Newsletter January 8, 2017

InvestorsFriend 2016 Performance

2016 was a good year as our four Strong Buys rose an average of 26.1% and our 24 stocks rated (lower) Buy or higher rose an average of 17.0%. By comparison, the TSX rose 17.5% and the S&P 500 rose 9.5%. Click here for the details by individual stock.

Since the start of the year 2000 the average gain for the stocks that we rated as (lower) Buy or higher at the start of each year has been 12.4% compounded annually. That’s a total gain of  633%. And that excludes dividends.

The return on my own actual personal portfolio since the start of the year 2000 has been a compounded average return of 13.5% per year or a total of 755%. This includes dividends and deducts all trading costs.

These returns in the low double digits, if sustained, and if applied to even relatively modest annual savings, are more than enough to become quite wealthy over a period of several decades. These returns are also high enough to cause a retirement portfolio to grow rather than shrink despite withdrawals.

These returns were achieved based on investing in mature and relatively “blue chip” companies. No “grand slams” were required. These returns did not involve getting lucky in penny stocks or anything of that sort.

To illustrate the type of stocks involved I review  below each of the four stocks that we had rated Strong Buy at the start of 2016 and summarize the rationale as to why each was rated Strong Buy and how that turned out.

Canadian Western Bank – This stock rose 30% in 2016. It also paid a dividend yield of about 3.8%. At the start of 2016 it was trading at $23.38 which was down 46% from its all-time high of about $43 in the summer of 2014. Meanwhile its earnings were stable and had not declined. There were fears that its earnings were about to decline due to bad loans associated with the recession in Alberta. It appeared to us that the stock price had over-reacted to the probable earnings decline. And, we judged that this bank could safely be predicted to grow its earnings per share in the long term. Banks tend to be stable businesses with a “sticky” customer base. It had a strong history of growth. It was trading at only about a 10% premium to book value. Its trailing P/E ratio was very attractive at 9.0. The stock subsequently languished for most of 2016 but rose rapidly in November and December as oil prices rose sharply and with the generally strong markets. This was in spite of an earnings decline of about 12%.

Boston Pizza Royalties Income Fund – These units rose 27% in 2016. This was in addition to a dividend yield of 7.0%. We concluded that the dividend would rise with same-restaurant sales which we believed would rise perhaps 1 to 2% annually on average and that even in the face of the recession in Alberta were unlikely to decline more than a very modest amount. We believed that there was very little downside risk in terms of the cash distribution and that a 7% dividend that would likely grow slowly over time was highly attractive given the low level of interest rates. These units rose in price during the Summer of 2016 rewarding our faith in this investment.

TransForce Inc. – This stock rose 48% in 2016. This was in addition to a dividend yield of 3.1% of the start of the year price. We were attracted by the history of strong earnings per share growth.  The price to earnings ratio was attractive at about 11 and the return on equity was impressive at 23%.  We felt that the management quality was very good. Trucking is a relatively simple business and we felt that this company would continue to perform strongly as it had in the past. Despite the weak economy we concluded that this company offered good value. Our faith was amply rewarded as this stock rose steadily from February through October and then surged in the final two months of the year.

Melcor Developments – This stock ended the year at about the same price it started. But it did provide a dividend yield of 3.3%. This Alberta company is primarily in the business of developing raw land into residential home building lots and also develops and owns a stable of commercial rental buildings. We were attracted by the fact that the stock was trading at only about half of book value. And the assets were land and commercial buildings. While it was possible that land and commercial building values in Alberta would collapse, we were not seeing evidence that this was the case. We felt that the opportunity to effectively buy land and buildings at about 50 cents on the dollar would ultimately turn out well. This family-controlled business traces its roots back over 90 years and has been publicly traded since 1968.  It has weathered many recessions and we believed it would continue to prosper although in a volatile manner. This stock did not recover in 2016 and even dipped lower at times. But we expect that it will ultimately recover.

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Invest in Companies With “Good Economics”

As detailed in one of our articles , Warren Buffett, in 2008, said that he  “looks for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag.”

Buffett went on to state: “A truly great business must have an enduring “moat” that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore a formidable barrier such as a company’s being the low cost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success.” … “Long-term competitive advantage in a stable industry is what we seek in a business”.

With this in mind, our InvestorsFriend stock reports always address the issue of the economics of the business and the competitive advantage (if any).

The following is how we view the economics and competitive advantage of several well-known Canadian companies:

Dollarama – You might think that a store selling items at a maximum price of $4.00 would not have wonderful economics. In fact Dollarama has wonderful economics as evidenced by its high return on equity. It is also evidenced by a stock price that is up 1037% since its Initial Public Offering in late 2009. Its profit as a percentage of sales is running at 14.5% which is very high for a retail business. While there may be nothing proprietary about their approach, the following appear to be competitive advantages: All sales are final resulting in lower costs as opposed to allowing returns. They are 4.5 times larger than their nearest Canadian dollar store competitor, (Dollar Tree) which provides economies of scale in purchasing. They have clean, modern, well located stores. About half of the merchandise is direct sourced from low-cost foreign jurisdictions such as China. Consistent products are carried as opposed to surplus or liquidation type items. They do not accept credit cards, so sales are cash and debit which avoids credit card fees. The company is very popular with consumers and has little or no need to advertise except when opening new locations. Lack of advertising is a cost advantage.

Dollarama definitely has wonderful economics. That doe NOT mean it is necessarily a good investment at its current share price. Our full report available to our paid subscribers delves into that issue.

Canadian National Railway – This company has wonderful economics as evidenced by CNR’s return on equity which has been relatively steady at about 23% for the past five years. Its share price is up 1018% since I first analysed it in August of 1999. Rail is more efficient than trucking. There is very limited rail competition in most of the territory it serves. Often only one competing rail service. It seems doubtful that it would be possible for any new competitor to move into Canada and lay down a third set of tracks to compete with CNR and CP. (I think any business owner would tell you that having only one major competitor would be a dream come true). So, CNR definitely has wonderful economics. That doe NOT mean it is necessarily a good investment at its current share price. Our full report available to our paid subscribers delves into that issue.

Bombardier – This is a company with absolutely terrible economics. The introduction of a new airplane model requires huge investments – often far larger than initially budgeted for. Your competitors may be subsidized by governments. You have to discount massively. You may need to help your airline customers finance the purchase which is risky given that airlines typically or often have terrible credit ratings. You have to guarantee the residual or resale value of the planes after the end of their service lives. The product liabilities are likely massive in the event of a technical problem causing a crash. The rail side of the business is not as bad but has also been a terrible business. Bombardier’s terrible economics are evidenced by its losses and the fact that its share price is down over 90% from its peak in September of 2000. And the share price is lower than it was in 1995 which is the earliest data shown in Yahoo Finance.

Bombardier makes excellent products and contributes greatly to the economy. But with its terrible economics and track record it is not a good candidate for a long term investment. Our report discusses its economics and its potential in more detail.


Shawn Allen
InvestorsFriend Inc.

January 8, 2017