InvestorsFriend Inc. Newsletter December 17, 2005

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Performance

I am totally pumped about the performance of our stock picks this year and in fact every year since this Site started.  In the past three years my personal portfolio has returned an extremely satisfying 121%! And the the Strong Buys have done even better returning 189% in the past three years.

If you have not already done so, right now is an excellent time to take action and subscribe to our stock picks. While we update our stock ratings all throughout each year, we do make a special effort to update the picks for the start of each new year. Also with RRSP contribution season at hand, you may be looking for investment ideas.

The fact that you have subscribed for this newsletter tells me that you are probably someone who has an interest in taking charge of your investment decisions. If so, I believe that my stock rating service will be of great interest to you.

Our Stock picks have performed tremendously this year;  the Strong Buys are up 29.1% , the model portfolio is up 32.8% and my personal investment return is 31.5%.

Somewhat incredibly, we achieved this despite choosing to almost ignore the oil and gas sector as well as golds and minerals. (Although the model portfolio has a modest exposure to oil and gas).

Some of our big successes in 2005 were... A small property development company that is up 135% and a property insurance stock that is up 48%. Many other picks were up 15 to 30%.

One of the big keys to our success once again this year  was the fact that we had extremely few losers. Out of 18 stocks rated in the Buy or Strong Buy range, fully 16 are up in price and only 2 are down. One of the best ways to make money is to not lose money. One stock that goes to zero needs 5 stocks going up 20% just to make up for the one total dog. By having very few losers we were able to achieve 30% average gains without having to rely on having one or two super-star stocks that went through the roof.

Achieving Success in Investing and in Life

Are you confident that 2006 will be a very positive year for you in terms of your investment goals and your other important goals in life? If so, carry on. If not here are some thoughts that may help.

Perhaps one of the best ways to achieve success in any field is to to be coached or mentored by someone who is already highly successful in that particular field. For example have you ever heard of an elite athlete who did not give credit to coaches and mentors? If you can't find such a highly successful person to coach or mentor you then you may be able to simply copy their publicly known techniques.

Many successful people have written books. These include autobiographies and instructional books. Why not study them? In almost every case the greats in any field of endeavour are effectively standing on the shoulders of the greats that went before them. Whatever your field is, I believe that one of the easiest ways to get ahead is to study and copy the techniques of the greatest people in that field.

Stock Return Outlook for 2006

I can't predict what the average return will be in the Canadian stock market for 2006. But neither can anyone else do so with any accuracy.

In 2003, 2004 and 2005 (to date) the TSX composite index has returned 24%, 13% and 20%.

The TSX composite index is approaching its high of 11,402 that was reached in September 2000. That peak was largely caused by the "tech bubble" and Nortel in particular. Nortel was actually losing money at that time and overall the TSX composite level at that time was simply not supported by earnings. In part the high recent returns are  the result of climbing out of the hole that resulted when the market crashed down from the tech-bubble peak.

This time around the earnings on the TSX are a LOT higher. In my view, there is little chance that we will see a major stock market crash - such as a 25% drop. (There may be a bubble in real estate these days, but there is no bubble in the stock market).

However, the TSX composite is also not priced at a bargain level. My article on the TSX valuation finds that the TSX is at least somewhat over-valued at this time. And the high market gains of the past three years are clearly unsustainable (simply cannot happen year after year).

All else being equal I would expect the TSX composite index in 2006 to return something less than 10% and certainly a negative return is quite possible. But all else is never equal in the short term. If oil keeps rising then the TSX could have another good year.

In any event, no matter what the market does, there will always be plenty of stocks that outperform the market and give positive returns. The trick of course, is to find a reliable way to identify some of those stocks. For six straight years, I have been successful in doing so.

Christmas Reading

I recommend Stephen Jarislowsky's recently published book "The Investment Zoo - Taming the Bulls and Bears". Mr. Jarislowsky is 79 years old and with $1.3 billion dollars in personal worth was listed as number 25 on a list of the richest Canadians by Canadian Business Magazine. His "little" firm has over $50 billion in assets under management. (to put this in context, the Royal Bank's mutual fund business has $57 billion in assets.)... So, Mr. Jarislowsky is clearly an extremely successful investment manager. That should be reason enough to read the book. (One of my rules is that when extremely rich investors are willing to talk about how they did it - I listen). This book is concise at 150 pages and is basically a light enjoyable read.

The Articles section of this Web Site also contains a wealth of good investment reading material.

Pension Problems

There are so many problems (for employees, pensioners and the sponsoring corporations) with defined benefit pension plans that it is hard to know where to begin. The following is a summary of some of these major problems.

Problems for pensioners:

In most cases there are actually few problems for pensions. One problem they face is that in most cases pensions are not fully indexed to the cost of living. And inflation in the costs faced by pensioners (drugs, housing nursing care, energy, transportation) is likely far higher than indicated by the consumer price index. The consumer price index is driven down by price deflation in many manufactured items including consumer electronics. But many pensioners may not be buying these discretionary items.

Most pensioners do not have to worry that their pension benefits will be reduced. If a pension deficit develops it is normally current and future employees as well as the employer that has to make up the deficit over a period of years. However, in rare cases, pensioners do have to worry that their pensions could be reduced. If a corporation with a pension deficit becomes bankrupt then there would normally still be segregated pension assets to draw upon. But if there is a pension deficit then this would normally trigger a reduction in benefits. (Unless the government or a pension insurance fund steps in to cover the losses)

Problems for Corporations (and investors)

A major problem for corporations and investors is that pension accounting results in very volatile amounts for pension expenses. If the pension assets perform well, then the pension expense is lower and vice-a-versa. And this occurs even though changes in pension assets and liabilities are largely smoothed by amortising certain changes over many years. If the annual change in the net funded position of the pension was immediately recognized on the balance sheet and flowed to net income, then the volatility in pension expenses would become extremely volatile. Since accounting rules in general appear to be becoming more conservative, it is possible that such an accounting change could be made. (In that case it would be necessary for analysts to adjust the pension expense to a normalised level).

Pension expenses and company contributions, aside from being volatile have also increased rapidly which is reducing net income.

Many corporations (and therefore shareholders) face unfunded liabilities in the pension that may or may not be recorded on the balance sheet.

Problems for current employees

A big problem for current employees is that pension contributions have been rising rapidly. Required pension contributions have increased as the assumption regarding the return on plan assets has decreased (probably without a corresponding decrease in the assumptions regarding wage increases.) The required contribution has also increased due to longer life expectancies. In addition in cases where unfunded liabilities exist, current employees are facing higher contributions to make up for past contributions that a were, in retrospect, too low.

There are some real horror stories regarding contributions. Alberta teachers are currently contributing about 12% of wages, while their employers contribute 14%. This total of 26% is partly caused by a pension deficit. In any event this is a horrendous level of pension contributions and is close to 3 times higher than the total contributions of about 8% to 10% that were considered standard, just a few years ago.

For more information on the woes of pension plans see my updated pension article.

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