Graham's Investing Blog

The Disappearing Middle Class

2010-09-05T20:53:00.004-04:00

Check out the numbers in this article by Robert Reich. They show the middle class' erosion of purchasing power over the years.

"In the late 1970s, the richest 1 percent of American families took in about 9 percent of the nation’s total income; by 2007, the top 1 percent took in 23.5 percent of total income. " OUCH!

The article also discusses how the middle class has dealt with this over the years. It's hard to see what the disappearing middle class can do next to boost family income. The implication is a long term drop in consumer buying. Very consistent with PIMCO's new normal.

bought AKO.A

2010-08-05T21:36:00.037-04:00

Sorry, I'm a bit late on this one. I bought AKO.A on June 23 at $19.88 CDN. This includes $20 in commissions, which should have been 10$ but I did not specify all or none, so they split my order in two and charged me twice. Thanks a lot. Lesson learned.

Embotelladora Andina S.A. is a Latin America Coke bottler based in Chile, but with sales in Argentina and Brazil as well as Chile. It bottles other stuff besides Coke, and gets about half its revenue from Brazil.
There are two share classes: AKO.A and AKO.B. The B shares get a 10% higher dividend than the A shares, but have no voting rights. Also, the B shares are a lot more liquid. However, at the time I bought these, the A shares had a higher yield. Of course, there are also corresponding ADS issues which trade in new york in USD.

I'm not sure why but the shares have just shot up to $23 USD. AKO.B is up too, and on slightly higher volume at that.
So why buy this company? I think it's a good consumer staples stock for Latin America. It's a good brand (Coke) and what it sells is cheap enough that a lot of people can afford it. For those with less money, it makes a nice treat. For those with more, they can get addicted to the caffeine and drink lots.

Here is what I like about this company:

inexpensive consumer staples
great brand (Coke)
Good market (Brazil)
Compared to similar companies (Diageo, PMI, Yum), AKO has very low debt.
I started out looking at the Greek Coke bottler, but found AKO more compelling.

Here is what I don't like about this company::

EPS growth has been lacking the last few years. I think this is what has been holding back the share price.
You can see it graphically at morningstar by mousing over the little bar chart icons on the left & seethe graph below for a longer time frame.
You can see revenues are down, but taxes are up, leading to a drop in EPS.
Overall, it's a good company. The decision to buy comes down to your growth estimate.

That's the story. Here are the numbers.

growth and efficiency:

net margin > 7%*, last 5 years (actually >10 for each year) good trend. small drop in last few years.
roe > 15%, last 5 years (actually >20 for each year)
eps growth over 3 years, average for the last 5 years = 27.9%
increase/decrease in outstanding shares last 5 years -> none
improvement in efficiency ratios over 10 years, but stable for last few years.
free cash flow> 0 last 5 years: all 5 years. a bit choppy but growing trend.
avg eps growth (in chilean currency) since 2001 = 20%
expected growth rate: 10% (analyst estimate)**

* I read somewhere that the long-term S&P500 average net margin was 7%.
** From reading a lot of expected growth ratings, it seems to me that when analyst don't know what to guess, they often guess 10%.

Valuation:

p/e ratio vs historical is v low, but not vs the S&P. (I.e. (S&P P/E)/(AKO P/E ) is a bit lower than in the last 5 years.
yield is hard to figure because AKO gives out a big dividend at end of fiscal (May) and the dividend amount really bounced around, like many companies outside North America. The dividend was lower in 2009.
fwd p/e (morn.) 13.3
peg :1.3
fwd yld (morn) 1.68%
morningstar:
p/e, p/s, p/b all slightly lower than industry.
rev growth 3yr avg higher than industry
eps growth 3 yr avg much less than industry
net margin much much higher than industry
roe much much higher than industry.
debt/eq much much less than industry

Financial health

payout ratio TTM is 48%.
leverage: 1.74 (always less than 2)
current ratio: 2.13

DCF valuation

Had a lot of trouble figuring cash flow TTM due to the currency difference and the multiple originals per ADR. SO I used TTM eps instead, including the eps from the quarter ending in june 2010.
avg YoY eps growth (in Chilean currency) since 2001 = 20%
discount rate: 2.83% (ten year tsy yield)
eps ttm (Q2 report + s&p) = 0.85 USD, per ADS.
for a deps valuation of $21.87 USD per ADS.

A couple of notes about this. First I calculate the value of the earnings that will accumulate over the next ten year; not over an infinite period. This is to make it more comparable to the 10 year bond, whose yield I use as the discount rate.

Second, I think its silly to expect a growth of only 10%. First, the historical growth rate is much higher. Second, Brazil has great demographics, with more young people than old people, low debt and the poor are becoming less so. (There is an article on this in the current issue of the economist. It shows the payoff from what many people derisively refer to as "social engineering"). Anyway, with 10% growth, you get deps valuation of $12.54.

The recent news is that EPS have dropped. That's because of higher Brazilian taxes due to a loss of tax credits and a higher rate of taxation resulting from the increased revenues from Brazil. While EBITDA was up 9% yoy, net earnings were down 14%. It looks like these taxes are not a one-time expense; they should continue to be this high in the future. If the shares drop, they could get close to fair price.

Another Gem from Bill Gross

2010-07-29T22:30:00.001-04:00

Gotta read this one.

Preferred Shares - Update

2010-07-05T22:18:00.004-04:00

Since I sold out my preferred share positions, the Euro blew up and people are fearing a double dip recession. Consequently, fears of inflation abated and 3 of the preferred share issues are up between 2% (cl.pr.b) and 6% (bns.pr.m, pow.pr.b). BCE.PR.A is down 4%.

Preferred Shares - Performance

2010-07-05T21:12:00.014-04:00

As I explained in earlier posts, I had bought some preferred shares because they had gone down in price and was hoping to see a normalization of share prices before fear of inflation kicked in. It didn't really happen. Here's my investment performance on those preferred shares:

	bns	bce	cl	pow
buy price	20.25	22.00	23.39	21.70
sell price	18.71	21.67	24.85	21.00
buy date	11-Aug-09	4-Nov-08	11-May-09	10-Aug-09
sell date	8-Apr-10	23-Apr-10	8-Apr-10	8-Apr-10
net gain/loss	-54.81	155.50	131.13	-4.84
return	-5.41	4.71	11.21	-0.45
annualized	-8.23	3.21	12.33	-0.68

net gain/loss includes dividends and 20$ in trading fees for each security.

The total return weighted by shares per security was 3.46%. Annualized that comes out to 2.36%. Over that period, XBB, a Canadian bond ETF gained about 4% and the TSE gained about 16% without counting dividends or interest, compared to my 3.46% including dividends. So, all in all, not very good for me.

Forget NBG

2010-05-18T15:03:00.004-04:00

Forget NBG. The spread of the downturn has created bargains elsewhere, such as Google. NBG's a good bank, but at the end of 2009, it had about 20% of assets exposed to greek gvt debt. That's over 20B euros, about 20x 2009 earnings before taxes. That's a looooong time for write downs.

National Bank of Greece

2010-05-06T17:24:00.005-04:00

I took a look at NBG's Dec 2009 annual report to try to determine its exposure to Greek gvt. debt. Including loans to government and agencies, it appears to have 18% of assets in the Greek government. It is also apparently hedging its exposure to Greek government fixed rate bonds by buying German bond futures. Couldn't find any specifics. I hope it was hedging for rising interest rates!

If Greece defaults, then a fair-ish book value for NBG would be 2.89 USD/ADS share (based on a little algebra from the data at reuters.com). According to Reuters, NBG is trading at 2.71, for a P/B of 0.75. I would buy at 2.50, or a P/B of 0.7, and sell at a P/B of 0.8 (2.89 USD). Keep in mind that as the Euro falls, so does the book value. A P/B of 0.7 at today's exchange rate is not necessarily the same share price as a 0.7 P/B at next week's exchange rates.

US Bond Outlook - Update: Stay Away from Junk

2010-05-06T14:48:00.006-04:00

In a recent post, I recommended investing in high-yield bonds since they still seemed to have some capital appreciation left. The performance of high-yield bonds is similar to the performance of the stock market as a whole. You can see below that in the last few days, the S&P500 is tanking, and along with it, a high-yield ETF.

So, I changed my mind. Stay out of the high-yield stuff until Mr. Market has calmed down. You might miss a bit of the run-up, but you'll still get a nice yield.

Preferred Shares - Sold

2010-04-26T21:33:00.005-04:00

Several days ago (sorry for the late post, as if anyone actually reads this thing!) I sold my preferred share positions (BCE.PR.A, BNS.PR.M, CL.PR.B, POW.PR.B). The reason is pretty simple: Mr. Market is anticipating more interest rates increases. Since these preferred shares pay a fixed rate of interest, when interest rates go up, the shares prices of fixed-rate preferreds go down.

My idea was that the share prices would recover to historically more normal levels as the economy improved. In the meantime, I would be getting a 5 to 6% yield. That happened for (see figure below) CL.PR.B and for BCE.PR.A, but not for the others. But even CL.PR.B and BCE.PR.A eventually succumbed to the effects of the expectation of increased interest rates.

from bigcharts

In a future post, I'll show my returns on each preferred.

US Bond Outlook

2010-04-22T19:46:00.048-04:00

Is the corporate bond runup over?

LQD is a corporate bond index ETF. IEF is a treasury bond index ETF. I'm using these as a proxy for corporate bond and Treasury bond prices.

At the beginning of the market meltdown, there was a divergence of corporate bond prices and Treasuries, then in March 2009, prices began to converge, with Treasuries dropping and corporates rising. (Figure 1). On March 31, 2010, the 1 year return for Vanguard's intermediate-term Treasury fund (VFITX) was -0.41%, and for its intermediate term investment grade corporate bond fund (VFICX) was 21.96%.

Figure 1

from bigcharts

Historical prices suggest the runup in corporate bond prices is just about over (Figure 2). Yields would serve as a better measure, but the prices are good enough stand-ins for my purposes.

Figure 2

from bigcharts

The rise in interests rates should also adversely affect both Treasuries and corporate bonds, but an article by Vanguard argues that this would probably occur mainly with shorter-term maturities because any action by the Fed will calm fears of long-term inflation. Ok. So I'll stay out of short-term bonds.

TIPS (aka TIIS)

Vanguard also argues that TIPS might be vulnerable. One can assess the relative pricing of TIPS and Treasuries by comparing their yield spreads to the anticipated rate of inflation because the Treasuries carry inflation risk, and the TIPS do not. An expectation of high inflation should show up as a high spread, and vice versa. The current (April 22, 2010) TIPS/Treasury spread seems to be reasonable right now (2.13 for 5 years, and 2.33 for 10 years). It's true there has been a run up in TIPS, similar to the runup in corporate bonds (see Figure 3), so the TIPS party might be over, but it doesn't seem to me that they are overpriced. Moreover, since they offer inflation protection, I think they're a safer refuge in the current environment than Treasuries or corporates (but keep in mind that Vanguard disagrees).

Figure 3
(Note: TIP is a TIPS ETF)

from bigcharts

High-Yield (Junk) Bonds

Junk bonds are another, interesting, option. An asset rotation study performed by PIMCO shows historical returns of different asset classes across the business cycle. Early in the expansion cycle and in mid expansion, high-yield bonds, convertible bonds, and especially emerging market debt have done well, even beating equities! However, figure 4 below suggests the party's almost over for both convertible bonds (Vanguard's VCVSX) and high yield bonds (Vanguard's VWEHX) (Recall that IEF is an intermediate term Treasury ETF, and that LQD is an intermediate term corporate ETF).

Figure 4

from bigcharts

Another way to value high-yield bonds is through the yield spread. The typical spread has been about 300 to 400 bps over comparable maturity Treasuries (pimco). Right now, the spread is about 500 bps (see bloomberg). So it seems there's still a bit of price appreciation (about 13%) left in high yields (or price depreciation left in Treasuries!) Note how the estimate computed from yield differentials is close to the difference between the return in Treasury prices and the return in high-yield bond prices from Figure 4. The yield on Vanguard's convertible bond fund in contrast is only 3.69%, about the same as a 10-year Treasury. It's not clear, but there may not be any price appreciation left in convertibles.

High-yield default rates have also been falling, and Moody's predicts that trend will continue into 2010. Hey, it's Moody's, gotta trust Moody's, right? Of course, default rates will only continue to drop if the recovery continues.

Interest Rates

Any action by the Fed could through a wrench into all of this, causing bonds prices across the board to drop. It's worthwhile noting though that high-yield bonds act a bit more like equities having less sensitivity to rising interest rates than other bonds, because interest rates increases co-occur with falling credit risk at the beggining of a recovery. Maybe this explains PIMCO's asset rotation findings discussed earlier.

What makes me uncomfortable about this recovery is that it was fueled by government spending. It's not clear to me (and to many others) that this government spending was able to sufficiently prime the pump for the private sector to sustain the recovery going forward.

Bond Allocation

As always, in my opinion it's better to directly hold the actual bonds so that you can hold them to maturity, thus avoiding a loss on your capital. Inflation eats away at your returns a bit more, but it makes for less of a roller coaster ride. I can't do this in my Vanguard account so I'm going to modify my bond fund allocation instead.

Given, the above discussion, here's how I'm going to allocate my funds across the bond asset class. Bottom line: beware rising interest rates!

Vanguard Inflation-Protected Securities Fund (VIPSX): 30%
Vanguard Total Bond Market Index Fund (VBMFX) (holds gvt and corporate investment grade bonds): 20% *
Vanguard High-Yield Corporate (VWEHX): 20%
Vanguard Intermediate-Term Investment-Grade (corporate) (VFICX): 10% *
Vanguard Money Market (really really short term bonds): 20%

* more sensitive to interest rates.

My Vanguard Performance - The Lost Decade

2010-02-27T00:19:00.003-05:00

You might have heard of the lost decade. The cumulative total return for Vanguard's s&p 500 index fund for the last ten years (ending jan 31, 2010) is -8.48%, according to vanguard. (Appears to include reinvested dividends and management fees, see here). Hence the phrase the lost decade. My vanguard portfolio cumulative total return from Jan 1, 2000 to Jan 1, 2010 was 67%.

Fight the Power

2010-02-23T12:29:00.002-05:00

Nothing to do with investing, but I hate it when those in power are incompetent. The truth needs out! And here's a way to do it:

http://www.cbc.ca/bc/features/gopublic/

Got inside information that should be exposed? Bogged down by bureaucracy? Been wronged and no ones taking responsibility?

We want to hear from you.

Go Public is an investigative news segment on CBC TV, radio and the web. We expose waste, incompetence and wrongdoing and hold the powers that be accountable.

Building on the success of Kathy Tomlinson's segments in B.C., Go Public is now a feature on The National. That means we want to hear from people across the country - with stories they want to make public.

My performance - securities

2010-02-20T14:49:00.026-05:00

Here's my stock picking performance from march 2008 to Feb 19, 2010. I had some difficulty finding a tracking tool that takes dividends in to account. Apparently Google added dividend tracking to its portfolio tool, but, also apparently, it's pretty buggy.

These analyses are from my brokerage account tool. It takes dividends into account. I compare my performance to a global balanced benchmark. I erased the amounts of my investments, but the percentage change is there.

I beat the global balanced benchmark for all periods but 1 year. Since march 28, 2008, my performance is 8%, while the benchmark is -2.6%.

My benchmark is composed of a bunch of ETFs with dividends re-invested. Half of my initial benchmark investment was in a Canadian bond ETF (XBB), and the other half replicated the MSCI world index. These days you can invest in an MSCI world ETF, but not back in the old days of March 2008. So I looked at the composition of MSCI world, and replicated it with a Canadian ETF, a US ETF, and an EAFE ETF. (No emerging markets.)

You can see that the Canadian portion did really well. That's partly because the benchmark portfolio, as well as my portfolio, is in Canadian dollars. The Canadian dollar has appreciated against the US dollar and the Euro, so that's why Canada did well compared to the other regions. If you had a portfolio denominated in another currency, Canada would still have outperformed, but the other regions would have shown a better return than in a CDN$ portfolio.

My portfolio has 3 preferred shares (they have "PR" in the symbol). I haven't held them very long, but they are doing ok. They all trade below redemption value, so I think one could buy more. However, with interest rates going up the preferred shares might drop some more. Or, if people take higher interest rates as a sign of a recovery, the preferred share prices might go up instead. My three stock picks have done very well since I bought them. You can see my previous posts for discussions about these shares.

I also bought government real return bonds. These provide me with a global real return bond exposure. Some of these bonds were bought in mutual funds so I use equivalent ETFs in the portfolio to automate tracking. The Canadian real return ETF has done well, but the others have not, mainly because, as I mentioned above, the Canadian dollar appreciated against other currencies, reducing my returns from foreign bonds.

My three stock picks are hedged through a double inverse Canadian ETF (HXD). That's the big stinker in the portfolio. As an alternative to this ETF, I could have hedged with long-term index puts, or I could have used stop loss orders. The problem with stop loss orders though is that you can get whipsawed. You sell when the stock drops and lock in your loss, but you don't buy back until the stock goes back up. Classic opportunity loss. I still think that this is a cyclical bull in a secular bear market. Consequently, I'm going to hold on to my hedge at least until next January, or next market drop bigger than 10%.

I also bought a put on the SPDR KBW regional banking ETF (KRE) right before it shot up 20%. Ouch! Good thing I only bought a tiny amount.

Finally, I also bought two Australian bonds. One is a real return, with a real yield of 2.83%, maturing in 2015, and the other, also maturing in 2015, is a conventional bond yielding 5.35%. These will be hard to track because their market value is not automatically updated in the tracker. I'll also have to add interest payments by hand.

My Vanguard performance

2010-01-21T21:16:00.019-05:00

I have a 401K at Vanguard that I don't contribute to anymore. Consequently, any changes in account value result from investment performance. Here's my performance (for periods ending Dec 31st.).

these are the averages for world allocation funds for ytd, 1 yr, 3yr, 5yr, and 10 yr:

My performance turns out to be pretty good. I used morningstar to find world allocation funds with similar performance to mine. This provides an estimate of my rank among world allocation funds:

5 yr rank: top 31%.
3 yr rank: top 13%.
1 yr rank worse than 86%.

Now, if you understand the math behind these things, you'll realize that while I outperformed the average, I also did it with less risk.

Below you see the performance of the best world allocation fund that beat my performance over 5, 3, and, 1 years. You also see the average performance for the world allocation category.

Looking at the big dip, the Waddell & Reed fund went from 40K to 22K. A drop of 20%. It still hasn't fully recovered. The average performance for the category went from 17K to 11,272; a drop of 33.7%.

In contrast , my portfolio dropped from 30,250 to 25,212; that's only 17% (see below). At the end of 2009 my portfolio had fully recovered and stood at 33K. (On the whole, not as good as Waddell and Reed, though).

Much better performance than average, with a lot less risk. Pretty good, pretty good. I certainly earned my investment management fees.

more words of wisdom from bill gross

2010-01-20T21:55:00.006-05:00

In a morningstar video, bill gross says he estimates that the Fed buying has lowered the 10 year treasury yield by 50 basis points (1/2 a percentage point). A 50 basis point increase means about a 14% price drop. He also says he prefers German bonds because the German budget policy is less inflationary.

time to get out of treasuries ?

2010-01-20T19:12:00.007-05:00

Bond genius bill gross is reducing his exposure to treasuries. In his post (Jan 2010), he explains that Treasury yields are too low, and that the Fed has been buying up too much of them. (Same deal for the Bank of England buying gilts). Gross is expecting a drop in treasury prices soon, especially since the Fed is plotting its exit strategy (i.e. selling its Treasury holdings). (See also Jubak's post on Gross' moves and comments)

More generally, there appears to have developed a supply and demand imbalance for government bonds. The supply has gone up due to various bailouts, but empty pockets are lowering demand. This should mean that gvt bond auctions won't attract that many buyers, meaning low prices and higher yields. To prevent that, central banks, like the Fed, have been buying up their own national bonds. It can't go on forever. When it stops gvt bonds prices will drop.

Gross suggests TIPS (real return bonds) might be an option because these mega deficits will result in inflation, but TIPS yields are really low too. According to bloomberg, the yield on a 5 year TIPS is 0.17%. Yuk.

Baby Boomer Retirement & Corp Profits

2010-01-19T18:34:00.006-05:00

A couple of interesting stats from a survey of Canadian baby boomers. First, of those who kept track, they decreased their spending by 30% the first year of their retirement. Of course, that's the ones who kept track of their spending. They'll tend to be the more fiscally responsible ones. The others are probably out buying miatas, gold-plated golf clubs and world cruises. The other stat is just as concerning: 75% of yet to retire respondents project that will just just get by when retired.

When baby boomers retire (starting now) you can expect a big drop in consumer discretionary spending.

Nokia: back in or still out?

2009-12-13T22:34:00.004-05:00

Pretty downbeat article on Nokia from the NYTimes. One analyst even questions whether Nokia can maintain its dividend! Ouch. I think a big problem with Nokia is its aging Symbian platform.

As far as I know (correct me if I'm wrong), RIM also has an out-of-date platform, with every e-mail message going through RIM's servers (see wikipedia entry). While RIM's technology does allow caching of messages on the client, RIM (or the customer) has to pay for the costs of the service. I don't see why someone couldn't write an iPhone app that does the same for internet-based mail, including outlook internet mail.

Bought KRE put - exp june 2010, strike 20$, $2.05

2009-12-07T13:52:00.003-05:00

KRE is the symbol for the SPDR KBW regional banking ETF. These are banks that are not too big to fail and are indeed failing, and will continue to fail due to their over exposure to commercial real estate. More on that later.

The Carry Trade

2009-11-26T20:45:00.013-05:00

The carry trade involves borrowing at a low interest rate and investing (or lending) at a higher return. Lately, big money investors have been engaged in the carry trade by borrowing US$ at very low rates and investing in Australian bonds, emerging markets, and commodities, as well as plain old stocks and bonds. Traders are essentially betting on a falling US dollar, and they've been right so far.

The problem with this type of carry trade is that it is creating a bubble. A bubble occurs when investors borrow against an overpriced asset to buy more of that asset. (See Galbraith's A Short History of Financial Euphoria in the amazon panel on the right for an interesting treatise on bubbles). When interest rates or the US dollar go up, or the market price of the asset starts to fall, investors have to sell what they can to avoid defaulting on their loans. This leads to panic selling and falling asset prices.

So you can expect a fall in emerging markets, Oz bonds, and commodities, and probably everything else. This could happen as soon as mid to late 2010 if the Fed raises rates then. It could happen earlier if the US dollar rises.

Interestingly a big doom and gloomer based on the carry trade is Roubini, who predicted the securitized debt meltdown (see here).

Citron Research

2009-11-05T21:44:00.005-05:00

Anther great resource is Citron Research. Citron exposes the seamy side of companies. For example, I was all set to buy LPHI until I read Citron's post on it.

Bought Canadian Utilities @ $38.55

2009-11-02T20:24:00.016-05:00

It you believe that slow and steady wins the race, then you'll like Canadian Utilities (CU.TO, CDUAF.PK). Most of its operations in Alberta. About a year ago, I calculated that about 70% of its revenues were either regulated or under long-term power generation contracts. Its current dividend is $1.41 CDN, and its TTM earnings are $3.18 CDN, for a coverage ratio of 2.25. So, the dividend is safe. Also, its revenues don't depend much on consumer discretionary spending, of which I expect there to be less and less.

Unlike Fortis, or Brookfield Asset Management, CU doesn't have any commercial real estate holdings.
the expected yield based on this price is 3.65%
the present value of a $100 investment is $149.38, with a discount rate of 3.5%. (Still, you have to take this with a grain of salt. I think general economic growth will be a lot lower in the future.)
Its valuation is pretty good, as shown below in this graph from TD Waterhouse.

Over the last 10 years...

CU's ROE has hovered around 15%, despite being a utility
Its balance sheet has been conservative

Leverage around 3 (good for a utility) (and currently 2.4)
a current ratio between 2 and 3 (and currently 3.4!)

It has not had a negative cash flow year
It's a Canadian dividend aristocrat
A real widows and orphans stock

Wait a few days before buying because the ex-dividend date is November 5.

PIMCO Commentaries - Another Great Resource

2009-10-28T22:07:00.004-04:00

You can read commentaries from the PIMCO team, including the famous Bill Gross, here. Bill Gross' commentaries are not only highly informative, they're often a bit weird. He must be an interesting guy. You can also read previous commentaries in the archive.

Is Gold Overpriced? II

2009-10-14T21:54:00.004-04:00

As a follow on to my earlier post, I should have noted that the gold standard was in effect in the US until 1971, with some breaks during the war periods and some odd happenings from WWI to Bretton Woods in 1946. However, the figure in the report I mentioned is not about the price of gold, but its purchasing power. For example, it may have cost an ounce of gold to buy a really good suit in 1880. If so, then it also cost an ounce of gold to buy a really good suit in 1950. That just seems weird to me, gold standard or no.

The purchasing power of gold started to deviate significantly from its historical range only after 1971, when the US currency was no longer pegged to gold. Perhaps the loss of confidence in the currency (and the hyperinflation of the 70s) led people to gold.

Following the end of the inflationary period in the early 80s, investor turned to the US dollar in times of financial crisis, as well as to gold.

With the US' increasing debt load, the luster seems to be off the US dollar as the currency of reserve, tipping the balance to gold (and the Canadian and Australian dollars.) These shifts can readily bee seen by examining the world gold council's graphs of the price of gold in various currencies. Since fall 2008, the price of gold is up 40% in USD, but pretty much flat in A$ and CDN$.

The price of gold (in USD) may go higher still, but it won't have anything to do with its historical purchasing power. It will have to do with a loss of confidence in the US dollar. Betting on confidence is a bit too speculative for me. I do own a bit of gold in the diversified part of my portfolio. If my investment in gold exceeds the proportion I've assigned to it, then I'll rebalance (i.e. sell).

Dividends

2009-10-14T15:37:00.001-04:00

Even so, the old farmer said to his son:

A cow for her milk,
A hen for her eggs,
And a stock, by heck,
For its dividends.

An orchard for fruit
Bees for their honey,
And stocks, besides,
For their dividends.

John Burr Williams

Is Gold Overpriced?

2009-10-13T22:24:00.002-04:00

There's gold in them thar hills! Gold I tells ya! Gooooold!

Now, in 1971, the purchasing power of gold was about equal to what it had been going all the way back to 1796, yessiree (see Figure 1.1 of this report from the World Gold Council). Back in '71 gold was about 40$/oz (see graph). Since then why, the purchasing power of gold has gone up. Indeed it has. But if'n we take 1971's gold value to be fair an' square, then the fair value of gold in 2009 should be $213.17 (according to the bls inflation calculator).

Now, of course there be some fussin' about how Uncle Sam calculates inflation (I'll leave you to figure that one), so $213 may be a might shy of gold's true worth. Still though, $213 is a long long way from $1000.

Bought CSF.TO at $8.95

2009-09-08T20:27:00.022-04:00

Cash Store Financial is a growth stock that stopped growing its earnings and then became a value stock. It's in the payday loan business in Canada. However, rather than backing the loans, it acts as a broker between lenders and borrowers. With credit tightening everywhere, more people will need to avail themselves of payday loan services like CSF's, even in a continuing recession. Maybe especially in a continuing recession.

Another point in CSF's favour is an increase in payday loan regulations. In most cases, the new provincial regulations allow the existing payday loan operations to still make a nice profit, but perhaps not nice enough if you're a small operator. CSF believes, and I agree, that the smaller players will be looking to exit the market. CSF sees this as a buying opportunity.

Another interesting feature of CSF is that upper management really pays close attention to operations. In my opinion this should be upper management's primary function. In too many companies however, operations is all but ignored in favour of strategizing, writing mission statements, backdating options, and creating golden parachutes. In contrast, CSF's upper management tours the country and meets each branch manager. Management examines the performance of each branch and creates a plan to bring the laggards up to speed or closes them.

This is also a good time in the consumer credit marketplace because other lenders are tightening their credit (see for example, Jim Jubak's blog post). This is just part of the continuing global deleveraging. This will drive more business to CSF.

Another couple of interesting points about CSF.TO.

Its expansion is funded by cash flows.
It has no long term debt
It scored 100% on my piotroski screen (but ignoring p/b).
It has a good dividend yield of 2.8% at $9.25/share.
A low payout ratio of 32%
It's making money. Pretty good these days.

A couple of disturbing things about CSF.TO

As a broker CSF isn't directly exposed to credit risk. However, CSF pays retention fees to its lenders to compensate them for losses due to defaults. So, indirectly, CSF does take on credit risk. If the economy goes south, defaults and retention fees will go up. Ouch.
In a company that grows by opening new branches, there is always the possibility that EPS growth comes purely from new branches opening. Consequently, you want to be sure that same store sales are up too. While CSF's same store revenue has been rising, this rise is a function of the age of the store: the older the store, the lower the same store revenue increase (see page 24 of the 2008 AR). That's worrisome. CSF is in the process of developing of new products to increase revenues. Gotta keep an eye on that.

My suggestion to management is to also try to diversify its portfolio of lenders in an effort to reduce retention payments.

CSF earnings were a bit hard to analyse because it spun off its rent to own division on March 31 2008, and in Q3 2005 it eliminated "rollovers" which had a big negative impact on eps. I was able to eliminate the effects of the spin off by looking at segmented earnings in the annual reports. There were a lot of non-recurring charges as well, a few for the spinoff, another for a lawsuit that was just settled. However, I couldn't figure out anything comparable for to rollover fees. See below for eps for the last few years.

In the AR, management attributes the drop in earnings from 2006 to 2007 to the end of the rollovers. It seems to me that there is too long a time interval between the end of the rollovers and 2007 for that explanation to be completely believable.

Nonetheless, based on these data, I calculate that a 10 year investment in CSF has a discounted present value of 20.40$ (CDN)/share, where 3.5% is the discount rate. The problem with this estimate is that there's not much data to go on, and it's likely to be a bumpy ride.

Jim Jubak

2009-09-08T20:16:00.003-04:00

Jim Jubak is back! He has access to info that I sure don't. He has a very good stock picking record. I highly recommend his blog.

BCE update

2009-08-29T13:57:00.003-04:00

In a recent post, I noted that BCE's payout ratio was high. The ratio I used was expected 2009 dividends over 2008 eps. TTM eps from 2009 Q2 are $2.096. Expected 2009 dividends per share are $1.305, and probably $1.40 thereafter because 2009 dividends have gone up twice and are now at $0.35/share/quarter. So, the payout ratio, given by $1.40 over TTM eps is 67%. That's not too bad. Another thing to consider is a non-operating charge in Q4 2008 of $267 million (which businessweek has listed as a loss on sale of investments), or $0.33/share. If you add that back to TTM eps, you get a payout ratio of 57.7%. There have also been on-going restructuring charges for the last TTM of about $0.40/share. At some point these will disappear, reducing the payout ratio even further.

A note of caution. Over the TTM, revenues are down. Eps are flat-ish because of a reduction in costs. I guess they fired people.

sources: retuers.com and businessweek.com

Power Corp

2009-08-28T22:48:00.004-04:00

Below you will find a link to a very interesting article on the power behind power corp: the Desmarais family. Here's a quote:

After Sarkozy was elected president in May 2007, he awarded Desmarais the Grand Croix de la Legion d’Honneur, an order of merit established by Napoleon in 1802. “If I am the president of France today, it is thanks in part to the advice, the friendship and the loyalty of Paul Desmarais,” Sarkozy remarked.

Talk about connections!

The article also talks about some of Power Corp's many and varied investments.

http://hotrodatquincy.blogspot.com/2009/08/buffett-loses-to-desmarais-as-power.html

Bought preferred shares from BNS, POW

2009-08-20T22:35:00.025-04:00

I recently bought some more preferred shares. I bought shares from the bank of nova scotia (BNS.PR.M) at $20.45, and power corp (POW.PR.B) at $21.90 and $21.92, including commission.

Preferred shares are similar to bonds in that they usually pay a fixed dividend and can be redeemed (called) by the issuer at a specified price. There is often a schedule, such that during different periods of time, the shares can be redeemed for different amounts. Usually, the amount will start off high, and drop as time goes on. Typically the final amount is $25.00/share, and sometimes $50.00/share. The final redemption price for both POW.PR.B and BNS.PR.M is $25.00. Consequently, you usually don't want to buy a preferred shared trading at more than the redemption price. I like to buy them at around $20 to $23 to give myself the chance of some capital appreciation if the shares are redeemed.

The risks of my preferred share investments are the same as those for bonds, except that bondholders are ahead of preferred shareholders in the creditor queue during bankruptcy. Fixed-rate preferred shares (such as those mentioned here) have interest rate risk, and preferred shares in general have creditor risk. The issuer could also suspend the dividend payment on the preferred. If it's a cumulative preferred, the issuer will owe the dividends that were not paid. I think you're more likely to see a cut in the dividend on the common if the issuer gets into trouble.

The interest rate risk is that interest rates will go up, and the value of the preferred shares will go down (so the yield goes up), just like bonds. I'm not too worried about that, but you never know about interest rates. There could be a run on government bonds because of the massive debt that governments have racked up, and that could lower the price of all securities.

The credit risk is that the issuer will go belly up. Not to be taken lightly these days. However, I don't think BNS will go bankrupt. Except for CIBC, the Canadian banks are pretty solid. Moreover, BNS doesn't have large US holdings (unlike RY and TD which have been forced to take writedowns on their US holdings). The bigger risk is that BNS cuts the dividend. To assess that we need to look at the financials.

Canada Life (CL.PR.B) which I bought earlier is also pretty safe I think. Power corp is harder to assess. It's a financial conglomerate with holdings in life insurance companies and mutual fund companies (e.g. Putnam). I can't assess all the portfolios of its subsidiaries like I did with Canada Life. So instead, I look at the ratio of total dividends paid on the common to total dividends paid on the preferreds. My reasoning is that they'll cut the common before they cut the preferred. I also look at the payout ratio.

Here's an image of my spreadsheet containing recent data on a bunch of preferreds I looked at.

Click on the image to see a bigger version.

CU, and CIU are issues from Canadian Utilities and TCA is TransCanada Pipelines. Power Financial is a subsidiary of Power Corp. (Not too much imagination there).

Anyway, you can see that BNS.PR.M, CIU.PR.A, POW.PR.B, and PWF.PR.F are all still in the right price range, and the yields are pretty good too. The DBRS ratings are pretty good, but how much do you trust DBRS these days? The payout ratios on the common are also pretty good, especially for Power Corp, but not for Power Financial. All the firms pay out much much more in dividends on the common than on the preferreds (that's calculated over all preferred series for each issuer, not just the ones shown in the table). Consequently, if there were dividends to be cut, you might see it on the common only. Another factor in determining credit risk is the extend of debt in the capital structure. However, financial companies and regulated utilities will typically show a lot of liabilities in their cap structure, and that's what we see here.

Note that the payout ratio on the common shares for BCE is quite high (80%) and that makes me uncomfortable (I still own some BCE.PR.A), but the yield is not much higher than the other issues. It's even worse for Power Financial. At least Power Corp has money coming in from somewhere else than Power Financial. Overall, you might consider BNS.PR.M, CIU.PR.A, and POW.PR.B, with POW.PR.B being the riskiest.

Global Water ETFs

2009-07-28T22:10:00.006-04:00

I'm interested in the water sector (utilities, engineering, pipes, etc.) so I'm looking into water sector ETFs. There are two that are pretty similar in terms of geographical diversification and sector diversification. They even have more than a few stocks in common, though there are a lot that are not, which seems odd. These two ETFs are PowerShares Global Water (PIO) and Claymore's S&P Global Water Index ETF (CGW).

What really seems odd however is that CGW yields almost 8%, while PIO only paid out a single dividend in the last two yeas of $0.008 in mid-june 2009, according to Yahoo finance. What gives? If they're so similar, why the big difference in yield? Some info can be obtained by looking at the ETFs annual and semi-annual reports. Claymore's is here: http://www.claymore.com/etf/fund/cgw. I got PowerShares' through morningstar: http://quicktake.morningstar.com/fundnet/secfiling.aspx?symbol=PIO&country=USA.

On page 21 of Claymore's annual report, you can see that CGW received a bit over $15M in dividends from August 2007 to 2008. But CGW only distributed 1/10th of that to shareholders (page 22). With 15M shares outstanding that's about 10 cents/share, which is close to the dividend shareholders received in December 2007 ($0.108). In December 2008, CGW distributed almost $12M (page 28), or $1.24/share, for a yield of 8% based on the recent price/share 0f $16.33.

But what can we expect in the future? From August 2008 to February 2009, CGW collected $1.2M in dividends, so perhaps we can expect $2.4M in dividends for the 2009 fiscal year. Still, a lot of European companies don't provide quarterly dividends, they may do it semi annually, or just annually. Also, they are more likely to keep their payout ratio fixed and let the dividends fluctuate with earnings. Nonetheless, you can see that that's a lot less than the $15M collected in FY 2008. So, if we do the math we get: $15M-$1M-$12M+$2.4M=$4.4M, or $0.45/share (there are only 9.64M shares now; see page 28), or at the current $16.33/share, an expected 2.8% yield for 2009. Realistically, we're talking somewhere in the 1% to 3.5% range. If we just consider our estimate of $2.4M for 2009 (ignoring leftovers from previous years), the yield falls to 1.5%. Nowhere near the 8% quoted by Yahoo. Of course, Yahoo calculates this stuff automatically. Just goes to show you that you have to be careful.

PowerShares had a different approach. On page 138 of the semi-annual report, you can see that for FY 2008, which ends in October, they received $0.32/share in dividends (investment income) but did not make any distribution to shareholders in FY 2008. At some point between October 2008 and April 2009, they distributed $0.16/share, while making $0.07/share in dividends. So perhaps we can expect the fund to make $0.14/share for 2009. That's a lot lower than last year's $0.32. Still, a lot of European companies don't provide quarterly dividends, they may do it semi annually, or just annually. Also, they are more likely to keep their payout ratio fixed and let the dividends fluctuate with earnings. Consequently, $0.14 is just a rough estimate. If those dividends were distributed, they would provide a 0.9% yield for 2009, based on today's price of $15.33/share. That's not too far off the yield of 1.5% quoted above for CGW based on 2009 dividend income.

Well, so there you are. Gotta check under the hood.

Bought Canada Life Preferred (B) @ 23.39

2009-05-12T21:04:00.006-04:00

On May 11, 2009, I bought a preferred share issue from Canada Life insurance for 23.39/share (cl.pr.b). At that price, the yield is 6.7%. I am not hedging this purchase. This preferred share is redeemable at 25$.

I was looking for a solid company with a high yielding preferred share issue. Canada Life also has common shares, but they have all been bought by great west lifeco. Canada Life has the following characteristics.

The payout ratio on the common shares for last FY was 49%
It paid out 521.56M in dividends on the common shares, but only 14.46M on the preferred shares.
These two preceding bullet points are important because Canada Life would have to stop paying dividends on the common shares before it decreased payments on the preferred shares. These preceding points show how safe the preferred dividend is.
It made money in 2008, in terms of net income, comprehensive income, and cash flow. At lot of Canadian insurance companies did not.
Its assets/liabilities is 1.1, which is pretty much the same as several other Canadian insurers I looked at. (Reuters and GlobeInvestor were showing very low debt/equity ratios which I don't know how they calculated. I guess they excluded insurance policy liabilities, but I'm not sure. Consequently, I made up my own simple measure of assets/liabilities.)
Its ROE was above 15% for the last four years, which is pretty good for a life insurer according to Pat Dorsey (2004; The Five Rules for Successful Stock Investing)
Unlike Berkshire Hathaway and Fairfax Financial, Canada Life has most of its investments (67.5%) in A rated bonds.
Unrealized losses represent 5% of its investment portfolio.

Pretty solid, it seems to me.

Why Invest at All?

2009-05-12T20:45:00.006-04:00

My last post was all doom and gloom. So the question arises as to why invest at all? Why not just stay in cash? There are two answers:

1- Because the stock market is a leading indicator. In the past, it has gone up before economic recoveries. Indeed, both the TSX and s&P500 are up a bit more than 30% since their March low. If it sticks, the markets would have again risen before the recovery.

2- By buying stocks with a good yield, I benefit from that yield even though I'm hedging. For example, if I buy XYZ at 100, yielding 5%, and it goes up to 150, my hedge will wipe out that capital appreciation. But I'm still getting 5%. Had I waited until the stock was at 150 before buying, the yield would only be 3%. If my hedge works perfectly, I'm ahead by buying early and hedging.

HXD.TO (TSX hedge) bought @ $27.66

2009-04-08T22:02:00.003-04:00

I haven't blogged for several months 'cause I've been busy. On the other hand, I haven't invested in anything since the last time I blogged except for HDX.TO, the Horizon Beta Pro S&P/TSX double inverse ETF. If the S&P/TSX goes down by x% on a given day, HXD.TO will go up about 2x%.

HXD.TO, like other inverse ETFs, works as a hedge, but only if the index really drops. If the index goes sideways, you lose money. That's because you need even bigger gains to get back to even after you've lost money. For example, if you invest 100$, and lose 10% on day 1, you're down to 90$. To get back to 100$, you need to make 10$, or 11.1% of your current 90$ balance. (Hence Warren Buffet's two first rules of investing.) So if the index goes sideways (up 10%, down 10%, up 5%, down 5%) you'll lose money.

I bought HXD.TO on October 31st, at $27.66/share. It's now at $24.60/share.

Buying a hedge like this is not very Benjamin Graham-esque (because I'm worrying too much about that nutty Mr. Market). However, I still see a lot of downside in the current market:

1- The firings are just getting going.

Remember that this crisis arose in the credit markets. The firings began about april or may 2008 and have kept going up since then. Until unemployment drops, spending will be anemic and corporate earnings will continue to slide.(http://data.bls.gov/PDQ/servlet/SurveyOutputServlet). Note however, that the stock market often recovers before earnings do! Makes things a bit tougher to predict.

2- Alt-A and Option mortgage rate resets.

Sub prime mortgage resets resulted in a big increase in mortgage defaults, which resulted in asset write-downs, thus impairing the credit markets. A big spike in Alt-A and option mortgage resets is due for the 2010 to 2012 period. (See here for the ubiquitous credit swisse graph (http://economist.mrwhipper.com/?p=603), and here to get the credit suisse report http://www.imf.org/external/pubs/ft/gfsr/2007/02/pdf/chap1.pdf). Alt-As are designed for people who can't provide sufficient documentation to get lower interest rates. Because mortgage originators didn't hold the Alt-As (they were securitized), the originators would not incur any of the credit (default) risk. This incentive structure encourages some creativity in Alt-A mortgage documentation. Consequently, rating Alt-A mortgages as AAA is a joke, but they did it anyway. We're going to see a high default rate in Alt-As (though perhaps not as bad as with the subprimes), and its going to cause more problems in the credit markets.

Option mortgages are not much better. These include interest only mortgages and negative amortization mortgages, in which you don;t ay down the principle. Think these people can handle higher interest rates?

Moreover, with dropping housing prices, a lot of these mortgages are going to be upside down, even more so with the rate reset. Consequently, the value of the collateral (the house) and therefore the value of the mortgage is a lot lower than it would have been pre-recession.

The rate reset will also have a domino effect on other consumer debt (car loans and credit card debt), increasing their default rates. Think about it: if you have to choose between paying your mortgage and your credit crd debt, which do you think you would choose?

Default rates will go up, the value of the assets used as collateral (houses, used cars, and the junk people put on their credit cards) will drop even more, so the value of holding this securitized debt is going to fall some more too. This is going to freeze up the credit markets again.

3-Delevering

Is it deleveraging or delevering? Whichever it is, it's happening big time and is likely to continue, especially given what I've said above.

Consumer debt securitization allowed non-banking investors (like investment banks, hedge funds, mutual funds, etc.), often refereed to as the shadow banking system (see bill gross' columns here (http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2008/IO+January+2008.htm)), to "invest" in consumer debt. This resulted in an expansion of available credit and lower rates. The problem is that the shadow banking system was also levered, maybe even 40 to 1 (http://articles.moneycentral.msn.com/Investing/JubaksJournal/fluke-credit-crisis-was-a-heist.aspx?page=2). So when the value of the shadow banks' consumer debt assets dropped, and they had to meet their margin requirements, and/or pay back some of their loans, they had to liquidate whatever they could liquidate: stocks and bonds.

Similarly, delevering might have resulted in an increase in the US dollar. Investors (shadow bankers and individuals) were borrowing US dollars and buying foreign stocks and other assets. When these investors had to pay back their loans or meet their margin requirements, or shore up their assets, they had to trade their foreign assets for US dollars, sending the US dollar up. (http://seekingalpha.com/article/108305-deleveraging-pushes-the-dollar-up)

One way to see delevering in action is to look at margin debt on the NYSE (http://www.nyxdata.com/nysedata/asp/factbook/viewer_edition.asp?mode=table&key=278&category=8). Margin debt peaked in July 2007, and has been falling ever since. When that stops falling, it'll be an indication that delevering is petering out. However, bill gross (http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2009/Investment+Outlook+April+2009+Evolution+or+Revolution+Bill+Gross.htm) (of pimco bond fame) thinks that delevering is a long term trend.

4- Junk

And then we have junk bonds. Defaults rates are going up for those as well, leading to a drop in junk bond values, and more delevering.

5- CDS

Because securitized debt and junk bonds are risky, investors decided to buy credit default swaps to decrease their credit default risk. The problem is that the CDS is only worth what's in the "insurer's" portfolio. If the "insurer" holds toxic debt too and a lot of defaults occur at the same time, the insurer becomes overwhelmed and can't pay. AIG is a case in point. In my opinion, once the default rates increase, CDSs won't end up being worth much, leading to even more write downs.

Jim Jubak recently stated that the net CDS obligations in case of default total 2.8 trillion. (You have to figure out the net because a lot of CDSs are offsetting.) That's a 50% drop from the peak, but it's still a lot.

In comparison, Geithner's most recent bailout plan is to buy up to $2 trillion in toxic debt ( http://www.nytimes.com/2009/03/24/business/economy/24bailout.html?_r=1). In the case of defaults, the CDSs would still have to pay out. They would just pay whoever is administering the Geithner money. This gives an indication of the size of the CDS problem.

Soooo, that's why I hedge.

Connors Brothers goes private

2008-11-26T17:47:00.003-05:00

The Connors Bothers sale has gone through at $8.50 per share (see here). cbf.un has been de-listed from the TSX.

BCE buyout hits a snag

2008-11-26T17:30:00.003-05:00

KPMG today stated that BCE will not meet its liquidity requirements set out in its buyout. (see here) This places the buyout at risk. Predictably, shares tanked: bce-pa.to was down 25%!. Jeez. But I'm still getting paid 5% for waiting.

Bought BCE.PR.A @ 22.00 CDN$

2008-11-04T19:26:00.006-05:00

Today I bought some Bell Canada Enterprises (BCE) preferred shares (series AA), BCE.PR.A. BCE is being privatized in the largest leveraged buyout ever! Good timing, eh? Indeed the deal was signed and supposed to close this past summer, but some of the banks involved (Citi, Royal Bank of Scotland, Deutsche Bank) asked to delay the close until Dec 11 in the hope that the credit markets would be more receptive. (See NYTimes story)

The delay and the current state of the credit markets have led people to believe that the deal will be further delayed or cancelled. Consequently, the BCE common are trading well below the purchase price of 42.75 $. Similarly, the preferred shares are trading below their purchase price of 25.76 CDN$. (see BCE site here)

The reason I bought the preferred shares instead of the common is that the preferred shares are yielding 5.45% @ 22$/share. In contrast, the common's dividend was suspended. If the deal is delayed, I get paid for waiting. Not so with the common. If the deal is cancelled, BCE gets 1.2 billion $CDN in compensation. I expect that the preferred would soon go back to trading at its usual 25$/share, and I'd sell. Regardless, I get my 25$/share, the only question is when.

Why TIPS/TIIS/Real Return Bonds Have Fallen so Much

2008-10-31T22:30:00.004-04:00

Interesting article from morningstar explaining that hedge funds were borrowing short to buy TIPS long. So when the credit dried up, they had to sell TIPS to pay back their loans (i.e. deleverage). The consequence being that the price of the bonds really dropped. A similar phenomenon is also undoubtedly occurring with share prices.

I remember a similar thing happening to long bonds when the yield curve reversed, in the 90s I think it was. That's why I think it's better to buy bonds and hold them to maturity, especially G7 government bonds, for which the risk of default is pretty non-existent.

Bought Royal Bank @ 40 $CDN

2008-10-31T20:55:00.008-04:00

I bought some shares of the Royal Bank a while back when they were trading at 40 $CDN on the TSX. RY also trades on the NYSE in $US.

RY fits into my strategy of buying high-yielding solid stocks to hold for 10 years or more. I'm looking for stocks with the following characteristics:

dividend yield above 3.5% (which is a reasonable rate for inflation, not right now of course, but averaged over a long period)
a history of dividend increases of at least 3.5%/year
payout ratio less than 75%
steady EPS growth over 5%/year
ROE consistently over 15%
35% discount to 10 year return discounted to present value at a rate of 3.5% (inflation again).

RY meets these criteria. Nonetheless, it does hold some dodgy assets

Auction rate securities it promised to buy back
some sub-prime related instruments
some credit default swaps
and some loans to the construction industry

Added up, they amount to 9.78 billion $CDN, or 1.78$/share. (Actually, its probably more now that the CDN dollar has dropped.)

To calculate the present value of a 10 year investment in RY, I assumed that RY would have to write down 100% of the value of these dodgy assets starting in 2009. That's pretty extreme. I don't think the whole value of these instruments will evaporate. Nonetheless, it provides a conservative estimate of expected returns based on the past 10 years earnings growth. The past 10 years may have been an abnormal economic boom period so my extreme assumptions about the dodgy assets provide a bit of a counterweight. The dodgy asset write-downs would come out of retained EPS. Given the following assumptions

Share price = 40$
EPS growth = 17.15% (10 year rate from 1998 to 2007)
inflation = 3.5%

Over 10 years, a 100$ investment would grow to 327$, without compounding the dividends. Given the 10 year average payout ratio of 40%, a good chunk of the gain would come in the form of dividends, which would grow at 17.15%. Using my inflation estimate to discount to present value, this represents a 132.11% gain. Viewed another way: at 40$/share, RY was trading at a 57% discount.

In contrast, using S&P500 EPS data for 1998 to 2007 from professor Shiller (thanks professor) and 848.92 as the share price, I calculated that an investment in the S&P500 would return 47.97% in present value terms. (EPS growth is a lot lower if you consider earnings for 2008, but that would include some of the financial institutions' write downs and bankruptcies so it might not be the best predictor.)

That RY is a good value is also indicated by traditional valuation measures, like dividend yield and P/E. Its 5% yield (at 40$) is much higher than its year-end yields have been in the last 10 years (ranging from 1.6%, to 3.17%). Its P/E (given by 40$ over 2007 EPS) is 10.58. The next lowest year-end P/E was 13.29 in 2000.

In terms of management effectiveness, its ROE has consistently been over 15%, and it hasn't had a negative EPS in the last 10 years.

Finally, its EPS and dividend growth have been very steady, as can be seen in the graph below.

Previous Blog URL

2008-10-31T20:40:00.003-04:00

My previous blog was at wordpress. I switched to blogger to get some AdSense revenue. I figure that if I put in my 2 cents, I might as well get my 2 cents!