Investorsfriend.com Newsletter February 16, 2003
Investment Goals and Risk Tolerance
Every investor is advised to think about their goals and their risk
tolerance. My latest article provides a framework to help you think this through
in a logical fashion. My conclusion is that your goals should be fulfilled in a
sequence from having an emergency fund, to insuring sustenance in old age, to
insuring comfort in old age, then luxury in old age and then ONLY if all of
those have been assured to work on simply getting "stinking rich" if that is what
you want. In terms of risk my article argues that as you begin to save for each
of these levels in sequence you can take substantial risks but then as each
level is reached you should lock in that level by focusing on capital
preservation. That way you never risk your comfort in old age just because you
are working on the next level of luxury in old age or getting "stinking rich".
It then becomes illogical to say that you are a conservative or an aggressive
investor. Instead, we should all be conservative with the future grocery
money and fairly aggressive with a certain amount in the current level that we
are trying to complete. Also investors that have already accumulated a
significant amount should generally lock in a certain amount of that by focusing
on capital preservation and only putting a portion of their portfolio at risk.
Risk tolerance is not really a matter of risk preference but should be much more
driven by when the money is needed and what it is needed for.
For more detail see my article on this ratcheted
solution to retirement planning.
This article is in contrast to some of my earlier work that supports the
logic of being 100% in equities. It is true that 100% equities on average will
lead to the largest pot of money in the end. But as I thought more about risk
tolerance, I have changed my thinking. I guess there would be no point for me to
do the amount of reading, studying, and thinking that I do if I were not
prepared to change my mind, so I make no apologies for that.
What To Buy Now
My model portfolio for 2003 is up about 5.9% in 2003 to date, despite the
fact that North American Market have declined. My Strong Buys are up an average
of 7% in the first 6 weeks of 2003. After several years of giving away all of my
advice for free I decided I was no longer motivated to continue all of this work
for free. You can access all of my research electronically and instantly for
$10.00 per month on a subscription basis and you can cancel at any time.
Therefore you can get access to all of my research and specific strong buy picks
for an investment of as little as $10.00. However with very few exceptions, the
people that have subscribed have chosen to maintain their monthly subscriptions.
If you have already subscribed then I thank you. Otherwise, you may wish to
consider doing so at the following link. Research for
sale.
TELUS
TELUS on Friday, reported Q4 and 2002 earnings (well actually a loss). I'd
like to give you my opinion on their shares as an investment. But I can't. They
predict earning only 40 to 55 cents per share next year so that puts the P/E at
just over 40 at the current stock price. So that in isolation would point to a
sell.
But I need to understand their cash flow. Maybe all those investments they
are expensing to acquire mobile phone customers will pay off in huge profits in
years to come. And I would think that their historic local phone wireline
business would be a huge cash cow. But I can't see the evidence in their report.
Their quarterly reports always run to well over 40 pages and contain reams of
discussion about customer growth and "earnings" BEFORE depreciation, taxes,
interest, depreciation and (phew this a long list) amortization. That's all well
and good but what if all this growth continues to unprofitable? And what if
depreciation, taxes, interest, depreciation and amortization are all actually
real expenses as GAAP accounting implies that they are?
Their debt is huge and they have only a BBB credit rating.
My bottom line is that I don't think that their reports are user friendly at
all (despite that the Chartered Accountant's keep giving them gold metals for
their annual reports). I can't figure out at all what the shares are worth. I
recently sold half of my TELUS shares. I consider the shares I now hold to be a
pure speculation.
CALPINE
Calpine a big U.S electricity generator that I follow also reported earnings
last week. My big complaint is that U.S. companies including Calpine normally do not provide a
balance sheet in their earnings releases. The balance sheet will come weeks
later in a formal 10Q report. In this respect I far prefer our Canadian
reporting system where the balance sheet is always included in the quarterly
earnings press release. Vive le Canada!
I also prefer fairly short quarterly reports. It's funny how when a company
is nicely profitable, the numbers tend to tell the story. Profitable companies
don't have to blather on for pages and pages.
I'm not going to update my Calpine report until I see a balance sheet.
Another problem with Calpine is that they just wrote off a large amount to get
out of certain contracts to buy some $4 billion worth of equipment and
construction in the future. The problem is that this is at least the second such
write-off and who knows if this is the end.
RRSP Contributions
Do not use the low markets as an excuse to skip your RRSP contribution. In
fact lower markets should make you more inclined to invest. But more importantly
you can just deposit cash to your RRSP now and decide what to do later. Many
investors seem to think that RRSP means mutual fund. It of course just means
that the funds are registered as being retirement money and are eligible for a
tax break. The money can be left in cash or invested in short term fixed income
or a huge variety of stocks or mutual funds. Just put the money in now to get
the deduction and you can let it sit if you want. (Of course this assumes that
investing in an RRSP is right for you, that is another discussion you can have
with a financial advisor, but don't forego it just because of low markets).
Fixed Income versus Growth Stocks in the RRSP
For years I have read that RRSPs should be mostly fixed income and growth
stocks should be kept in an unregistered plan. Being stubborn, I did not really
believe this since the people saying it fid not really offer any arguments as to
why this was the case.
It definitely makes sense if you are committed to having some fixed income
in your portfolio (i.e. you are not 100% equities) and if you are lucky enough
to have maxed out your resisted savings plans including RESP. Clearly if you
have taxable accounts then the stocks which are taxed at lower rates should be
outside the RRSP leaving the fixed income sheltered inside the RRSP.
But if all your investments are in RRSP I was of the opinion that it could
logically be 100% equities if you were younger since equities have historically
always out performed in the long run.
But when you consider that something unforeseen could happen and you might
need to cash your RRSP to live on much earlier and considering the need to
focus on capital preservation to lock in incremental levels of lifestyle in
retirement as discussed in the article above, I begin to agree more with the
idea of having a fixed income component inside the RRSP.
Also there is another logic. The market is generally thought to provide a
higher return for stocks at the expense of higher annual volatility. The market
return for securities is set by taxable investors. This is clearly demonstrated
by the fact in the U.S. tax-exempt municipal bonds have lower yields than regular
taxable bonds. Pension funds and registered plan investors would prefer the
higher yield and would not bid up the price of tax-exempt municipal bonds to
create the lower yield. This proves that the taxable market sets securities
prices not the registered plan market participants. Logically, growth stocks
are also being driven down in yield by that fact that at least some tax is
payable due to capital gains. In a pure tax exempt environment the yield on
bonds would fall more than the yield on stocks. The taxable market rewards stock
investors with a certain incremental additional amount of return on an after tax
basis.
RRSP investors and pension plans can take advantage of the fact that yields
on taxable bonds have been driven up to compensate for the taxes. But RRSP
investors can defer the taxes for decades and thus get something of a free
ride by enjoying the higher bond yields set in the taxable market. Therefore, all
else being equal an RRSP investor should have a higher allocation in bonds and
fixed income compared to a taxable investor.
The RRSP investor is not getting as
much additional incremental return for stocks versus bonds as compared to the
taxable investor. This is because the RRSP investor's bond return is not reduced
by taxes and so the favorable capital gain treatment of stocks is not worth as
much to the RRSP investor as it is to the taxable investor. The bottom line is
that there is a certain amount of market inefficiency in putting stocks into an
RRSP. Now this is partially or even perhaps totally offset by the much longer
time horizon of the typical RRSP investor. If you have a "lot of religion" about the long
term benefits of stocks then you can still justify a heavy allocation of stocks
in the RRSP. But due to the market efficiency factors you should probably take
some advantage of the favorable yield on bonds. And for Canadians this works
even better with higher yield income trust products.
INCOME TRUSTS
I am increasingly convinced that Income Trusts are a superior form of
business organization. They create added shareholder value by lowering the total
taxes paid to revenue Canada. This is explained further in my popular past
article on Income Trusts.
Canadian investors would be wise to include Income Trusts in their
portfolios.
OIL AND GAS
I am not an oil and gas analyst and I believe that analysis of oil and gas
companies requires a different approach. Their value is not necessarily revealed
in financial statements but is more dependent on their oil and gas reserves in
the ground. However, my sense is that oil and gas is a good investment at this
time and should be included in portfolios.
Air Canada
I love to hate this company. I have to laugh when Robert Milton expresses
incredulousness at the fact that small profitable airlines are worth more than
huge unprofitable airlines. In a recent speech to students in New Brunswick he
made it sound like the market is completely irrational for valuing the likes of
Jet Blue at a higher value than the hugely larger American Airlines. It is scary
if he really thinks this is irrational. Why shouldn't an airline with say 50
planes be worth more than one with 5000 airplanes if the big airline loses
money while the small one actually makes money? The planes themselves have value
but if an airline has huge debts and huge losses then it is very rationally
close to worthless.
If Robert Milton believes what he said in that speech then he is even dumber
than I thought. I don't think he is quite that stupid and so it is disappointing
that he would (in my opinion) mis-lead students in this fashion.
He is right that the Airline industry suffers from structural problems. Chief
among these is the fact that Airlines compete viciously and ruinously on price
to the point of losing money. Air Canada has been among the leaders in pursuing
this type of destructive behavior. There is surely a problem in the industry and
Robert Milton is in my opinion surely a part of the problem.
End