocks to cut risks. Granted that the high stock count is probably necessary given his enormous wealth. However, if you don’t know what you’re doing, concentrating your stock portfolio will not turn you into an astute investor. Since no investor is omniscient, s/he can cushion any unforeseen blows from company-specific risks, such as strikes and natural disasters, by spreading your eggs to different baskets.

In my own portfolio, I have about 27 core holdings, a number of smaller positions, a couple of ETFs and a handful of mutual funds. Admittedly, the number of holdings seems excessive, but certainly not enough to qualify as diworsification. I don’t have plans to scale down at the present. Being primary a quantative investor, I find the current portfolio quite manageable.

Reduce volatility without sacrificing return
One of my favourite theories is the Modern Portfolio Theory, which goes something like this: when you construct a collection of high-risk, high-reward and uncorrelated stocks, it reduces the volatility of the overall portfolio without sacrificing the expected return. The key is to pick businesses that don’t correlate with each other. That way, individual stocks may oscillate violently around the expected return, but due to the low correlation, the oscillations cancel each other out, and you benefit from a smoother and more consistent return.

Reduce unsystematic risk
Diversification also reduces company-specific risks, also known as unsystematic risks. Examples include strikes at railway companies, broken oil and gas pipelines, and natural destructions by fires and hurricanes. This one goes along the line of not putting all your eggs in one basket. By diversifying, you can improve you odds of hatching most of your eggs.

I’ve been told that investors cannot diversify away from systematic risks, which include inflation, interest rates, recessions and political instability. Even though we can’t eliminate systematic risks, I’m open to the possibility of at least minimizing systematic risks by investing in companies with these characteristics:

• Ability to pass inflationary costs to the customers
• Clean balance sheet to insulate from rising interest rates
• A lineup of consumer stables including essential products and services
• Diversified international revenues

Further readings on diversification:
- Modern Portfolio Theory by Investopia
- Systematic Versus Unsystematic Risks by Investment Review
- How Many Stocks Diversify Unsystematic Risk? by Morningstar

The Dividend Guy is rightfully scolding IGM’s Investors Dividend fund for milking $291,117,000 a year in mutual fund fees. I’m both proud and guilty of being an IGM Financial shareholder. I’m proud because IGM has been steadily increasing revenues, profit margins, earnings and dividends, while maintaining Return on Invested Equity above 20%, and decreasing debt levels. I’m guilty because the prosperity rides on the backs of investors’ ignorance. Let’s face it. By analyzing Investors Dividend’s top holdings, one can easily conclude that the Investors Dividend fund is nothing more than a closet index fund with a tilt toward dividend paying stocks. Even an amateur like myself can assemble an index look-alike portfolio. Heck, pay me 1/100th of $291,117,000, and odds are favouring me to beat this fund over the long-term.

Not only is the Investors Dividend the largest mutual fund in Canada, the MER is also a whopping 2.88%. So much for economies of scale. To appreciate just how much investors are forgoing with the MER, let’s compare the performances between Investors Dividend and the TSX total return. The 5-year compounded returns are 9.71% and 12.43% respectively, or a difference of 2.72%. Peculiarly similar to the MER, the point is investors are better off buying cheap index funds and ETFs, rather than enriching IGM Financial with a jumbo MER for inferior performances.

Here is a totally unoriginal idea. Don’t buy this mutual fund. Buy the company that operates the fund. Buy IGM Financial. At 400 shares, this position is spoiling me with $684 worth of dividends per year, and this money is coming out of the $291,117,000 pot. I’m a guilty IGM shareholder, and you can give me some virtual spanking.

I’ve been noticing that a number of bloggers - including myself - are topping up their BMO positions as the stock is rattled by commodity trading losses. Money Diva initiated 400 shares of BMO earlier in the week. My own BMO position grew to 250 shares last week with a new adjusted cost base of $63.20. BMO, to me, has the best balance of high yield and dividend growth. At $68.69, the stock is yielding a cool 3.99%, while its dividends surged from $1.20/share to $2.26/share over the past 4 fiscal years. At this price point, I think this is a window of opportunity for aggressive investors to snatch up some BMO with leverage, and still maintain a positive cash flow.

Continuing with my dividend tax calculation post, a BC resident in the 30.65% bracket wouldn’t pay any dividend taxes. If you leverage to buy BMO, you’d receive 3.99% in dividends tax-free and a small tax refund. The loan interest rate would be 5.75% from Interactive Brokers, but the interest is tax-deductible. If your tax bracket were 30.65%, your after-tax cost would be 3.99%, thus canceling the dividend yield. In other words, it’d cost you nothing to invest in BMO with borrowed money.

The reward is in the dividend growth. Granted that part of the recent growth came from rising payout ratio, but even with a modest projection of 6%/year growth, the yield can still overcome the interest rate by 1.35% in 5 years. The beauty of this setup is that you’re never forced to sell. Leveraging alone isn’t dangerous, as long as you can afford the interest.

80% of actively managed mutual funds under-perform the benchmark over a long period.

Although there is a truth to this adage, one has to peer beneath the surface instead of simply painting over the entire mutual fund spectrum with the same brush. There is always a flip side to a story. If you’re up to the challenge, read this long article on how closet index funds are contaminating the statistical finding.

Occasionally, the underperformance of fund managers vs. the index is trotted as evidence of the efficiency of the market. However, this confuses the absence of evidence with evidence of the absence. A new study suggests that closet indexing accounts for nearly one third of the US mutual fund industry. Stock pickers account for less than 30% of the market, yet they have real investment skill.

Before going further, I’d like to emphasize that I’m a proponent of passive investing. ETFs and index funds are the way to go if you’re looking for something easy, effective, cheap, and tax-efficient. While I don’t deny the merit of passive investing, I believe the market is very inefficient, and investors do get blind sided by the occasional market bubbles. Remember the TSX losing half of its value during the dot com carnage?

The correction taught us a lesson that performance isn’t everything. Let’s throw in a simple example of choosing between investment A and B. Investment A has a chance of making $100, but you must risk $50. Investment B has a chance of making $90, but you must risk $20. Investment A has a higher expected return, but investment B has a higher risk-adjusted return. Below is a comparison of TSX versus Chou RRSP over a 21 year period. You can see clearly that Chou RRSP’s line is much smoother. Since the manager, Francis Chou, is a renowned deep value investor, he builds a margin of safety on all his purchases. With this process in place, Francis Chou tends to give you a more consistent and steady return as evidenced by during the tech bubble. As a bonus, Chou RRSP did come out ahead of the index and with less risk/volatility.

This is not a post against passive investing. Remember that passive investing is not a religion. You can buy good quality actively managed funds like Chou RRSP without letting go your index funds and ETFs.

Disclosure: I have held Chou RRSP for 2 years, and am planning to pick up Chou Associates soon. This is not a recommendation to buy.

Source:
- Chou RRSP (GlobeFund.com)

Two of my most admired personal financial blogs are pressing the hot button on a very sensitive topic: leveraged investing. To read more on the lively discussions, check out The Canadian Capitalist and Million Dollar Journey.

The pro-leverage group believes that when done properly, leveraging is an effective way to build wealth. The anti-leverage group advocates the old fashion method, which is to pay off your mortgage and invest with cash. It is not necessary to leverage your portfolio in order to reach your financial goals. As The Canadian Capitalist put it:

If you are like me, you want to pay off your home, save for retirement, send your kids to University and eventually, not having to depend on a paycheck. You are not aiming for a spot on the Forbes 400 and couldn’t care less about the list. Do you need leveraged investments to achieve your goals? Not really. A far simpler and less-risky path is to spend less than you earn and invest the difference in a low-cost, diversified portfolio. Why take more risks than you need to?

Just to throw in my two cents. I pick the middle of the road. Most investors concentrate on capital appreciation, but my investment strategy is cash flow centric. Since time is on my side, a moderate amount of leverage is safe as long as I’m getting a positive cash flow out of the portfolio. In Canada, investment loan interests are tax-deductible, while dividends are tax-free for most people. If you’re in the 33% tax bracket, a 3.85% dividend yield is enough to cover a loan interest rate of 5.75% after-tax assuming you leverage your entire portfolio. At the moment, my portfolio has about 17% cash in a high interest saving account, but I’m comfortable with up to a 15% leverage. There’s still plenty of free cash flow left for reinvestments, or paying down debts.

• Norm Rothery reveals a list of Canadian stocks that Benjamin Graham might like.
• Construct a will for free online.
• A quite mathematically detailed and negative critique of Canadian Universal Life Insurance programs.
• TSX Group will have to compete with a new trading system in 2008. I’m not pleased about this announcement as I hold shares in TSX Group. A discussion group is happening here.

Just a quick update on my portfolio. I accumulated more shares to my existing TSX Group position today. The stock is down recently, because first-quarter profits of $0.53/share miss the consensus estimate by 3 cents.

I don’t mind it as long as revenues are up 15% on stronger listing and market data revenues. The drop in profits is attributed to raising costs, but it is not wasted money:

Expenses jumped 29 percent to C$47 million, due in part to additional employees taken on after the acquisitions of Shorcan Brokers Ltd. and certain fixed income assets from Scotia Capital last year.

Also boosting costs were advisory fees related to joint ventures TSX entered into with the International Securities Exchange Holdings Inc. and IntercontinentalExchange Inc. during the first quarter.

“While we continue to aggressively manage our cost base, we’re not going to hesitate to invest in initiatives that we believe will grow the business over the long term,” TSX Chief Financial Officer Michael Ptasznik said on a conference call.

TSX Group is the operator of Toronto Stock Exchange and TSX Venture Exchange. TSX Group has a consistent history of rising dividends, and is one of the few non-financial companies with 3+% yield.