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Newsletter July 20, 2024

The Year to Date

Stock markets have been very strong this year to date. The S&P 500 is up 15.4% and the Toronto stock index is up 8.3%.

A standard globally diversified portfolio with a standard mix of 60% equities and 40% fixed income is up about 6.9% (VBAL) or 7.5% (XBAL).

In all cases here, dividends would add somewhat to the gains.

State of the Economy

The U.S. economy has continued to be strong with very low unemployment levels and strong GDP growth.

The Canadian economy is relatively weak with rising unemployment levels.

Interest Rates

The market consensus is that on Wednesday July 24th, the Bank of Canada will cut interest rates for the second time this year and follow this up with two more cuts by the end of the year. The U.S. FED is expected to make its first interest rate cut in September and cut once or twice more by year end.

What could go wrong?

There are many things that could send markets lower. Some that come to mind are:

  • The valuation of the S&P 500 is somewhat rich. The trailing unadjusted actual price/earnings ratio is currently quite elevated at 28.6. The forward p/e based on actual expected GAAP earnings in the next year is also elevated at 23.8. The forward p/e based on forecast operating earnings – which is what most analysts focus on – is also somewhat elevated at 21.6. It’s certainly possible that the continued strong earnings of the big tech stocks will justify this high valuation, but it leaves the market vulnerable to a pullback.
  • Recessions in both Canada and the US are possible, perhaps even likely. The goal of higher interest rates has been to cool the economy, so we should not be surprised if that succeeds. In Canada we face the added negative impact of so many mortgages renewing at higher interest rates.
  • A Democratic Party win in November could be negative for markets given their plans to increase both corporate income taxes and taxes on higher personal incomes. Some of Trump’s personal tax cuts will expire in 2025 unless extended.
  • A Trump win in November could also be negative for markets given his plans to erect higher tariff walls.
  • Geopolitical risks are always a possibility including conventional wars, trade wars, and even possible threats of nuclear wars.

What to do?

Given uncertainties, it’s prudent for investors to include geographic diversity in their portfolios and to include fixed income as well as equities.

It may be a particularly good time to lock in today’s yields on fixed income given that interest rate are expected to decline. I’ve just updated my article on Fixed Income Choices which includes simple high interest savings accounts paying 4.3% in Canada and 4.9% on U.S dollar savings and also includes information on GICs.

At this time I think perpetual preferred shares are attractive. They mostly yield 6.0 to 6.4% and in addition they should offer capital gains if interest rates fall as expected. They are eligible for the Canadian dividend tax credit. These can be a great choice for a portion of portfolios of older investors or anyone seeking dividend income. I have six of these on our list rated “Buy” or (higher) Buy. To see the list you can Subscribe at a cost of just $15 per month or $150 per year. To Subscribe click “Become a member” at the top of any page of this website.

And if you are looking for a REALLY simple solution, and not interested in investing in individual stocks, you can invest in VBAL or XBAL on Toronto which will give you a prudent standard balanced and diversified portfolio at a very low management fee.

END

Shawn Allen

Investorsfriend Inc.

July 20, 2024

 

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RRSPs Tax Trap or Ultimate Wealth Builder?

RRSPs: Tax Trap or Ultimate Wealth Builder?

Depending on who you believe, RRSPs are either a “tax-trap” or “The Ultimate Wealth Builder”.

An RRSP contribution reduces your current income tax but the resulting investment, while it grows tax free, is taxable when withdrawn.

The tax savings from an RRSP contribution vary by province and vary greatly by income. For most Canadians with a taxable income between about $55,000 and about $100,000, the marginal income tax rate is about 30%. The following example using a typical 30% marginal tax rate illustrates the advantage of RRSP investing.

At a 30% marginal tax rate, a $5,000 RRSP contribution results in income tax savings of $1,500. Therefore, your net cost of the contribution is $3,500 but you have added $5,000 to your RRSP account. This results in the popular misconception that an RRSP contribution increases your net worth. That’s false because if you withdraw that $5,000 in the future and if your marginal tax rate remains 30% you will pay $1,500 in income tax and net $3,500.

That looks discouraging but there’s much more to the story.

If that $5,000 earns an average 7% return it will grow to $50,000 in 34 years. If you then withdrew the $50,000 at the same 30% marginal tax rate you would pay $15,000 in income tax and net $35,000 after tax.

Those who view an RRSP as a tax trap would argue that you saved $1,500 in taxes at the outset and are now paying $15,000 in tax and so it’s a very bad deal. They would say you would have been better off to invest the $5,000 in a taxable account where the lower tax rates on dividends and capital gains would result in a tax bill well under $15,000.

But that argument ignores the fact that the original investment only cost you $3,500 after tax. Therefore, a fair comparison would be to investing only $3,500 in a taxable account. And at 7% that would only grow to $35,000 before tax in the same 34 years. The RRSP netting $35,000 after tax easily beats the taxable account with $35,000 before tax, especially considering that income tax would have been payable every year on realized earnings in the taxable account.

The best way to think about this RRSP is that it was initially funded 70% by your own contribution and 30% by the income tax savings. It became a pre-tax pot of money. As it grows, think of it as being about 70% your money and 30% the “taxman’s” money. When it reached $50,000 it amounted to your 70% share having grown tax-free to $35,000. Think of the $15,000 tax as the taxman simply taking back “his” 30% share of “your” RRSP. He has not touched your 70% share even as it grew ten-fold.

But not all situations work out the same.

Some retirees will end up in, say, a 50% marginal income tax bracket. In that case the tax paid on the $50,000 withdrawal would be $25,000. Think of this as $15,000 representing the taxman’s 30% funded share of the RRSP plus an additional $10,000. Your net after-tax gain would be $25,000 minus $3,500 or $21,500. And that $10,000 tax would amount to a tax rate of 46.5%. In this scenario you would likely have been better off investing in a taxable account.

Most Canadians can expect to retire in a lower marginal income tax bracket and therefore the tax paid on RRSP withdrawals will represent less than the taxman’s percentage funded share of the RRSP. Believe it or not, this means that their own net cost of the RRSP has grown at a negative income tax rate. For example, if a contribution made at a 50% marginal tax rate can be withdrawn at a 35% marginal tax rate, the tax is less than the taxman’s funded portion of the original contribution.

The bottom line of this story is that the tax on RRSP withdrawals is usually not nearly as bad as it seems. If you had invested the lower after-tax dollars in a taxable account or even in a TFSA it never would have grown as large as the higher pre-tax amount has grown in the RRSP.

While an RRSP contribution can work out well as explained above, there are other investment choices that are even better for most Canadians.

In most cases, maximising TFSAs and (if applicable) RESPs and First Home Savings Accounts should take priority. RRSP contributions are now most applicable to those with higher incomes.

Unused RRSP room can also be very useful in the event of an unusually large taxable income in a particular year such as a large severance payment or a large taxable capital gain. And a spousal RRSP can be very beneficial for single income couples.

As indicated above, marginal income tax rates vary greatly by province and by income level. You can check the marginal income tax rate at your income level for your province at https://www.taxtips.ca/marginal-tax-rates-in-canada.htm

An RRSP contribution or withdrawal can also impact various income-tested benefits as well as the old age security clawback.

With the increased choices of tax-advantaged investment vehicles and the complexity of the income tax system, it’s becoming increasingly important to consult a tax accountant to help make your decisions.

END

Shawn Allen, CFA, CPA, MBA, P.Eng.
President, InvestorsFriend Inc.

Note: This article was originally published in the Internet Wealth Builder Newsletter dated February 19, 2024

 

 

Newsletter October 28, 2023

Canada’s new First Home Savings Plan

Brand new for Canadians this year is the First Home Savings Account (FHSA). If you or perhaps your adult child will be a first time home buyer in the foreseeable future, then this new plan should be of interest to you.

For first-time home buyers it allows a maximum contribution of $8000 this year and that contribution is tax deductible.

The FHSA allows for a maximum contribution of $40,000 over 5 to 15 years. If the money (including the growth of the money) is ultimately used to purchase a first home then the withdrawal is not taxed.

I wanted to draw your attention to this new account at this time because the end of the year is approaching. It turns out that if a future first-time home buyer does not contribute anything or the does not contribute the maximum $8000 by December 31, they CAN carry forward the unused contribution to 2024. But they would lose the chance to make a maximum income tax deduction in 2023. Correction: You can only carry forward the unused room from 2023 if you actually open a FHSA by December 31. (And note that if they again do not contribute in 2024 the maximum carry forward to 2025 would be $8,000 and not $16,000). Edit: For potential first-time home buyers there is NOTHING to lose by opening a First Home Savings Account by December 31 and you can contribute just a few dollars or up to $8000. If you can only contribute a few dollars you will at least create unused contribution room to carry forward.

My message is that potential first-time home buyers should probably take action and open a FHSA account before the end of this year and consider contributing up to $8,000. This is especially relevant and important for those with high enough incomes to benefit from the the income tax deduction.

In Ontario, the income tax savings will range from 20.05% of the FHSA contribution to as high as 53.35% of the contribution for those with taxable incomes over $236,000. For those with taxable incomes between $53,000 and $87,000 the tax savings will be 29.65% or $2,372 for an $8,000 contribution. This if basically “free money” and those to which it is applicable should take advantage of it.

Why the Stock Markets are down

The Toronto Stock Exchange is down 3.3% year to date and it’s down 16% from the high for this year reached at the beginning of February. And the S&P 500 is down 11% from its peak level reached this past summer.

Higher interest rates have pushed stocks lower in four ways.

First, even if companies continue to earn and to grow at the same level as previously, those earnings and the associated dividends are simply less valuable as interest rates increase. For example a dollar that is guaranteed to be received in 10 years has a theoretical value of 82 cents when interest  rates are 2% but only 56 cents when interest rates are 6%. Stated another way, stocks have to offer a higher expected return as interest rates rise. And if the expected future earnings and cash flows have not changed then the only way a stock can offer a higher expected return is to decrease in price.

Second, compounding the above is the fact that many companies can expect to have lower future earnings as interest rates rise because of the higher interest they must pay on debt. This impact varies greatly by company depending on their debt level and how much, if any, of their debt is locked in with fixed interest rates for several or more years.

Third, in the most extreme cases the higher interest payments can threaten the financial viability of a company and in that case its share price can drop precipitously.

Fourth, higher interest rates tend to slow the overall economy. In fact Central Banks increased interest rates with a goal of slowing the economy and therefore inflation. A slower economy tends to lower the expected earnings of most companies even those with no debt.

How to Get Started Investing Now.

This month, I updated my article on how to get started investing in a prudent balanced and diversified way. Both stock and bond prices have declined on average in recent months. While this could continue, the fact is that the lower prices are presenting an opportunity for new investors. And anyone getting started investing now is not likely doing a “once-and-done” form of investing. Younger investors in particular can invest funds each month or year. A scenario of lower stock and bond prices, if that does continue, will be an advantage. Investing will almost certainly provide a better future as compared to never getting started investing.

Preferred Shares

My updated article on preferred shares explains why they have fallen in value and why they are now offering attractive returns.

END

InvestorsFriend Inc.
Shawn Allen
October 29, 2023

 

 

 

 

 

Preferred Shares October 28, 2023

PREFERRED SHARES – PERPETUAL AND RATE RESET

As of late October 2023, preferred shares are probably a very good choice for Canadian investors.

Higher interest rates have pushed their prices down and their yields up. The price drops have been painful for those holding these shares. But now that interest rates are predicted to be near their peaks and to start moving lower within a year or two, these shares could provide not only attractive yields but also possible capital gains. With inflation coming down their yields can reasonably be expected to exceed inflation going forward. And perhaps to significantly exceed inflation.

For Canadian investors in taxable accounts they also offer the added benefit of lower income taxes (compared to interest income and REIT distributions) due to the dividend tax credit. For taxable accounts they offer  significantly lower tax rates especially for those with lower incomes.

In Canada, there are two main categories of Preferred shares. These are Perpetuals and Rate Resets.

I address the two types separately below.

I’ve listed some specific preferred share names and trading symbols  for investors to consider.

When buying or selling preferred shares, be aware that they usually have low trading liquidity which can lead to wide bid-ask spreads. Therefore, use limit orders and and attempt to buy at or near the last traded price or lower rather than accepting the higher offer price. For thinly traded stocks, using a lower price and some patience can often be rewarded with a modest discount.

PERPETUAL PREFFERED SHARES ARE NOW RIPE FOR INVESTMENT

Perpetual preferred shares are one of the simplest investments available. They simply pay a fixed quarterly dividend that never changes. The dividend depends mostly on the level of long-term interest rates on the date these shares are issued. It also depends partly on the credit rating of the issuing company. But for the most part only companies with relatively high credit ratings issue these shares. They are almost always issued at a price of $25. The issuing company almost always has the right to buy them back at about $25 to $26 and that can happen if interest rates fall significantly. This does limit and cap the potential capital gain upside from these shares.

As long as the credit rating of the issuing company remains strong, these shares fluctuate mostly with changes in long-term interest rates. In general, they never rise much above about $26 or $27 because, in that case, the issuing company could typically redeem them and issue new ones at a lower dividend that would be issued at $25. These shares fall in price when long-term interest rates rise and that’s usually also associated with higher inflation. Since the dividend is fixed in nominal dollars, these shares do not protect against unexpectedly higher inflation. They also tend to fall in price during times of stock market panics.

They can be expected to be good investments when the yield is at least a couple of percentage points above expected inflation so that they then provide a positive real return. If purchased at a significant discount to their $25 issue price they can also offer capital gains.

These perpetual preferred shares have been poor investments when interest rates have risen and pushed down their prices. For example, a perpetual that initially pays 4.5% on a $25 issue price is doomed to fall in price if interest rates rise such that the market required yield on similar preferred prices rises to a noticeably higher level such as 6.5%.

Interest rates have of course risen dramatically since the in the last 20 months. And so perpetual preferred shares have declined significantly in price. But now it appears that interest rate are at or near their peak level and they are likely to soon stabilise before probably declining after a year or two.

As documented below, high quality perpetual preferred shares are now yielding about 7%. Because most of them were issued at lower yields their prices have declined noticeably in order for them to yield today’s market-required yield of about 7%.

If interest rates do now stabilize at about their current levels and if inflation moderates down to about 3% or lower, as expected, then these approximate 7% yields will prove to be have been a good investment. And if interest rates do start to decline after a year or so then they will also offer capital gains.

Nothing is guaranteed but it does appear to be a very good time to accumulate a position in these shares.

I would rate all of the following as Buys. The best approach would be to choose several in order to diversify across industries and perhaps across the different credit ratings. In interpreting the credit ratings note that PFD1 is a higher rating than PFD2 and that I have listed the shares in the order of highest credit rating to lowest. As noted above be cautious with the bid / ask spreads and enter limit orders as opposed to market orders. Using the dividend levels indicated in the table you can easily calculate the annual yield at the current market price.

Issuing Company Symbol  Current Price Dividend Current Yield Credit Rating
Royal Bank RBC RY.PR.N  $19.35  $1.225 6.33% PFD1L
Great West Life GWO.PR.Y  $15.42  $1.125 7.30% PFD-2H
Power Financial Corporation PWF.PR.G  $19.93  $1.475 7.40% PFD-2H
Intact Financial IFC.PR.E  $18.61  $1.300 6.99% PFD-2
Canadian Utilities CU.PR.E  $17.50  $1.225 7.00% PFD-2
Fortis Inc. FTS.PR.F  $18.10  $1.225 6.77% PFD-2L
Emera EMA.PR.E  $15.25  $1.125 7.38% PFD-3H

RATE RESETS ALSO LOOK ATTRACTIVE 

If you’re looking for attractive dividend yields, it’s time to think about rate reset preferred shares. Their yields are now more attractive and in many cases their dividends will soon reset to even higher levels. I’ll provide details and specific recommendations below. I’ll also explain their poor past performance and how these shares work.

 Why is now the time to invest in rate reset preferred shares?

The most obvious reason is that their yields have increased to attractive levels. Many strong credit issues are yielding about 6% to 8%.  Lower-credit-quality issues are yielding even more, but the risk is higher.

On average, these preferreds are currently about as low in price as they ever have been. For example, TD.PF.A, issued in 2014, is currently trading at close to the lows it made in early 2016 and late 2019. The only time it was much cheaper was briefly during the extreme depths of the “Pandemic Panic” in March 2020. After previous low points it went on to make substantial gains.

Any rate reset share that is resetting soon will move to a substantially higher dividend. And any that are resetting in the next 18 months will also reset at substantially higher dividend levels unless the five-year Canada bond yield plunges in the interim. That’s because their current dividends were set based on a five-year government of Canada bond yield in the range of 1.3% to 2.5%, while the current yield on that bond is about 4.1%.

If interest rates do start to decline, as some expect, then rate resets with relatively high dividend levels, and where the reset date is several years in the future, will be more attractive and should provide capital gains. If interest rates do stay high, it’s hard to imagine that earning 6% or more on a rate reset share is going to be a bad investment.

Understanding rate reset dividends and share price fluctuations.

The dividend on rate reset preferred shares consists of two components. The first is set at the prevailing market yield on the five-year government of Canada bond. This resets every five years. The second component is a market-required “spread” that is set at the level required to entice investors to pay the initial $25 issue price. This component is fixed and does not reset.

Both components have varied greatly over time. For example, in March of 2015, with the five-year bond yield at a low 0.81%, TD.PF.D was issued with a spread of 2.79% and a total yield of just 3.60%, paying just $0.90 per year. Just ten months later in January 2016, the government bond yield was even lower at just 0.66% but the market required spread was dramatically higher at 4.84% as TD issued TD.PF.G at 5.5% paying $1.375.

TD.PF.D, with its lower spread, has often traded below $25 and is currently at about $17. In contrast, TD.PF.G, with its higher initial dividend and far higher reset spread, always traded above $25 (with a brief exception during the Pandemic Panic) and was redeemed at $25 on its first reset date in April 2021.

Unfortunately, most rate reset preferred shares have often traded below their $25 issue price, and sometimes well below, for several reasons. First, when the market interest rate on the five-year government bond has increased, the reset date to reflect that was up to five years in the future.

Second, and this is the biggest reason, the market required spread has often increased versus the issue date, (and increases dramatically during times of market panic) but this component is fixed and will never reset to reflect a higher required spread. When the yield on the five-year bond decreased, the market required spread usually increased, which pushed down the price of existing rate resets with their lower and fixed spreads.

Third, as investors learned that rate reset shares could trade substantially lower despite their reset feature, they became unpopular, which further increased the market required spread.

Fourth, in the case of lower-credit-quality issuers, credit concerns can send the price down.

For all these reasons, rate reset preferred shares have mostly been poor investments due to their unexpected capital losses. The exception to that has been for those who bought near the low points and then sold after the subsequent substantial recoveries.

There was a low point and buying opportunity in early 2016 and a subsequent very significant recovery that peaked around October 2018. That was followed by a long downtrend that ultimately bottomed sharply with the Pandemic Panic in March of 2020. The subsequent very sharp and full recovery finally peaked near the end of 2021 and prices have trended down sharply since then. Only astute traders will have done well on that price action.

 Action now: Rate reset shares are once again mostly trading at low prices, well below their $25 issue prices. They are now offering not only attractive dividends but probable capital gains. Stick with high quality issues from banks, other large financial institutions, and large utilities.

All the following issues are Buys based on their dividends and their low prices, which provide the potential for capital gains. The potential reset yields below are based on the current price and an assumed 3.5% five-year Canada bond yield. This 3.5% is likely conservative for those resetting in the next six months but beyond that it’s anyone’s guess what that yield will be.

Issuing Company Symbol  Current Price Current Yield Spread Reset Date Reset yield if 3.5% Canada Credit Rating
Canadian Western Bank CWB.PR.B  $            17.30 6.2% 2.76% 30-Apr-24 9.0% PFD-3
Enbridge Inc. ENB.PF.A  $            15.18 6.7% 2.66% 01-Dec-24 10.1% PFD-3 (high)
TD Bank TD.PF.A  $            16.92 5.4% 2.24% 31-Oct-24 8.5% PFD-2 (high)
Intact Financial Corporation IFC.PR.G  $            19.20 7.8% 2.55% 30-Jun-28 7.9% PFD-2
Royal Bank RY.PR.S  $            10.24 5.9% 2.38% 24-Feb-24 7.3% PFD-1 (low)
Emera EMA.PR.H  $            18.75 8.4% 2.54% 15-Aug-28 8.1% PFD-3 (high

Closing Comments

If your main goal is to lock in an income stream for the long term then the perpetuals are probably the best bet. The rate resets are subject to changing dividends at each reset date. In the near term many will reset to higher dividends but then the next reset five years later will be at a lower dividends if interest rates decline as expected.

It appears that both types of preferred shares offer the potential for capital gains but that is not guaranteed.

Again, the bid ask spreads are wide and so investors should look at the recent price action and enter limit orders somewhat below the ask price in most cases.

END

Shawn Allen, CFA, CPA, MBA, P.Eng.

President, InvestorsFriend Inc.

October 28, 2023

An earlier version of this article from July 2023 turned out to be somewhat early.

InvestorsFriend Newsletter April 2, 2023

Bank Shareholders – Beware of Bank Bailouts!

Mythology has it that banks and their shareholders got “bailed out” in the 2008 financial crisis. And yes, some of them did, but not all of them.

Washington Mutual was the sixth largest bank in the U.S. and it was taken over by the Federal Deposit Insurance Corporation and the company went broke with zero recovery to shareholders. A complete wipeout! Certainly no bailout for shareholders. As for its executives, yeah they probably fared very well considering the circumstances. I believe the depositors were all made whole, even the uninsured deposits. So it was the depositors who were bailed out, not the shareholders. And that’s how it should be.

Other shareholders that were wiped out during the financial crisis included the shareholders of Lehman Brothers who were completely wiped out. And the shareholders of Bear Sterns received $2 a share for their shares that had peaked a year or so earlier at $171. Approximately a 99% wipeout.

There were other fairly large lenders and many small ones where shareholders were completely wiped out in 2008. Any notion that bank shareholders were all bailed out is simply wrong.

But it is true that  the shareholders of most banks did benefit from the 2008 bailouts and assistance to banks. That was was somewhat inadvertent as I will explain below.

Who or what is bank regulation meant to protect?

First and foremost, bank regulation is meant to protect bank depositors. Not bank management, not holders of bonds issued by banks and not bank shareholders. The economy would suffer greatly if people and corporations did not think their money was safe in banks. 

So why did many large bank shareholders also get bailed out in 2008?

It was because taking actions that would have protected only the depositors of the large banks while letting their shares go to zero would have been too disruptive to the financial markets and the economy. As is often said, some banks were to to big to (allow to) fail.

What happened with Silicon Valley Bank?

At December 31, 2022 it reported $212 billion in assets and $16 billion in equity. That’s leverage of 13 times but that’s not at all unusual for a bank. It had $91 billion of its assets or 43% invested in securities and the great majority of these securities were mortgage-related securities. It’s very normal for banks to invest in securities in addition to making loans. But having 43% in securities is a very high level. While these were very safe investments 95% of the $91 billion would not mature until at least 10 years. And these securities were yielding or earning an average of just 1.63%. This was a huge problem as interest rates jumped. The biggest chunk here was $57 billion in “Agency-issued Mortgage Backed Securities” with at least 10 years until maturity and earning an average of 1.54%. Mortgage rates never got that low but once bundled up and sold as agency-backed securities, the yield on these investments was down close to the yield on actual long-term U.S. treasuries which got very low. This bank was implicitly betting that interest rates would not rise.

This $91 billion was not required to be marked-to-market under accounting rules because the intention was to hold until maturity and collect the full amount. But that would become very problematic if they had to start paying far more than this 1.63% on deposits.

Looking at this, the whistle blowers who claimed that this bank was “technically insolvent” certainly had a good point. A the very least it looks like SVB was going to suffer years of low or negative profits because the rates it paid on deposits were now up very sharply and it was stuck with massive amounts of securities earning low rates that would not mature for at least 10 years.  The catalyst for the bank failure was the run on deposits that arose when SVB was said to be “technically insolvent” and word of that spread.

How did the takeover by the Federal Deposit Insurance Corporation (FDIC) proceed?

The FDIC seized the bank on Friday March 10 after the bank suffered a massive loss of deposits based on rumors that it was “technically insolvent”.

On March 26, 2023, the FDIC announced that it had sold all of Silicon Valley’s loans and all of its deposits to First-Citizens Bank. This was apparently at a Fire Sale price. It did not include SVB’s problematic securities assets (those long-maturity mortgage-backed securities). First-Citizens got $72 billion in loans at a $16.5 billion discount or 77 cents on the dollar. If First-Citizens can ultimately collect the $72 billion in loans there will be a $16.5 billion dollar gain but some of that gain (or any losses) will be shared with the FDIC. First-Citizens is also taking over $119 billion in deposits. Since the deposit liabilities of $119 exceed the discounted value of the loans ($55.5 billion) by $63.5 billion, it would appear that the FDIC will also be sending $63.5 billion in cash to First-Citizens. FDIC will next sell the problematic $90 billion in other SVB securities and assets. Those are not worth anything close to $90 billion because they are mostly long term mortgage-linked securities at far below today’s market interest rates. FDIC may sell these these at a discount even to the already discounted market value. Warren Buffett may be thinking of throwing in a low-ball bid at this very moment. And he is likely the only person in the world who could commit instantly to buying many billions of these securities with no need to check with his Board.

Conclusions and lessons:

The main lesson of the above paragraph for bank shareholders is that if a bank you own shares in suffers a run on the bank for any reason and gets seized by the FDIC (In Canada the CDIC) they will sell the loan assets of your bank at an absolute fire sale price and your shares will almost certainly be worthless. If your bank has issued preferred shares and bonds (usually bonds are issued to institutional investors), those will also almost certainly be worthless because the FDIC will sell off the loans at such a big loss. 

The lesson for the public is that yes depositors mostly get bailed out here. (Uninsured deposits above the insurance limit may or may not get fully paid.) And bank management loses their jobs but likely collects all their salary and bonus. Management loses the value of their stock options and shares. But share owners and bond investors in the bank typically get wiped out. No bail out for bank shareholders. 

The only time bank shareholders get bailed out is when there is a systematic threat to the banking system (such as happened in 2008) and the banks get rescue packages without being thrown into receivership. Receivership it seems is death to bank shareholder value. 

I suppose bank shareholders losing 100% of their investment in the event of a bank failure is fair. But I just wonder if a more orderly and slower receivership process would preserve at least some value for bank shareholders or at least for the bond investors (who rank higher in priority). One thing is for sure: It is absolutely right that the main focus be on protecting depositors. The interests of bank bond investors and bank shareholders rightly rank far below the interests of depositors.

END

Shawn Allen, CFA, CPA, MBA, P.Eng.
InvestorsFriend Inc.

April 2, 2023

 

InvestorsFriend Newsletter February 25, 2023

The Investment Outlook for 2023

2023 began with stocks and longer-term bonds ripping higher in January as long-term interest rates backed off somewhat from earlier peaks. Then in February, stocks and long-term bonds gave back some of those gains. Still, the S&P 500 remains up 3.3% and the Toronto stock exchange remains up 4.3% for the year to date.

The outlook is always uncertain and so most investors should probably hedge their bets by holding not only equities but also fixed income and cash.

The great news is that cash in investment accounts is now earning just over 4%. And you can easily get over 4% in short-term GICs. The yield available on all forms of fixed income has risen. In 2022, most fixed-income investors suffered capital losses as longer-term interest rates rose. (Investors learned or re-learned that fixed income does not mean fixed value.) But that’s far less likely to be a concern in the rest of 2023 since long-term interest rates have already risen very significantly and may be more likely to decline modestly by the end of this year rather than increase much. So, an allocation to fixed income should do reasonably well this year.

Equities are always a tough call in any given year. They rise in the long term and so it’s wise to have a fairly heavy allocation to equities. But current stock valuations on average are not cheap and could be driven down as many investors may tend to sell shares in favor of fixed income. Other investors will buy those shares but the share prices would be “bid down”.

In addition to a lot of free information, InvestorsFriend has a paid Stock Picks service which includes a good selection of stocks as well as fixed income. This also includes short daily comments on the market each weekday. The cost is a modest $15 per month or $150 per year. Click here or on the Stock Picks link at the top of every page on this web site to see the page where you can subscribe to that service if you wish. [Notice my “hard sell” approach here.] And you can see full details of our past track record by clicking the “Performance” link above.

Not everyone is interested in owning individual stocks and so we also provide (for free) information on building a portfolio using Exchange Traded Funds.

These Higher Interest Rates are a Massive Game Changer

Higher interest rates have already cooled off the Canadian housing markets significantly. Single-family home prices in the highest priced areas like Toronto and Vancouver have apparently declined over 20%.

Let’s take a look at some of the rather shocking math here.

Just 14 months ago on January 1, 2022 the interest rate (or yield) on a 30-year U.S. treasury bond was 2.01%. Today it’s 3.88%. The value of a $1000 U.S. treasury bond purchased 14 months ago has plummeted to $678. That’s a 32% capital loss on a so-called risk-free bond! This investor is locked into to getting $20.10 per year in interest while newer 30 year bonds issued today are paying $38.80. So, the value of that lower interest rate bond had to plummet.

And let’s look at how the payment on a $400,000 mortgage changes as a 5 year mortgage rate has jumped from about 2.0% to about 5.0% in the space of about 14 months.

The monthly payment at 2.0% is (was) $1694. Furthermore, and very importantly, $1,030 or 61% of the first payment was going to pay down principle and only $664 or 29% of the payment was going towards interest. And after 10 years, 34% of the mortgage was paid off.

But at a 5.0% interest rate the payment increases by 37% to $2,326. And there’s more bad news. Now only 29% or $677 of the first payment is going to pay down principle. 71% or $1650 is going just to pay interest. So your payment is 37% higher and yet you are paying far less towards the principle. After 10 years this mortgage is only 26% paid off.

To run the numbers for a different mortgage amount or interest rate, use this handy link.

So mortgage payments for home buyers have just shot up by about 37%. And not only that but the amount going to principle in the first payments drops by 34% despite the higher payment. So, it becomes harder to pay off the mortgage earlier.

This is a game changer and all else equal has to lead to lower home prices and this has already occurred especially in Toronto and Vancouver. But, all else is never equal and there may be other factors such as immigration that could offset some of the decline.

Next, consider that just 14 months ago, cash bank account products in self-directed investing accounts were paying just 0.05% (not a typo!). Now these same accounts are paying 4.0 to 4.35%. That’s another game changer.

Many fixed income investments that might have looked reasonable 14 months ago at 5% suddenly do not look attractive in comparison to getting 4% in a daily interest account. The prices of most preferred shares fell hard in 2022 as their prices came down to “compete” with the higher interest rates and yields suddenly available on other fixed income investment options.

Equity valuations also came under pressure due to higher interest rates. a A P/E of 20 that seemed reasonable when cash was paying 0% suddenly is less attractive when cash is paying 4% and when there are suddenly many options to earn 6% or more in dividends.

Higher interest rates also lead to higher expenses for corporate debt. And that can push stock prices down. But the bigger impact is that the required higher “discount” rate on future cashflows pulls down the P/E ratios that stocks trade at – meaning stock prices decline, all else equal.

Yep, it’s a game changer!

Marginal Income Tax Rates

With a few days left in RRSP season and with tax filing season upon us, it’s a good time to take a look at marginal tax rates.

I’ll look at Ontario because it is the largest province but I also have a handy link where you can find the marginal tax rates for all the other provinces.

For the 2022 tax year, the marginal tax rate on regular income such as wages and interest in Ontario is 20.05% up to a taxable income of $49,231. People in that tax bracket should probably not make an RRSP contribution since the marginal tax rate at withdrawal time could easily be higher. It’s interesting and shocking to see that in that first tax bracket the marginal tax rate on eligible dividends is negative 6.86% Eligible dividends are dividends from almost any Canadian company on the stock exchange including their preferred shares. These dividends are “eligible” for the dividend tax credit. For this tax bracket, it seems that the dividend credit in Ontario is higher than 20.05%.

Of course, the vast majority of people, especially those with lower taxable incomes have no eligible dividend income, or very little at most. But a small percentage of people are in a position to take big advantage of the low tax rate on eligible dividends.

Investors should be aware of their tax bracket and the marginal tax rate that they face on regular income (including wages, interest, non-Canadian dividends, pensions and RRSP withdrawals), capital gains (half the tax rate on regular income), eligible dividends, and Non-eligible dividends (which are dividends from Canadian small businesses).

Here’s a link to a great web site that gives the marginal tax rates for all the different tax brackets with a page for every province and territory in Canada.

More useful links

Click the “links” button at the top of every page on this web site. There are links there to a lot of sites that are very useful for investors.

END

Shawn Allen

InvestorsFriend Inc.
February 25, 2023

 

 

 

Summary 2022

InvestorsFriend Inc.’s performance – Year 2022

2022 was a negative year in the markets. On average our Buy or higher rated stocks lost 11.4%. That was worse than the Toronto Stock Exchange Index which lost 8.7% but quite a bit better than the S&P 500 which lost 19.4%.

Group

 

Rating to start 2022

 

Price Increase

Our Performance

Average of 3 strong buys

 

Strong Buy

 

-16.4%

bad

Average of 13 buys

 

Buy

 

-10.2%

bad

Average for all 16 buys and strong buys

 

-11.4%

 

Average of 4 weak buys

 

Weak Buy

 

-18.8%

bad

Average of 1 weak sells

 

Weak Sell

 

-13.4%

good

Average for all 5 Neutral ratings (weak buy or weak sell)

 

-17.0%

 

Average of 3 Sells

 

Sell

 

-42.1%

very good

Average of 0 Strong Sell

 

Strong Sell

 

0%

bad

Average Sell / Strong Sell

 

 

 

 

 

Rated As – Strong Buy at January 1, 2022

Name

Beginning 2022 Price

Rating to start 2022

 Price Dec. 31 ’22

Price Increase

Our Performance

Canadian Tire (CTC.a, TO)

                          181.44

 Strong Buy at $170

          141.50

-22%

very poor

BHP Billiton Limited or BHP Billiton plc (BHP Australia or BHP or BBL New York which are equivalent to two Australia shares)

                           29.89

 Speculative Strong Buy at 27.26

           31.03

4%

good

Toll Brothers Inc. (TOL, New York)

                           72.39

 Strong Buy rated at $70.48

           49.92

-31%

very poor

Average Strong buy

 

Strong buy

 

-16.4%

bad

3

 

 

 

 

 

Rated As  – Buy

Name

Beginning 2022 Price

Rating to start 2022

 Price Dec. 31 ’22

Price Increase

Our Performance

Canadian Western Bank (CWB, Toronto)

                           36.30

 (higher) Buy at $32.39

           24.06

-34%

very poor

AutoCanada Inc. (ACQ, Toronto)

                           42.70

 (higher) Buy at $33.92

           23.31

-45%

very poor

Metro Inc. (MRU, Toronto)

                           67.32

 (lower) Buy at $66.16

           74.97

11%

good

MELCOR DEVELOPMENTS LTD. (MRD, Toronto)

                           14.24

 Buy rated at $12.50

           10.65

-25%

very poor

Melcor Real Estate Investment Trust (MR.UN, Toronto)

                             6.79

 Buy rated at $6.71

             5.53

-19%

bad

Enbridge Inc. (ENB, Toronto and New York)

                           49.41

 Buy at $50.70

           52.92

7%

good

Alimentation Couche-Tard Inc., ATD.B

                           53.00

 Buy rated at $49.85

           59.50

12%

good

American Express Company (AXP, New York)

                          163.60

  (lower) Buy at $165

          147.75

-10%

bad

Royal Bank of Canada (RY, Toronto and U.S.)

                          134.46

 (higher) Buy rated at $103.72

          127.30

-5%

bad

RioCan Real Estate Investment Trust (REI.UN, Toronto)

                           22.94

 (lower) Buy rated at $23.00

           21.13

-8%

bad

Berkshire Hathaway Inc. (BRKB, New York)

                          299.00

 (lower) Buy at $251

          308.90

3%

good

Linamar Corporation

                           74.93

 (higher) Buy rated at $69.13

           61.30

-18%

bad

Ceapro Inc. (CZO, Venture)

                             0.61

 Speculative Buy at $0.54

             0.59

-3%

bad

Average Buy

 

Buy

 

-10.2%

bad

13

 

 

 

 

 

 Rated As Weak Buy

Name

Beginning 2022 Price

Rating to start 2022

 Price Dec. 31 ’22

Price Increase

Our Performance

Enbridge Inc. Series 9 Preferred (ENB.PF.A)

                           20.38

 Weak Buy / Hold at $21.33

           15.52

-24%

very poor

Aecon Group Inc. (ARE, Toronto)

                           16.88

 Weak Buy / Hold at $17.98

             9.11

-46%

very poor

Stantec Inc. (STN, Toronto and New York)

                           71.07

  Weak Buy / Hold rated at CAN $59.59

           64.88

-9%

bad

Canadian National Railway Company (CNR, Toronto CNI, New York)

                          155.38

 Weak Buy / Hold at $144

          160.84

4%

good

Average Weak Buy

 

Weak Buy

 

-18.8%

bad

4

 

 

 

 

 

Rated As – Weak Sell

Name

Beginning 2022 Price

Rating to start 2022

 Price Dec. 31 ’22

Price Increase

Our Performance

RIWI Corporation (RIW, Canadian Securities Exchange)

                             0.91

 Weak Sell / Hold at CAN $1.31 , U.S. $1.04

             0.73

-20%

good

Canadian Western Bank Preferred Shares Series 9 (CWB.PR.D)

                           26.86

 Weak Sell / Hold at $26.74

           25.00

-7%

good

Average Weak Sell

 

Weak Sell

 

-13.4%

good

2

         

 

 

 

 

 

 

0

 

 

 

 

 

 Rated As  – Sell

Name

Beginning 2022 Price

Rating to start 2022

 Price Dec. 31 ’22

Price Increase

Our Performance

Shopify Inc. (SHOP, on Toronto and U.S.)

                       1,377.39

 Speculative Sell at $U.S. $1323

          347.10

-75%

very good

Costco (COST, New York)

                          567.70

 Sell at $559

          456.50

-20%

good

Canadian Western Bank Preferred Shares Series 5 (CWB.PR.B)

                           24.94

 Sell at $24.72

           17.00

-32%

very good

Average Sell

 

Sell

 

-42.1%

 

3

         

 Rated As  – Strong Sell

Name

Beginning 2022 Price

Rating to start 2022

 Price Dec. 31 ’22

Price Increase

Our Performance

Average Strong Sell

 

 

 

 

 

 

 

 

 

 

 

Average Sell/ Strong Sell

 

 

 

 

 

DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.

© Copyright:  InvestorsFriend Inc. 1999 – 2022.  All rights to format and content are reserved.

InvestorsFriend Newsletter January 20, 2023

Will 2023 be a good year in the markets?

No guarantees, but I think 2023 is shaping up to probably be a decent year in the markets despite certainly some risks associated with recession and inflation and more people unable to make their monthly payments due to higher interest rates and inflation – not to mention anyone that loses their job.

Why do I think 2023 could be a good year:

1: With the S&P 500 down 19% in 2022 we are starting from a much lower level from which it will be easier to make gains (but again, that’s absolutely not guaranteed). 

2. Most importantly, it was the significant increase in interest rates that acted as a strong “gravitational force” on stocks and especially on medium and long term bonds in 2022. Now, even if interest rates stay at about current levels the stock and bond prices have already moved down to reflect the stronger “gravity”. 

3. For the first time in years, we can now easily earn close to 4 to 5% on very short-term cash and near-cash investments. That will be helpful no matter what stock prices do. (Yes, inflation is running higher than that but that’s a topic for perhaps my next newsletter.)

In my last newsletter dated December 5, I wrote that it was probably a good time to invest. See that newsletter again for more reasons why I believe that and exactly how to instantly achieve a diversified and balanced  investment for some or all of your portfolio.

AMBITION IS THE MOTHER OF SUCCESS

(I very recently wrote the following for another publication that I contribute to, so a few of you may have already seen it.)

Think about the role that ambition plays in the greatest success stories both in life and in business.

 For example, Tiger Woods was groomed and strived for greatness in golf from literally the age of two. Donald Trump has his detractors, but no one would accuse him of lacking ambition. When you think about the most successful CEOs in recent or past decades (Steve Jobs, Jeff Bezos, Elon Musk, Bill Gates, Sam Walton, Warren Buffett and the other greats), they all obviously had great ambitions.

 In my analysis of public companies, I have often been struck by the raw ambition of certain CEOs. For example Shopify was started by a then 23 year old Tobias (Toby) Lutke in Canada in 2004. It would not have become today’s enormous world-wide company without his enormous ambition. And Chip Wilson of Vancouver would not have grown lululemon into an international giant without being extremely ambitious.

 I have marveled at CEOs that were already multi-millionaires, even billionaires and yet they keep striving for growth. Alain Bouchard at Couche-Tard comes to mind as does Alain Bedard at TFI International.  

 Some companies seem to have growth and ambition embedded in their DNA. For example, Canadian Tire and CN Rail have both cycled through a handful of different CEOs in the past couple of decades. Yet their approach and thirst for continued improvement and growth and their success has remained consistent.

 On the other hand, I have recently been frustrated to see that some companies with mediocre results seem to be complacent. They excuse poor performance and blame it on outside circumstances or even on their own “legacy” operations. Often, they refuse to set out profitability goals and generally exhibit a lack of ambition.

 Great Ambition is not a sufficient trait to ensure great success but it’s almost always a necessary trait. Great success will rarely, if ever, be found where there is no great ambition. Success in all areas of life tends to come from setting ambitious goals and striving to meet those goals.

 But goals alone are not enough. I’ve often been skeptical of grand plans for growth. I was more interested in companies that could tell me about actual past success. “Don’t tell me, show me”. But if a company appears to be unambitious and complacent then I will certainly not expect much growth

INVESTMENT VALUATIONS AND INTEREST RATES

(In May 2022 I wrote the following for another publications that I contribute to, so a few of you may have already seen it. My newsletter to you dated March 26, 2022 also covered this interest rate math although not in this detail.)

Higher interest rates and rising inflation are now top of mind for investors. And for good reason.

It’s worth reviewing just how powerful is the force of higher interest rates on investment valuations. The impact of higher interest rates is most direct and easiest to see on bonds and any fixed income investments.

Consider the following: The market yield on a US 30-year bond hit the incredible low of 1% on March 9, 2020, as markets panicked about the pandemic. I guess the buyers that day did not stop to consider that this was literally a 100 year pay-back period! Today [today here refers to May 30, 2022 when I wrote this but the math still applies], the market yield on that same bond is 3% and the value of a $1,000 US Treasury bond purchased on March 9, 2020, and with 28 years left to maturity is down to $625. That’s a massive 37.5% loss on a so-called risk-free bond! And if the market yield on that bond hits 5% in a year’s time, that bond with 27 years left will be worth just $414. The impact of higher interest rates on long-term bonds is absolutely dramatic. And it’s an iron-clad rule. It’s like gravity.

Even more dramatically, consider what happens to the value of a perpetual fixed income stream as interest rates rise. The formula for the value of a perpetual is simply the annual amount to be received divided by the interest rate. Therefore a risk-free $1 annual interest income to be received in perpetuity is worth precisely $50 if the market yield on such perpetuals is 2%. The value then falls by precisely half every time the market required interest rates double. So, it’s worth $25 at 4%, $12.50 at 8%, and $6.25 if the market perpetual interest rate went to 16%. This is so brutal and ugly that it’s almost comical. But it’s true.

The same powerful gravitational force works on equity investments as interest rates rise. But it’s not as easy to see or usually as dramatic for several reasons: The market required yield on equities is never precisely known but it is higher than for bonds and does not increase as fast as interest rates. And the dividends and earnings on equities can be expected to increase to offset some of the impacts of the higher market required return.

As an example, consider a company that currently earns $1 per share and pays out 50% of earnings as a cash dividend. Let’s assume a 20-year holding period and that the earnings will grow at 5% per year. In 20 years, the earnings will be $2.65, and the dividend will be $1.33. Let’s also assume the stock can be sold at 20 times earnings after 20 years and that the market required return on this equity investment is 7%. The math indicates that this stock is worth $21.96 today under those assumptions. But if the market required return on equities jumps to 10% then the value of this share should immediately plunge to $14.25 for a capital loss of 35%.

The above math explains why stock prices have fallen as interest rates have risen and as the market turned its attention to the probability that interest rates will continue to rise.

END

Shawn Allen, CFA, CMA, MBA, P. Eng.

InvestorsFriend Inc.

InvestorsFriend Newsletter December 5, 2022

InvestorsFriend Newsletter December 5, 2022

Is NOW a good time to invest?

Those thinking about putting money into stocks and bonds are always wondering whether now is a good time to invest. And those with money invested are often wondering if they should pull some or all of their money out of the markets.

And this is particularly the case today when the direction of the stock market seems so uncertain due to talk of recession, the impact of inflation and higher interest rates and even the possibility of the war in Ukraine turning into a much larger conflict, possibly even a nuclear conflict. Scary stuff!

But the reality is that there is seldom a time when investors and potential investors don’t face major uncertainties and fears. The future is never clear. It’s only in hindsight that past markets seem far less risky.  Various market crashes and plunges that seemed to last forever when we lived through them eventually start to look like short-term blips after enough time passes.

So, it’s never really clear which way the market will head in the short-term. A more realistic goal is to at least analyse whether or not the market seems over-valued or undervalued in relation to its earnings and the longer term growth trend for earnings/ 

A few days ago, I competed a detailed analysis of the valuation of the S&P 500 when it was at level of 4026 and trading at trailing price to earnings (P/E) level of 21.5 and a forward P/E ratio of 20.1. I concluded that the market at that level was probably about fairly valued. Based on that, I would say that now is a reasonable time to invest in stocks and there was no indication that it is a time to aggressively pull money out of the market. The key, as always is to be balanced and keep some funds in cash and fixed income in order to not become overly exposed to the market. And that’s especially true for those with larger portfolios.

Last year on November 12, 2021 with the S&P 500 then sitting at 4,641 and trading at a lofty P/E ratio of 26.4 times trailing year earnings, I concluded that the S&P 500 was over-valued and that its fair value as a point estimate was 3788 at that time. During 2022 the S&P 500 dropped as low as 3,492 (that was on October 13, only seven weeks ago). It’s now recovered to 3990. But it appears that I was correct that the market was over-valued last November.

What to Invest in Now?

The theoretical best investment portfolio is always “a little bit of everything”. A portfolio that is well “balanced” across the various asset classes (primarily fixed income and equity stocks) and well diversified among industries and regions of the world, in theory, has the best expected return versus risk profile in the face of uncertainty.

Such a balanced and diversified portfolio will always give an average result. The very definition of average should be based on such a portfolio. About half of investors using any other approach will outperform the average and about half will underperform. Nevertheless, the fully balanced and diversified portfolio is theoretically the best unless you have good reason to think you can outperform the average.

And indeed many of us do think that we can do better than average through analysis and by following certain advisers and approaches.

But most investors should consider putting some, most, or all of their investments into a balanced and diversified portfolio. And the good news is that these days you can do that by simply purchasing just one low-fee Exchange Traded Fund on the Toronto Stock Exchange such as Vanguard Canada’s VBAL or iShares XBAL. Some have described investing only in such funds as “VBAL and chill”.  

You can rest easy with such an investment because you will get an average return. The investment could certainly decline (probably temporarily). But any losses will be in spite of the fact that you made a theoretically good and prudent investment. You can honestly tell your spouse that any decline is not your fault. And any losses are almost certain to be temporary in any case. 

For more detail on this approach see my article here. The article also covers versions of  these EFTs that are somewhat more conservative or more aggressive.

For those interested in investing in individual stocks with at least some portion of their funds, InvestorsFriend does offer advice on that as well. Click the “Stock Picks” link at the top of this page for more information. 

Loss of Trust in Our Economic System

I think it’s fair to say that the most Canadians today have lost trust in our economic system. Most people do not trust competition to keep prices at a fair level (witness the current accusations that he grocery industry is using inflation as an excuse to price gouge). And most people do not seem to think that the economy is providing fair wages and a fair opportunity especially for younger people.

Sadly, I think these people have good reasons to think that way.

Consider how our the retail landscape has become more and more dominated by fewer and fewer national-chain competitors. Back in the 1960’s and 1970’s Canadian towns had main streets lined with independent locally owned grocery stores, clothing stores, insurance brokers, hardware stores, shoe stores and other businesses.  The owners were local people who in most cases were not extremely wealthy. There were some national chains like Canadian Tire and the car dealers and gas stations (which were also car repair shops) and of course the big banks. But I don’t think either these dealers or the bank managers were head and shoulders wealthier than most of the local people. Money was tight all around and with multiple competitors people tended to trust that competition worked to keep any particular store from gouging them. Everyday pricing was the norm. Telephone and electricity rates were regulated. Fast-food chains and casual dining chains were rare and just coming into existence.

Today, the great majority of our spending is with national or even international chains and corporations. Truly independent businesses are a far smaller part of the economic landscape. That has both pluses and minuses. These huge chains and corporations operate with economies of scale and lower costs. In a well functioning competitive economy (try not to laugh) most of their lower costs would get passed along to consumers with lower prices. 

But it’s a fact that there are far fewer of these national chains to choose from compared to the old days of numerous independent businesses. Consumers are well-founded in their suspicion that there is insufficient competition.

For example, today in Canada we have just 3 major national grocery chains (Loblaws, Sobeys / Empire, and Metro – although each of these operates under several brand names). Costco and Walmart are also major national grocery sellers. So, that’s just five choices in total and Costco and Walmart are not always conveniently nearby.

There is a recent huge  example that I believe proves that the largest corporations are not competing aggressively on price. In late 2017, Donald Trump reduced U.S. corporate income taxes massively from 35% to 21%. The financial press and analysts, seemingly without exception, predicted that stock prices would rise with substantially higher profits due to the lower income tax.  But I thought that competition would force companies to pass along most of the savings in lower prices. They would not want to, but I thought that, for example, if one grocery store did pass on the savings and one major fast food chain did then the others would be forced to follow. I was completely wrong.

Stock prices and profits soared and (except briefly during the pandemic) have never looked back In fact, profits on the S&P 500 in 2022 are just about precisely double what they were in 2016. And lower income taxes that were never passed along in lower prices are a good part of the reason (along with normal growth in the economy). This is strong evidence that these huge companies in the S&P 500 do not face much competition on the basis of price. And take a look at who these companies are. Among the top 6 companies in the S&P 500 are: Apple, MicroSoft, Amazon, Alphabet (Google), and Tesla. It’s not hard to imagine that by their nature these companies are not competing much on price. There are other reasons for their dominance. Some large companies including Costco and Walmart do compete heavily on price. But they are the exception rather than the rule.

The bottom line is that there is good evidence that corporate concentration and other factors have led to a situation where competition is not as effective in protecting consumers.

So, people are right to have a lower trust in the economy and that is a very bad thing. Well, I guess for us investors it’s a good thing. This may be a good case of “If you can’t beat ’em, join ’em”. (Become an investor.)  Critics take the opposite approach of “if you can’t join ’em, beat ’em” (up). Perhaps the best logical and moral choice is to do a bit of both.

END

InvestorsFriend Inc.
Shawn Allen
December 5, 2022

 

 

InvestorsFriend Newsletter March 26, 2022

Investors – Prepare for Higher Interest Rates 

We have liftoff!

It now seems clear that the four decade period of declining interest rates is finally over. Central Banks in Canada, the United Kingdom and the United States have all started to raise interest rates and have signaled that fairly significant increases are coming over the next year or two. That should worry stock investors.

Interest rates as set in the bond market have already moved up significantly. Since January 1 the yield on the ten year U.S. Treasury bond has increased from 1.72% to 2.48%. And the yield on a five year government of Canada bond has doubled from 1.25% to 2.51%.

Financial theory and math is crystal clear that higher interest rates act as a gravitational force on stock prices. It’s possible that higher profits will offset that and stock prices will continue to rise. But investors should not be surprised if stock indexes such as the S&P 500 decline as interest rates rise. In fact, it’s to be expected.

A reasonable defense against this possibility is to hold a higher proportion of cash and short-term fixed income investments. This will provide funds to invest in equities if their prices drop due to higher interest rates.

Investors that agree that interest rates will move materially higher should reduce their holdings of long-term bonds if they hold any. 

It may also be possible to select stocks or sectors that will do better than most in a rising interest rate environment.

In short, higher interest rates may become the story of the markets in 2022 and investors should prepare accordingly.

An Instant Balanced and Globally Diversified Portfolio

A great portfolio for anyone getting started investing and arguably even for experienced investors is to set up a balanced globally diversified portfolio using low-fee Exchange Traded Funds. In fact there are some Exchange Traded Funds that offer this in a single fund. I recently updated my article that provides the stock symbols to accomplish this. I included a suggested approach to specifically deal with expected higher interest rates. I also include more sophisticated approaches that use several Exchange Traded Funds. In all cases these portfolios can be purchased in minutes and thereafter require very little attention.

Warren Buffett’s latest Annual Letter

Literally millions of investors eagerly wait for and then devour Warren Buffett’s annual letter to shareholders. Why? Because it is always full of the finest pearls of investment wisdom to be found. It’s also always an easy read .

So let’s take a tour thorough this year’s letter which was dated February 26, 2022.

You see the full letter at www.berkshire.com or click this link directly to the letter.

First up is the table that compares the rise in Berkshire Hathaway’s share price with the performance of the S&P 500 index with dividends on the index reinvested.  The comparison period is for the 58 years ended September 30, 1965 (the year Warren Buffett took control of the company and ousted the former management) through to the end of 2021.

The table shows that Berkshire’s share price has compounded up at 20.1% per year while the S&P 500 including reinvested dividends has compounded up at 10.5%. Berkshire has not paid any dividends during that entire time except, strangely enough, one thin dime per share in 1967 which is ignored in the comparison.

Okay, so with Buffett at the helm, Berkshire has compounded up at a percentage return 91% higher or close to double that of the S&P 500. That sounds impressive but perhaps not earth shattering.

But the bottom line in the table shows us the amazing power of compounding a higher return over 58 years. The S&P 500 has gained an impressive 30,209% over those years but Berkshire’s stock price has risen a staggering 3,641,613%. So Berkshire has outperformed by 121 times! Stated differently $1000 invested in the S&P 500 on September 30, 1964 is now worth $303 thousand dollars while the same $1000 invested in Berkshire on the same date is now worth $36.4 million dollars.

Some of you will be thinking, okay but what about inflation? Indeed, inflation during those 58 years has eroded the purchasing power of a U.S. dollar by a withering 87%. So, in real terms, after inflation, $1000 invested in the S&P 500 on September 30, 1964 is worth $39 thousand dollars while the same amount invested in Berkshire shares on the same date is worth $4.7 million dollars. 

Anyway you look at it, the rise in Berkshire’s share price under Warren Buffett’s management has been spectacular and dwarfs that of the S&P 500 which itself was already an exceptionally strong investment.

Treating all shareholders equally

“Charlie Munger, my long-time partner, and I have the job of managing a portion of your savings. We are honored by your trust.

Our position carries with it the responsibility to report to you what we would like to know if we were the absentee owner and you were the manager. We enjoy communicating directly with you through this annual letter, and through the annual meeting as well.

Our policy is to treat all shareholders equally. Therefore, we do not hold discussions with analysts nor large institutions.”

So, Buffett treats all shareholders equally. Virtually every other publicly traded company treats large institutional owners and stock analysts far more favorably. They hold meetings for those people. They take questions from them. Top management spends countless hours dealing with only the biggest owners and the stock analysts. Buffett has always refused to do that.

Berkshire picks businesses, not stocks

“…our goal is to have meaningful investments in businesses with both durable
economic advantages and a first-class CEO. Please note particularly that we own stocks based upon our expectations about their long-term business performance and not because we view them as vehicles for timely market moves. That point is crucial: Charlie and I are not stock-pickers; we are business-pickers.”

This is an important mindset. Buffett never invests by looking at the history of a stock’s price changes. He looks as the earnings history and future potential. There is a huge difference in mindset when we see ourselves as owners of businesses as opposed to stocks (mere squiggles on a screen).

Berkshire’s success has been good for America and vice versa

“Berkshire owns and operates more U.S.-based “infrastructure” assets – classified on our balance sheet as property, plant and equipment – than are owned and operated by any other American corporation. That supremacy has never been our goal. It has, however, become a fact. … Berkshire always will be building.”

That’s an interesting fact. Much of the infrastructure Berkshire owns would have existed and been owned by others if Berkshire did not buy the railroad and utility companies that it owns. But, remember, Berkshire does not pay a dividend and instead has plowed billions into needed new infrastructure that the previous owners of those businesses may never have done. That’s been good for Berkshire and for America.

Buffett details how Berkshire Hathaway was formed by the merger of the Berkshire and Hathaway companies in 1955 and how poorly it performed in the following ten years prior to Buffett taking it over. This led to not much income tax being paid to finance the government.

“All told, the company paid the government only $337,359 in income tax during that period – a pathetic $100 per day.” And now? “Now, Berkshire pays roughly $9,000,000 daily to the Treasury.” (That’s 90,000 times more per day!).  “Absent our American home,
however, Berkshire would never have come close to becoming what it is today. When you see the flag, say thanks.”

Buffett never complains about paying income tax and always gives ample credit to the nature of the American economic system that makes his success possible..

END

Shawn Allen

InvestorsFriend Inc.

March 26, 2022 

To view all previous editions of this newsletter, click here.

 

 

 

 

 

Summary 2021

 

InvestorsFriend Inc.’s performance – Year 2021

 

 

2021 was an unexpectedly strong year. We were cautious in January and had no “Strong Buys” but our 21 Buys averaged a surprising 29.5% average gain. This beat the Toronto stock index which gained 21.7% and the S&P 500 which gained 26.9%. Our only two Buy-rated stocks that fell in price were our two and only two penny stocks. See the list below of all our stock picks as of the start of 2021 and how each did during 2021.

 

 
   
   

Group

 

Rating to start 2021

 

Price Increase in 2021

Our Performance

   

Average of 0 strong buys

 

Strong Buy

 

0.0%

good

   

Average of 21 buys

 

Buy

 

29.5%

very good

   

Average for all 21 buys and strong buys

 

29.5%

 

   

Average of 6 weak buys

 

Weak Buy

 

42.8%

very good

   

Average of 2 weak sells

 

Weak Sell

 

23.1%

very bad

   

Average for all 8 Neutral ratings (weak buy or weak sell)

 

37.9%

 

   

Average of 0 Sells

 

Sell

 

0.0%

bad

   

Average of 0 Strong Sell

 

Strong Sell

 

0%

bad

   

Average Sell / Strong Sell

 

 

 

0%

 

   

Rated As – Strong Buy at January 1, 2021

   

Name

Beginning 2021 Price

Rating to start 2021

 End 2021 Price

Price Increase

Our Performance

   

No strong buys this year

 

 

 

0%

 

   

Average Strong buy

 

Strong buy

 

0.0%

good

   

0

 

 

 

 

 

   

Rated As  – Buy

   

Name

Beginning 2021 Price

Rating to start 2021

 End 2021 Price

Price Increase

Our Performance

   

Canadian Tire (CTC.a, TO)

                      167.33

 Buy 

          181.44

8%

good

   

Canadian Western Bank Preferred Shares Series 5 (CWB.PR.B)

                        17.88

  (lower) Buy 

           24.94

39%

very good

   

Canadian Western Bank Preferred Shares Series 9 (CWB.PR.D)

                        25.50

  Buy 

           26.86

5%

good

   

Canadian Western Bank (CWB, Toronto)

                        28.62

 Speculative Buy 

           36.30

27%

very good

   

Metro Inc. (MRU, Toronto)

                        56.80

 Buy 

           67.32

19%

good

   

Alcanna Inc. (CLIQ, Toronto)

                          5.92

 Speculative Buy 

             6.84

16%

good

   

RIWI Corporation (RIW, Canadian Securities Exchange)

                          2.15

 Speculative Buy 

             0.91

-58%

very poor

   

MELCOR DEVELOPMENTS LTD. (MRD, Toronto)

                          9.42

 Buy 

           14.24

51%

very good

   

TFI International Inc. (TFII, Toronto)

                        65.53

 (lower) Buy 

          141.87

116%

very good

   

Enbridge Inc. Series 9 Preferred (ENB.PF.A)

                        14.67

  (higher) Buy 

           20.38

39%

very good

   

Melcor Real Estate Investment Trust (MR.UN, Toronto)

                          4.83

 Buy 

             6.79

41%

very good

   

CRH Medical Corporation (CRH, Toronto, CRHM, U.S.)

                          2.33

 Speculative Buy

             4.00

72%

very good

   

Alimentation Couche-Tard Inc., ATD.B

                        43.38

 (higher) Buy 

           53.00

22%

very good

   

American Express Company (AXP, New York)

                      120.91

  (lower) Buy 

          163.60

35%

very good

   

Royal Bank of Canada (RY, Toronto and U.S.)

                      104.59

 Buy 

          134.46

29%

very good

   

Toll Brothers Inc. (TOL, New York)

                        43.47

 (lower) Buy 

           72.39

67%

very good

   

RioCan Real Estate Investment Trust (REI.UN, Toronto)

                        16.75

 (higher) Buy 

           22.94

37%

very good

   

Dollarama Inc. (DOL, Toronto)

                        51.88

 (lower) Buy 

           63.31

22%

very good

   

Berkshire Hathaway Inc. (BRKB, New York)

                      231.87

 Buy 

          299.00

29%

very good

   

Linamar Corporation

                        67.42

 (lower) Buy 

           74.93

11%

good

   

Ceapro Inc. (CZO, Venture)

                          0.66

 Speculative Buy 

             0.61

-8%

bad

   

Average Buy

 

Buy

 

29.5%

very good

   

21

 

 

 

 

 

   

 Rated As Weak Buy

   

Name

Beginning 2021 Price

Rating to start 2021

 End 2021 Price

Price Increase

Our Performance

   

Boston Pizza Royalties Income Fund (BPF.un, Toronto)

                        10.83

 Speculative Weak Buy / Hold 

           15.45

43%

very good

   

Stantec Inc. (STN, Toronto and New York)

                        41.28

  Weak Buy / Hold 

           71.07

72%

very good

   

FedEx (FDX,NY)

                      259.62

 Weak Buy / Hold 

          258.64

0%

bad

   

Costco (COST, New York)

                      376.78

 Weak Buy / Hold 

          567.70

51%

very good

   

AutoCanada Inc. (ACQ, Toronto)

                        23.61

 Speculative Weak Buy 

           42.70

81%

very good

   

Canadian National Railway Company (CNR, Toronto CNI, New York)

                      139.94

 Weak Buy / Hold 

          155.38

11%

good

   

Average Weak Buy

 

Weak Buy

 

42.8%

very good

   

6

 

 

 

 

 

   

Rated As – Weak Sell

   

Name

Beginning 2021 Price

Rating to start 2021

 End 2021 Price

Price Increase

Our Performance

   

Constellation Software Inc. (CSU, Toronto)

                   1,299.36

 Weak Sell / Hold 

       1,857.60

43%

very bad

   

Aecon Group Inc. (ARE, Toronto)

                        16.36

 Weak Sell 

           16.88

3%

bad

   

Average Weak Sell

 

Weak Sell

 

23.1%

very bad

   

2

             

 Rated As  – Sell – These would normally appear below but we had no “Sells” at the start of 2021

   

DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.

   

© Copyright:  InvestorsFriend Inc. 1999 – 2021.  All rights to format and content are reserved.

   

 

 

v

 

Money Printing by Government, Central banks and Commercial Banks

Of Money and its Creation

Should we be worried about the value of our money and the possibility of rampant inflation? Are central banks “printing” excessive amounts of money? Are governments printing money instead of borrowing it? Are banks and fractional-reserve banking basically evil and dangerous and can they create and lend money from thin air?

Let’s explore some of these things. Maybe even with an open mind. 

But first: What do we mean by “money”?

Money certainly includes its traditional paper form which is issued by central banks. But it’s increasingly clear that most of our “money” consists of deposits in banks. Our pay cheques mostly flow electronically from our employer’s bank accounts into our bank accounts. Then we “spend” our money by transferring it to various retailers using our debit cards, or transferring it to other people using online e-transfers, or through online bill payments including pre-authorized automatic utility bill payments, or by using a credit card which we later typically pay through an online bill payment. And, although it is becoming less common, we spend our money by writing cheques, which also ultimately results in a transfer of our money to the deposit account of whoever we wrote the cheque to. 

As another example: I run a small online business. In almost 20 years of its existence that business has never collected a dime in “paper” money. Its monetary transfers include various electronic flows as well as cheques. But no paper money as such.

These days then, money consists largely (In Canada it’s over 98%!) of bank deposits but also includes the total paper money and coins in circulation. Given this, anything that increases the level of bank deposits (with the exception of deposits of existing paper money) or that increases the total amount of (paper and coin) currency in circulation increases the supply of money. 

A very interesting thing about money in the form of bank deposits is that the money one person or company or even the government spends ends up in the bank account of wherever they spent the money or sent it to.  Some money comes out in the form of paper money but even that tends to soon get deposited back into a bank account, for example when spent at a retail store. So, it’s a whack-a-mole situation. The result is that, these days, money tends to stay in banks although it is constantly flowing from one bank account to another, usually at a different bank, in millions of transactions each day. To borrow a phrase: What’s created in banks, (mostly) stays in banks.

The three key functions of money are that money is:

  1. A medium of exchange
  2. A store of value, and 
  3. A unit of account.

As discussed above, money is constantly flowing from one person or corporation or even government to another. It is its function as a medium of exchange that is its reason for existing. In order to be highly useful as a medium of exchange it has to have a reasonably stable stored value in terms of its purchasing power. And it has to be numerically quantifiable. Given those, characteristics it then constitutes a unit of account. We can count or account for the value of all the goods and services money can purchase in terms of units of money. A house is not money, but we can say that a house has a value of $400,000 for example. 

Money is an intangible concept that (as is becoming more and more apparent) has no need to exist in a physical form. Money is a value concept that allows us to trade our labours and efforts or whatever product or value we produce for any other good or service produced in the economy or to store that value for later.  Warren Buffett has described money as being a “claim check” on the goods ands services and assets of the economy. 

Who or what “backs” the value of our money?

At one time the value of money was pegged to some physical quantity of gold or silver. But that has not been the case for many years. So what “backs” our money and how can we have faith in its value?

The value of a dollar is in what it will purchase. It is the (mostly) free market that sets the prices for goods and services. Supply and demand and competition in the market place determine the purchasing power of a dollar in terms of goods and services. The number of dollars needed to purchase some things (such as houses) is also heavily influenced by interest rates. Central banks try to control the overall rate of inflation by controlling short-term interest rates and also especially more recently by purchasing bonds to control longer term interest rates.

At the end of the day, the value of our money is not “backed” by anyone or anything specifically but it retains its purchasing power fairly well in short term mostly as a result of the invisible hand of the markets and by the efforts of central banks to control inflation.

Most people will gladly accept money in payment for goods and services and will trust that its value will largely be retained in the short term. Money does tend to lose value over the longer term due to inflation. For the most part, that can be overcome through investing. While it appears that most people do trust in the value and utility of our money, each of us is free to trust or not to trust and to act accordingly.

Where does money come from?

The central bank creates (and prints or authorizes the printing of) a certain amount of physical paper money each year. Commercial banks have deposits at the central bank and they can take out some of those deposits in the form of paper money to meet any demand from their customers for paper money that is in excess of the paper money constantly flowing back into the bank such as from retailers. (In addition the banks can constantly turn in any worn out or damaged paper money and have it destroyed and replaced with new bills by the central bank, but that does not count as creating new money.)

But, as noted above, the vast majority of money consists of bank deposits and is not in the form of paper money. Today, one of the main ways, money is created is when people and businesses take out bank loans, or when the government borrows from a bank by selling it a government bond. The lending bank creates an asset on its balance sheet being a loan receivable from the borrower and simultaneously adds that amount as a deposit in the borrower’s deposit account which is a liability on its balance sheet. The bank’s net worth is unchanged and the borrower’s net worth is unchanged. The bank has taken on an asset (the loan) and a liability (the deposit). For the borrower, the deposit is their asset and the loan payable to the bank is their liability. This does add to the money supply and is in essence the creation of money (but not wealth) “out of thin air’. 

The opposite side of the above process is that when a loan is repaid the level of deposits in the banking system declines and money effectively disappears back into the thin air from whence it was created.

To understand the nature of bank lending and deposits it is necessary to be able to picture a simplified bank balance sheet. I have a short article that shows and explains the balance sheet of a small lending and deposit bank.

It may sound like this “money from thin air” process is a terrible and evil thing and amounts to the banks taking advantage of people and charging interest on money that did not cost the bank anything and seems likely to cause inflation. 

But consider the following:

1. There are limits on the “money from thin air” process including the following:

  • The total amount of loans is limited to a certain (admittedly large) multiple of the bank’s owners’ invested capital such as 12 times (which amounts to a minimum capital ratio of about 8%).

  • The bank is usually fully at risk if the borrower spends the deposited loan amount but fails to repay the loan. (Residential mortgage loans are usually an exception because the bank is covered by loan insurance.) The banks do face loan-loss risks and therefore try hard to lend only in cases where the borrower is very likely to be able to pay it back. This may be the biggest reason that lending and money creation does not usually balloon out of control.

  • The bank needs to keep some of its assets in cash (as opposed to loans) in case some borrowers withdraw their deposits. (Although the bank can easily borrow from other banks or even the central bank if needed and so this is probably no longer an important constraint although it used to be years ago.)

  • The money was borrowed for the purpose of spending and it will usually quickly be spent which will usually result in that deposit leaving the bank that created it “from thin air” and landing in a different bank. Because of this banks do have to compete to attract and retain deposits.

  • Central banks have some control over interest rates and use that and other regulatory tools to influence how much lending (and consequently money creation) banks engage in.

2. The “created from thin air” money does not belong to the bank. It strictly belongs to the borrower, in exchange for the pledge to pay it back.

3. It is the borrower, and not the bank, that typically initiates the process. It is the borrower who needed money. So, if this money creation process were evil (it’s not) then we should blame borrowers just as much as the banks.

4. This creation of money as customers borrow from banks presumably is a contributor to inflation. But it also facilitates all forms of business and the growth of the economy. If the economy and the therefore the amount of goods and services produced grows at about the same rate as the quantity of money grows then perhaps the process is not inflationary. In any case, central banks manipulate short-term interest rates with a specific goal of keeping inflation at or near a targeted level. 

Money created by government borrowing

When a bank invests in (buys) a newly issued government bond, this is the government borrowing from the bank. The federal government has deposit accounts at the large banks and the bank can credit (increase) the government’s deposit account. The government then has that money to spend but has the obligation to pay interest on the bond and to redeem it at maturity. This process creates money in exactly the same way that the commercial banking creates money when any customer takes out a loan as described above.

Central banks sometimes buy newly issued bonds directly from federal governments. The federal government has a large deposit account at the central bank. When it buys a bond the central bank credits (increases) the deposit account of the federal government which therefore has more money to spend. This creates money “from thin air” (also called printing money) just the same way the commercial banking system creates money. One difference is that central banks do not need to have any equity capital and so there is little or no limit on the amount of money a central banks can create by lending to the federal government. However, central banks have a prime responsibility to keep inflation at low levels and therefore a responsible central bank will not abuse this money creation process.

But, the government borrowing money by issuing  bonds does not always create new money. If any corporation, pension fund or individual buys a newly issued government bond using “cash” (money) that they have in an existing bank deposit account, then their deposit goes down and the government’s deposit increases and no new money is created.

How central banks buying government bonds “injects liquidity” into the system:

When the central bank buys back government bonds that are held by commercial banks that would increase the selling bank’s cash on deposit at the central bank. This is exactly what has been happening in Canada as the central bank bought government bonds starting in April 2020. Central bank deposits held by banks (members of Payments Canada) soared over 1000 fold from $250 million to $390 billion one year later.

The banks could use that cash on deposit at the central bank to invest in, for example, corporate bonds. A bank buying a corporate bond is effectively making a loan to a corporation and that does create money just as any other new loan does as described above. The added cash could also encourage the bank to make more loans. As explained above, a bank does not immediately need cash to extend new loans. But a bank would be reluctant to make new loans if its cash balance was too low since the deposit that it would create for the borrower could soon be “spent” and transferred to a different bank and the originating lending bank would need to transfer cash to that other bank as the customer’s cheque was deposited at the other bank. However, most of the time banks are probably not “cash constrained” or do not have trouble attracting new deposits to replace departing deposits and so it is not clear that this kind of bond buying by central banks would actually result in additional loans and therefore additional money in the hands of businesses and individuals. Given that banks do not seem to be cash constrained most of the time, and given that in the case of Canada over the past year the created deposits remained at the central bank, I am not clear that this injecting of liquidity (cash) onto bank balance sheets has much direct impact.

When the central bank buys back existing government bonds from pension funds, corporations and individuals that would put the money into the deposit accounts of those that are selling the existing bonds. That increases the cash money of the selling party. The central bank issues a cheque to the seller which they cash into their bank account and which ends up as an additional cash deposit of the bank in its central bank account. This would seem to be more stimulative than the central bank buying bonds from a bank because both increase the bank’s cash balance at the central banks (which does not appear to be stimulative) but this one increases the corporation’s cash as well. 

Perhaps the biggest impact of central banks buying bonds from commercial banks is not due to injecting cash onto commercial bank balance sheets but rather is the impact of lowering long-term interest rates. Lower interest rates stimulate more borrowing which, as explained above, increases the money supply. Lower interest rates are also indisputably inflationary for the prices of many assets including houses, land and equity stocks.

In summary, money is created when:

  1. People, corporations or other entities borrow from banks
  2. A bank buys a newly issued government bond. In effect this is the same as number 1, it is the government borrowing from a bank.
  3. The central bank buys a newly issued bond directly from government. This is the government borrowing from the central bank. The government can transfer the deposit created at the central bank to a commercial bank and issue cheques.
  4. The central bank buys existing government bonds from people, companies or other entities (NOT including banks).

Money is not created when:

  1.  People, corporations or other non-bank entities buy newly issued bonds from government. (Existing deposit amounts merely get transferred to government, no new deposits are created.)
  2. The Central Bank buys an existing bond from a bank. The bank gets reserves at the central bank but those are not counted as part of the money supply. This does count as injecting liquidity since the bank has added ability to make loans. But especially if the bank was not constrained in its loan making this does not directly cause the bank to make new loans and create money.

END

Shawn Allen
InvestorsFriend Inc.
February 25, 2021 (With minor edits to December 13, 2021 

 

 

 

Newsletter February 10, 2021

InvestorsFriend Newsletter February 10, 2021

Even More Sunshine and Roses

Our December 8th newsletter said that as the end of 2020 approached “all is sunshine and roses in the stock market market”.  The S&P 500 finished the year up 16.2%. The Toronto stock index was up only 2.2% in 2020 but that put it more than 50% above its March lows. Markets have continued to roar ahead so far in 2021. The S&P 500 is up another 4.1% this new year to date and Toronto is up 5.8%. 

Investors should be careful not to be lulled into a false sense of security. It’s ironic that markets feel like a safer bet now than they did back in March. In reality, we now know that last March was a fantastic time to invest.

I recently updated a detailed analysis of the valuation of the S&P 500. This analysis has tended to suggest that the market is over-valued – but it keeps on rising.

Long Term Bonds?

Traditional asset allocation practices and portfolio management advice suggests that most investors should have an allocation to fixed income and that this should include an allocation to long-term bonds. But long-term bonds have had puny yields for years now. Yet they have somehow managed to provide investors with good returns through capital gains for years now. They promise low returns and yet their results have given those that hold them a warm and fussy feeling.

I’ve just updated my in-depth long-term bond article that takes a deep dive into how long-term bonds have managed to outperform their own yields and which explains why that almost certainly cannot continue much longer.

The GameStop Debacle (Predictably) Harmed Retail Investors

In January a huge group of online retail investors were urged to gang-up and cause huge losses to (evil) institutional short sellers by acting together to push the share price of GameStop dramatically higher. This would cause the short sellers to have to buy shares at big losses to “cover” their positions and that buying would help push the stock price even higher. This plan was absolutely destined to cause huge losses to many thousands of retail traders. In fact, the higher they were able to push the price to impose big losses on the short-sellers, the more losses that were destined to be incurred by retail traders. Let’s explore why.

GameStop entered 2021 at a price of about $20 with 65 million shares outstanding. The number of shares sold short actually exceeded 65 million (which can happen) but for my analysis I will assume 65 million shares were sold short.

With 65 million shares sold short, this actually means that there were 130 million shares owned in total offset by 65 million sold short. It’s interesting to contemplate this. It means that, in effect, 65 million shares were conjured out of thin air by the short sellers. Those that bought the shares that were sold by the short sellers would not have been aware that their shares were sort of “phantom”. This also explains why short sellers have to cover any dividends on shares they sell short. The company itself is only going to pay the dividend on the actual number of shares, not on shares artificially created by short selling. I am not suggesting that this is nefarious in any way. It’s just how it works and is interesting to contemplate.

At $20 dollars, and a total of 130 million shares, this would mean a total value of $2.6 billion dollars in investor accounts offset by the short sellers obligation to buy back $1.3 billion worth so that the wealth held by all the shareholders minus the short position was $1.3 billion. And let’s imagine that the the true value of these shares was $40 and many of those holding shares believed that it was the (evil) short sellers that had pushed the price down to $20. (But the short sellers presumably believed the shares were worth less than $20 or at least were headed well under $20.)

The idea was that the massive retail group would act together and buy shares and bid the price up forcing the short sellers (who were deemed evil) to buy back shares at huge losses.

Imagine the situation as the share price got pushed up to say $200. By then most or all of the short sellers would have thrown in the towel and reluctantly bought back shares to close their positions at huge losses. Mission accomplished! 

Assuming the short position was now down to zero, there remained 65 million shares outstanding at $200 per share totaling $13 billion.  So who owned these shares? Well, the trading volume on the peak days ranged from 33 million shares to as high as 198 million shares. There were nine days when the number of shares traded exceeded the total 65 million shares issued and four days when the volume exceeded even the initial 130 million of shares that counts the actual shares plus all those sold short. So, on multiple days each share traded hands on average more than once. Much of the buying must have been retail investors selling to other retail investors. It’s likely that most of the owners of the total 130 million shares owned in early January would have sold for various gains. And many retail investors would have bought in January and then sold. By the time the share price got to $200 and then ultimately peaked at $483 the 65 million shares must have been owned largely by recent purchasers and most likely mostly retail investors. 

Many retail investors would have managed to buy low and sell much higher and made big gains. Some of those gains would have come at the expense of the short sellers. So mission accomplished. But given that the buying volume on the peak days (total trading was 1,206 million shares from January 13 to the end of January) was way beyond the 65 million the short sellers presumably bought back, the owners at and near the peak must have been largely brand new owners who had bought near the highs and who were likely mostly retail investors. Institutional investors would largely have known better than to pay hugely inflated prices. 

So, near the highs the 65 million shares must have been owned to a large extent by retail investors. And that was absolutely destined to happen given that it was the retail investors who got together to buy and push the price way up. The short sellers also bought but that was to cover their short positions and in effect those shares simply disappeared into the thin air from whence they were conjured (see above). 

So retail investors at the peak ended up being the proud owners of much or most of the 65 million shares at $483 for a total of $31.4 billion. But those shares which had traded for $20 in early January were likely to be actually worth at most $40 and certainly no where near $400 or $200 or even $100. 

The share price was then absolutely destined to decline. You can keep anything aloft by blowing on it hard enough, but eventually gravity prevails. In this case, as the share price went back to $50 that was a decline in value of $28 billion dollars compared to the peak value. Some retail investors who bought low but failed to sell would have suffered mostly only paper losses. But it would be extremely distressing to have seen huge gains in their brokerages accounts and then have that disappear. The regret at not selling at high prices would be immense. And many retail investors would have bought near the highs. After all, the trading volume on the day before it peaked was 93 million shares at a range from $249 to $380. A huge portion of the share owners as of the peak must have been recent purchasers at prices above $250. The pain of having bought shares at $250, or $300 or more only to seem them quickly plunge to about $50 would be immense.  Some of these investors would have quickly sold and limited their losses. But on Reddit, investors were encouraged to “hold the line”. Some people must have incurred massive losses. Imagine the regret! I really think it’s safe to assume that there will be divorces and even suicides over this.

Some will blame Robinhood for suspending buying of shares. It appears that Robinhood actually had to do that because it got a $3 billion margin call from the clearing house. In any case, once the shares were artificially driven up to over ten times their rational value, a decline, fast or slow, was absolutely inevitable.

In summary, when retail investors collaborated to push share prices way up in order to punish short sellers, it was absolutely inevitable that many of these retail investors would then end up owning most of the vastly inflated shares and the subsequent losses were inevitable. And given the trading volume that was necessary to drive the price up it was inevitable that the the particular retail investors left owning the shares (holding the bag)  at the peak would mostly have purchased those shares at very high prices. 

END

Shawn Allen

InvestorsFriend Inc.

February 10, 2021 

To view all previous editions of this newsletter, click here.

InvestorsFriend Stock Performance 2020

 

InvestorsFriend Inc.’s performance – Year 2020
Our Buy-rated stocks, on average, were up 13.7% in 2020. This beat the Toronto Index which rose only 2.2%. But it trailed the S&P 500 which rose 16.2%. 2020 was a volatile year in the markets. Although we beat the TSX handily we only batted 56% correct this year.
Group   Rating to start 2020 Price Increase Our Performance
Average of 0 strong buys   Strong Buy 0.0% n.a.
Average of 31 buys   Buy 13.7% good
Average for all 31 buys and strong buys 13.7%  
Average of 2 weak buys   Weak Buy 20.6% very good
Average of 1 weak sells   Weak Sell 50.2% very bad
Average for all 3 Neutral ratings (weak buy or weak sell) 20.6%  
Average of 2 Sells   Sell 28.2% very bad
Average of 1 Strong Sell   Strong Sell 0% n.a.
Average of 1 Sell / Strong Sell     28.2% very bad
Rated As – Strong Buy at January 1, 2020
Name Beginning 2020 Price Rating to start 2020  End 2020 Price Price Increase Our Performance
no strong buys   0%  
Average Strong buy   Strong buy 0.0% n.a.
0      
Rated As  – Buy
Name Beginning 2020 Price Rating to start 2020  End 2020 Price Price Increase Our Performance
Canadian Tire (CTC.a, TO)                      139.75  (higher) Buy           167.33 20% good
Canadian Western Bank Preferred Shares Series 5 (CWB.PR.B)                        17.65  (higher) Buy             17.88 1% good
Canadian Western Bank Preferred Shares Series 9 (CWB.PR.D)                        25.85  (higher) Buy            25.50 -1% bad
Canadian Western Bank (CWB, Toronto)                        31.89  (higher) Buy             28.62 -10% bad
MELCOR DEVELOPMENTS LTD. (MRD, Toronto)                        13.32  (higher) Buy             9.42 -29% very poor
TFI International Inc. (TFII, Toronto)                        43.77  (higher) Buy             65.53 50% very good
Boston Pizza Royalties Income Fund (BPF.un, Toronto)                        13.46  (higher) Buy             10.83 -20% bad
Enbridge Inc. Series 9 Preferred (ENB.PF.A)                        16.47   (higher) Buy            14.67 -11% bad
Melcor Real Estate Investment Trust (MR.UN, Toronto)                         8.12  (higher) Buy              4.83 -41% very poor
CRH Medical Corporation (CRH, Toronto, CRHM, U.S.)                         3.47  Speculative (higher) Buy             2.33 -33% very poor
Alimentation Couche-Tard Inc., ATD.B                        41.21  (lower) Buy             43.38 5% good
American Express Company (AXP, New York)                      124.49   Buy          120.91 -3% bad
Stantec Inc. (STN, Toronto and New York)                        36.70  Buy            41.28 12% good
Canadian National Railway Company (CNR, Toronto CNI, New York)                      117.47  Buy          139.94 19% good
Royal Bank of Canada (RY, Toronto and U.S.)                      102.75  Buy           104.59 2% good
Toll Brothers Inc. (TOL, New York)                        39.51  Buy            43.47 10% good
Fortis Inc. (FTS, Toronto)                        53.88  Buy            52.00 -3% bad
RioCan Real Estate Investment Trust (REI.UN, Toronto)                        26.76  Buy            16.75 -37% very poor
BHP Billiton Limited or BHP Billiton plc (BHP Australia or BHP or BBL New York which are equivalent to two Australia shares)                        23.51  Speculative Buy            26.52 13% good
Apple Inc. (AAPL, U.S.)                      293.65  Speculative Buy          530.76 81% very good
Starbucks (SBUX, U.S.)                        87.92  (lower) Buy           106.98 22% very good
Aecon Group Inc. (ARE, Toronto)                        17.52  (lower) Buy            16.36 -7% bad
Restaurant Brands International Inc. (QSR, New York and Toronto)                        63.77  (lower) Buy            61.11 -4% bad
Dollarama Inc. (DOL, Toronto)                        44.63  (lower) Buy            51.88 16% good
Berkshire Hathaway Inc. (BRKB, New York)                      226.50  (lower) Buy           231.87 2% good
Andrew Peller Limited                        11.81  (lower) Buy             10.48 -11% bad
AutoCanada Inc. (ACQ, Toronto)                        12.39  Speculative (lower) Buy             23.61 91% very good
Linamar Corporation                        49.13  Speculative (lower) Buy            67.42 37% very good
Amazon.com Inc.                   1,847.84  Speculative (lower) Buy       3,256.93 76% very good
FedEx (FDX,NY)                      151.21  Speculative (lower) Buy           259.62 72% very good
Ceapro Inc. (CZO, Venture)                         0.32  Speculative Buy / Hold              0.66 106% very bad
Average Buy   Buy 13.7% good
31        
 Rated As Weak Buy
Name Beginning 2020 Price Rating to start 2020  End 2020 Price Price Increase Our Performance
VISA (V)                      187.90  Weak Buy / Hold          218.73 16% good
WSP Global Inc. (WSP, Toronto)                        88.67  Weak Buy / Hold          120.59 36% very good
Heineken N.V. (HEIA, Amsterdam, or 2 HEINY, U.S.)                        94.92  Weak Buy / Hold             91.22 -4% bad
Constellation Software Inc. (CSU, Toronto)                      970.34  Weak Buy / Hold       1,299.36 34% very good
Average Weak Buy   Weak Buy 20.6% very good
4        
Rated As – Weak Sell
Name Beginning 2020 Price Rating to start 2020  End 2020 Price Price Increase Our Performance
lululemon athletica inc. (lulu, NASDAQ)                      231.67   Weak Sell / Hold           348.03 50% very bad
Average Weak Sell   Weak Sell 50.2% very bad
none
0    
 Rated As  – Sell
Name Beginning 2020 Price Rating to start 2020  End 2020 Price Price Increase Our Performance
Costco (COST, New York)                      293.92  (lower) Sell          376.78 28% very bad
Average Sell   Sell 28.2%  
1
 Rated As  – Strong Sell
Name Beginning 2020 Price Rating to start 2020  End 2020 Price Price Increase Our Performance
Average Strong Sell      
     
Average Sell/ Strong Sell 28.2% very bad
DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.
© Copyright:  InvestorsFriend Inc. 1999 – 2021.  All rights to format and content are reserved.

 

 

How to Lose Weight

How to lose weight 

Having lost about 40 pounds dropping down from close to 200 pounds to about 160 pounds and having kept that weight off for over five years now, I wanted to share my methods and thoughts with anyone interested. Key aspects of my approach are to make weight loss basically your top priority every single day and to weigh yourself daily.

The quick summary version of my approach to losing weight is:

  1. You first need to truly and fully commit to a weight loss goal.
  2. You need to focus on your weight loss goal every day and even virtually all day long and every time you consume or consider consuming anything.
  3. Weigh yourself every day. Progress must be measured and is your reward.
  4. Eat moderately and eat healthy meals and snacks. (This does NOT mean starving yourself to the point of misery at all!)
  5. Keep restaurants and dinner parties and other social eating events to a bare minimum.
  6. Increase exercise (but this is not strictly necessary).

The Details:

The first and most important step in losing any significant amount of weight is that you will have to focus on it and make it a top priority every day. Achieving any important goal in life almost always takes focus and commitment. You can’t just hope to lose weight or want to lose weight, you have to plan to lose weight and commit to that plan.

If you are going to truly commit to losing a significant amount of weigh then it will help a lot if you have a strong reason for achieving this goal. Do you need to lose weight for health reasons? to look better? to feel better? to fit into your cloths?

It will also help a lot if you have a certain date in mind by which you want to lose a certain amount of weight. For example your high school reunion is coming up. Or you are planning a beach or a pool-side vacation. Or any important event where you would like to show off a slimmer you.

So if you really want to lose weight and have a strong reason for wanting to do so and are ready to really commit to it and focus on it, here are my suggestions:

Weigh Yourself Every Morning

Weigh yourself every morning. Be sure to use a good quality digital scale that measures to an accuracy of 0.2 or 0.1 pounds and that gives consistent readings. The usual advice is to weigh yourself only weekly since daily weight can fluctuate several pounds which can be misleading and sometimes depressing.

But a daily weigh-in will help keep you focused on your weight loss goal each and every day. 

Weight gain and loss is very incremental. We all need to eat. You don’t need to go on anything like a starvation diet. You can eat your three meals a day and also some snacks and liquid calories beyond that. But it’s a fact that every extra bite we take in is incrementally going in the direction of higher weight. On a very temporary basis there is the physical weight of the food or drink that we take in. And, much more importantly, with the exception of water and other zero calorie items there is a longer term incremental impact from everything we consume.

My approach to weight loss (and later weight maintenance) was and is very much day by day. But also meal by meal and snack by snack. I kept it in mind that everything I consumed was going against my goal. More importantly though, everything that I thought about consuming but resisted the urge to consume was helping me towards my goal.

And I wanted almost immediate feedback and reward. I was able to resist most evening snacking because I knew it would add to my weight the very next morning. My reward for not snacking would be weighing less the next morning than if I consumed a snack. If I was not going to weigh myself until say Saturday there would be less motivation to have the discipline to resist snacking on say Monday night. 

And sure, the initial incremental weight loss in the morning from avoiding as opposed to consuming a snack on a particular evening would simply be the physical weight of the food. But even over a couple of days it would soon lead to incrementally fewer calories absorbed by the body.

Some morning weigh-ins will be depressing as you may gain two pounds seemingly randomly or possibly because of an over-indulgence. Even if that can be blamed on a temporary increase in water retention or whatever I firmly believe it is best to know. If your morning weigh-in shows you have gained say two pounds then you can try a little harder that day to minimize your consumption and perhaps add some additional exercise. If it turns out that was just an almost random fluctuation upward well then all the better because as that random fluctuation reverses and your extra effort kicks in you just might be 2.2 pounds lighter the next morning. But if the two pounds gain was more “real” then why would you want to wait a week before knowing about and trying to reverse it?

Conversely some of your morning weigh-ins will show a surprising amount of loss which may indeed be due to a temporary fluctuation. But why not celebrate the loss and resolve to try to make it permanent by making an extra effort to consume less and exercise more that day? If you can achieve a lower weight for any reason including less water retention then tell yourself that you can make that more permanent and also reach an even lower number with effort and focus. And you can.   

What foods should you eat?

I don’t have much knowledge in this area. But I would certainly say eat a balanced diet. For example, I found no need to avoid carbohydrates. I ate a sandwich for lunch almost everyday while losing weight. But more recently I found that avoiding carbohydrates was beneficial.

Be aware of the calorie and sugar content in what uou eat and especially in packaged foods. Many items in the “chips” isle have a shocking amount of calories listed for a shockingly small serving. For cereals I recommend the all-bran cereal and I noticed that shredded wheat (including the spoon size option) is one of the very very few breakfast cereals that have no sugar content.

My approach was to eat three normal and varied meals a day. Beyond that I snacked between meals but only when hungry and I concentrated on healthy snacks such as bananas, grapes and fruit of all kinds. Also, I consumed mostly only low or no calorie beverages. The easiest way to avoid unhealthy snacking is of course not to buy them in the first place. Avoid that potato chip aisle!

I minimized restaurant meals. In theory a healthy restaurant meal while skipping the appetizer and desert should be fine. But in my experience and based on daily weigh ins, eating at a restaurant almost always instantly led to incremental weight gain. An occasional restaurant meal is fine but recognize it will usually go against your goal.

Dinner party type situations are great fun and it is wonderful to have a social life that includes these. But sadly these events should be minimized. You know how these events go. Your host (including you if you are the host) wants to be generous and for every one to have a good time. At a dinner party it usually feels quite impolite to insist on small portions or to refuse the appetizers and deserts and the drinks. We all need a social life and need to enjoy these get togethers occasionally. But the reality is that these situations will work against our weight loss / weight control goals and do need to be minimized. It might help to be clear to your friends that you are a weight-loss and later a weight-maintenance plan and ask that they not “lead you into temptation”.

I am not a fan of the idea of eating small meals say five times a day as advocated by some. It may work for others but was not my approach. My view is that you can eat a healthy between meal snack. But I would never advocate having a snack at all if you feel you can simply resist the urge and wait until your next meal. Sorry, but every bite is always a step in the wrong direction. Resist if you can. I am not talking about making yourself miserable. But if you can resist a snack without much stress, go ahead and do that.

And go ahead and skip a meal when you can. Most days I am absolutely ready to eat at meal times. But if it occasionally happens that you are busy and your mind is not on even on eating then take the opportunity to skip that meal. The very next morning you will weigh less than you otherwise would have. 

In my experience “eating begats eating”. Our stomachs seem to get used to a given level of food. If we are always sort of topping up our stomach then it seems to get used to that and want that. On the other hand I found that when I cut back, my stomach seemed to eventually get used to that. I simply had less cravings for between meal and after dinner snacks. And I have always found that having one evening snack seems to often lead to an appetite for more. It may be easier to simply resist the urge to snack as opposed to trying to have a modest evening snack which may only whet your appetite for a lot more.

What about Exercise?

We should all be getting exercise since it is so beneficial. And it will help with weight loss. But added exercise is neither a necessary nor a sufficient component of weight loss. That is, you can lose weight even without adding exercise. And you will not likely lose weight by simply exercising while not controlling your eating. The old saying is “you can’t outrun your fork”. But adding a lot more exercise while focusing on reduced calorie consumption will certainly accelerate the weight loss progress. 

Other advice

Sleep more. If you have been in the habit of staying up watching television then simply try to go bed earlier. When you are not awake, you are not eating. And your body will burn almost as many calories per hour while sleeping at is does while sitting watching television or surfing the internet.

Drink plenty of water.

Counting calories or the equivalent is not required in my experience. If you stick to modest portions and a healthy balanced diet and stick to healthier snacks you don’t need to count calories. Actually your daily weigh in takes the place of that. If you are losing weight most days then your calories must be sufficiently low.

As far as alcohol goes I was surprised to find that moderate beer consumption did not have any big impact. Beer certainly has calories so it must have some negative effect on weight but it simply did not seem to have a big impact. But I would be the first to admit that abstaining from or minimising alcohol is an even better idea for lots of reasons.

Because weight is affected by what you eat and do every day, this is a goal that you have to be focused on virtually every day. Sure, you can take the odd day or even a couple of weeks off and not think about it. But in general you will need to be working on your goal of weight loss or maintaining your lower weight virtually every day. The hard truth is, it will need to be on your mind at every meal and every time you consume or even consider consuming anything.

Enjoy the feeling of satisfaction. You are going to feel good about your accomplishment of weight loss and about the will power you displayed. Enjoy that feeling; you earned it.

To modify a saying from Warren Buffett (see there is an investment connection here after all!) – “Weight loss is simple but not easy”. And losing weight and keeping it off may turn out to be among the best investments you will ever make. 

Best wishes to anyone who is actively attempting to lose weight. In my experience the rewards in both health and satisfaction with appearance will be well worth the sacrifice and effort. Before too long the mirror will be your friend rather than something to be avoided.

 

Final thoughts:

I’m no expert. Many approaches can work. But let’s face it; most people fail at weight loss. And so I just wanted to document and share what has worked for me. 

END

Shawn Allen

October 15, 2020 with a few edits on January 31, 2023

 

Newsletter September 29, 2019

Investing using Exchange Traded Funds

All self-directed investors should be making use of Exchange Traded Funds at least to some extent. This is most especially true for newer self-directed investors.

The simplest way to invest is to buy a single ETF that is diversified across countries and which contains a mix of fixed income and equity stocks and where the equities are well diversified across the various industry segments. For Canadians, Vanguard provides four such diversified ETFs with the fixed income component set at 60% (VCNS), 40% (VBAL), 20% (VGRO) or 0% (VEQT). iShares has has a very similar set of funds XCNS, XBAL, XGRO and XEQT. The Vanguard products hedge away the currency risk (or reward) on all the investments outside of Canada while the iShares products expose the investor to the currency risk (or potential currency reward). Correction: Neither iShares nor Vanguard hedges the currency risk on the equities portion. That is appropriate as currency fluctuations adds to the desired diversification. Vanguard hedged the currency risk on the fixed income portion perhaps to make that portion even more “Fixed” – though it is still subject to fluctuations related to interest rates and credit risk. iShares does not hedge any of the currency risk (or possible reward).

For newer investors as well as any investor with a relatively modest portfolio, a very reasonable strategy would be to choose just one of the above funds and invest the entire portfolio in that one ETF. These funds are widely diversified and so additional diversification is not strictly necessary. Due to the size of Vanguard and iShares and due to regulations and the manner in which these investments are held, there is likely virtually no risk that these giant fund companies would fail AND that this would lead to (other than modest and temporary) losses for the ETF investors.  

Financial theory suggests that holding a broadly diversified portfolio such as the above funds provides the best expected return for a given level of risk.

However, many investors would want to to use multiple ETFs to construct a more customized but still balanced and diversified portfolio. For example, for those with taxable as well as non-taxable accounts, the single ETF approach would be less tax efficient. Such an investor might want to include a preferred share ETF in the taxable account. And some investors would prefer a different geographic allocation and/or different weightings to various industry segments.

Our updated ETF Portfolio article provides more detail on the single ETF approach and provides a short list of low-fee ETFs that can be used to create a more customized balanced and diversified portfolio. It also has some suggestions on appropriate allocations to each ETF, but that would vary greatly based on individual circumstances.

Of course, many of us prefer to invest largely in individual companies. But in that case ETFs can be used to get exposure to particular segments and geographies and to help to make the portfolio more balanced. Our Canadian ETF article has just been updated and contains details on many ETFs including even some for commodities (Gold, Silver, Oil and Natural Gas).

INDICATORS POINT TO A SOFTENING ECONOMY

In addition to this web site, I am also a contributing editor to Gordon Pape’s The Internet Wealth Builder. The following is an article that I recently wrote for that publication:

There are many indicators that can provide clues as to the state of and direction of the economy. The following are a few of the key ones that I follow.

GDP growth. Real Gross Domestic Product growth is the broadest measure of economic growth. In the United States, real GDP (before inflation) grew at an annual rate of 3.1% in the first quarter of this year but then slowed to 2% in the second quarter. The slower growth in the second quarter was attributed to “downturns in inventory investment, exports, and nonresidential fixed investment”. This data suggests that the U.S. economy has been relatively strong, but that growth is slowing.

In Canada, real GDP for the first quarter grew at an annual rate of 0.5% but this rose to 3.7% in the second quarter, driven by higher energy exports.

Railcar loadings. Warren Buffett has often pointed to railcar loadings as one of the very best and most current indicators of how the economy is doing. Conveniently, the Association of American Railroads provides a timely chart that shows railcar loadings for the U.S. and Canada on a weekly basis with a comparison to the three prior years. The latest data is for the week ended Sept. 14.

For the United States, the chart shows that total weekly railcar loadings have been running noticeably below the corresponding week in 2018 virtually every week this year. For the past fifteen weeks the levels have also slipped below the corresponding 2017 levels. And in the latest two weeks, the 2019 level even slipped down to the 2016 level. This weakness was fairly consistent across all commodities with the exception of petroleum car loadings. They were materially higher virtually every week in 2019 but then slipped back to or below the 2018 level in the latest three weeks. This data strongly suggests the U.S. economy has softened broadly in 2019 and that it is getting softer as the year progresses.

For Canada, the chart shows that railcar loadings have been running at similar levels to 2018. Forest product shipments were the weakest category and have been running noticeably below the levels of any of the past three years. Non-metallic mineral volumes have been running below the 2018 and 2017 levels but above the 2016 levels. Petroleum and petroleum product volumes have exhibited, by far, the most growth in 2018. The remaining categories were relatively similar to the 2018 levels. This data presents a mixed picture but overall suggests a relatively flat Canadian economy compared to 2018.

Manufacturing sales. U.S. manufacturing sales for July rose 0.3% versus June on a seasonally adjusted basis and 1.3% versus July 2018.

Canadian manufacturing sales decreased 1.3% in July which followed a 1.4% decline in June. The declines were broad based, with lower sales in 11 industries that represent two-thirds of total manufacturing sales.

FedEx. FedEx is often considered to be a bellwether indicator for the economy. This week it announced poor results for its latest quarter, highlighting weakening global economic conditions driven by increased trade tensions and policy uncertainty.

Buffett businesses. Warren Buffett has often said that Berkshire Hathaway’s vast array of operating businesses provides him with an excellent window into the health of the American economy. In the first half of 2019, volume at many of its operations was down. Its railroad car loadings were down 4.5% in the first half of 2019. Same-store volume at its residential real estate brokerage operation was down 8% year to date. Industrial manufacturing revenues were up 0.6%.  The number of manufactured homes it sold at retail declined 6%. Revenues at its travel trailer division fell 13%.

Revenues at its service businesses (primarily related to aviation) were up 4.6%. New auto sales were down 3%. Home furniture revenues were down 3%. Berkshire also owns 25% of Kraft Heinz, which has experienced lower revenues in 2019. While revenues were up modestly in its railroad and utilities operations and at some of its other businesses, the overall picture indicates a slower economy in the first half of 2019.

Overall, the above indicators suggest that the U.S. economy is clearly softening, and that Canada’s economy is relatively flat compared to 2018. Investors can prepare for a softer economy by reviewing their asset allocations and by lowering their exposure to the most economically sensitive companies. An increased emphasis on more stable investments including short-term cash deposits may be warranted.

STOCK MARKET VOLATILITY

With the economy softening, and given trade tensions, it is a good time to think about potential declines in the stock market. 

“Volatility” – that’s the euphemism that the financial markets use to refer to market value losses. Technically, market gains are also “volatility”, but gains are never referred to in that way. Equity investors are always aware that volatility and losses are a possibility at any time. But it’s typically only after a material amount of loss has happened that we start to focus a lot more attention on volatility and how to avoid it.

At the end of the day there are two broad choices when it comes to volatility:

  1. Minimise it with action before the fact. This can be done by constructing a safer portfolio, which includes a material allocation of assets to non-volatile assets including cash, GICs, and shorter-term bonds. And with equity investments that are well diversified and perhaps mostly concentrated in lower volatility stocks.

 

  1. Accept the risk of volatility. This means accepting that a higher level of exposure to equities is extremely likely to result in higher long term returns but at the probably unavoidable cost of higher volatility and periodic losses over shorter periods of time.

END

Shawn Allen
InvestorsFriend Inc.

September 29,2019

Newsletter September 7, 2019

Buying too high and/or failing to sell as earnings deteriorate

 

Selling exceptional companies because they seemed too pricey

At times I have sold shares in companies that I knew were extremely excellent businesses that were very likely to continue to grow their profits per share over time. The reason for selling was that the shares looked very expensive with price to earnings ratios that seemed very high, for example, over 30. Examples of this include Visa, Costco, and Berkshire Hathaway. I have gone on to regret those sales. Each of those three have had occasional declines but for the most part they continue to rise over time. Warren Buffett has long suggested that once you have identified and bought shares in an exceptional business the wisest course is usually to avoid selling. Instead, accumulate more on dips.

 

Regression to the Mean in P/E ratios

Stocks with significantly above average earnings per share growth rates can justify and do deserve to trade at higher than average P/E ratios. But buying stocks with high P/E ratios does mean that we are effectively paying up in advance for the expected future growth. I’ve considered it to be prudent to assume that a stock with a high P/E such as 30 will tend to regress down towards the market average of say 18 over a five or certainly a ten year assumed holding period. But recent experience has been that many of the higher P/E stocks have remained much higher than average. This certainly applies to Visa and MasterCard.

Conversely, there are some apparently good companies that tend to trade at lower thahan average P/E ratios. At times an assumption that their P/E ratios will rise providing an attractive gain has paid off. But in some cases the laggards to contine to lag.

 

Winners win and losers lose?

The momentum strategy of investing tends to assume that stocks that are going up will continue to do so. And those going down will continue to do so. When stocks continue to rise because earnings continue to rise, this can certainly be a winning strategy. For the past several years momentum or growth strategies have out-performed strategies based on fundamental value. But that is certainly not always the case.

 

 

 

 

September 24, 2018 July Wholesale Trade report

Statistics Canada reports that “Wholesale sales rose 1.5% to $63.9 billion in July, more than offsetting the 0.9% decline in June.”

My first thought looking at that is that there is some measurement error involved. The error could come from the seasonal adjustment process. The true trend is probably a bit smoother than suggested by a 0.9% drop in June followed by a 1.5% increase in July.

In any case though, it is a positive report.

On a year-over-year basis the growth in wholesale trade is up 4.1% which is strong growth.

Ceapro Inc. Report

Ceapro Inc.

Results had turned sharply downwards in 2017 and 2018 after a period of rapidly increasing revenues and especially earnings per share from 2013 to 2016. Revenue per share growth resumed in 2019. Earnings turned sharply higher in 2020, 2021 and 2022 But then revenues and especially earnings per sharp turned very sharply lower in the first nine months of 2023. The company is focused on investing in research and views its existing profitable base business which involves selling certain ingredients to the cosmetics industry as a way to fund its research into what it hopes will be more profitable products. The reason book value increased sharply back in 2016 but that was due to a share issuance at a price well above book value. To date its research has not panned out in anything commercial but it claims to have several promising irons in the fire. Now the company is proposing a merger with another company and this along with the revenue decline has very much clouded the outlook.

Ceapro Inc. (CZO, Venture)  
RESEARCH SUMMARY  
Report Author(s): InvestorsFriend Inc. Analyst(s)
Author(s)’ disclosure of share ownership:  The Author(s) hold shares
Based on financials from: Dec ’22 Y.E. + Q3 ’23
Last updated: January 26, 2024
Share Price At Date of Last Update:  $                                   0.16
Currency: $ Canadian
Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): Highly Speculative Buy / Hold at $0.16
Qualifies as a stock that could be bought with confidence to hold for 20 years? No, it’s highly speculative
Has Wonderful Economics? Uncertain
Has Excellent and Trustworthy Management? Not certain
Likely to grow earnings per share at an attractive rate over the next decade? Not certain
Positive near-term earnings outlook? Unknown
Valuation? Attractive but speculative
SUMMARY AND RATING:   The graph for the past nine years shows a lot of volatility – earnings were sometimes negative. The value ratios have recently deteriorated badly and the only attractive ratio is the price to book value ratio. Management quality seems good in terms of the science but the ability to commercialise the science has been poor (non-existent). The insider trading signal is neutral. Executive compensation seems reasonable. The near term outlook is now very uncertain due a recent sharp sales decline and a proposed merger with another company. Possibly, something in the nature of a license deal to commercialise some of their research could occur in the medium term but that has failed to materialise for years. Cash generation in 2022 and 2021 was impressive and it then appeared that the existing products along with research grants, were generating more than enough cash to fund their research efforts. But cash flow will be negative in 2023. In the longer term, its research and product commercialization efforts may or may not result in attractive or even very attractive earnings.  They have various irons in the research fire – one or more of which may be successful and could be licensed profitably – but all of which are difficult to negotiate and take time. All their efforts always seem to be a long way from commercialization.  The wait for something to materialize from their research efforts grows tiresome. We consider this to be a higher risk investment based on the nature of  its operations and also based on the low share price (It is a penny stock range where stock prices are usually quite volatile). On a positive note, the company has no debt and so is in strong financial shape. We rate this as a Highly Speculative Buy / Hold. It’s suitable for only a modest position as a highly speculative investment which may have potential.
MACRO ENVIRONMENT: The macro environment such as interest rates and the state of the economy is probably not of much relevance to this company.
LONG TERM VALUE CREATION: There has been a long-term value destruction based on the share price. The book value per share has grown only modestly since 2015. Overall, there has been no value creation for investors.
DESCRIPTION OF BUSINESS: Ceapro Inc. is a small  “growth stage biotechnology company”. Ceapro has a line of existing cosmetic ingredient products (which it extracts from oats) which are profitable on their own but believes that its real value and future lies in the products and processes it is researching and developing. Through scientific research, it develops products or extracts from plants (currently mostly oats). It currently produces two ingredients for the cosmetics industry on a commercial scale.  Ceapro has developed (and/or purchased or licenced the rights to) certain proprietary and in some cases patented extraction and production technologies . Some of these are intended to produce commercially valuable methods to “deliver” a variety of drugs and treatments into the human body. They sell mostly (over 90%) through a single distributor and not by direct sales. The current products are used in the cosmetics and include an active ingredient in anti-aging skin creams. Brand names that contain Ceapro’s products include Neutrogena, Lubriderm, Aveeno, Jergens, Dove and others – We suspect Ceapro’s product is in one or a few but certainly not all or most of the products under these brand names. Ceapro indicates that it is the sole-source provider of ingredients in a number of products – but the purchasers can drive a hard bargain on price and the quantities needed are not large. Many or all of its newer products would require partnering with much larger companies. In 2021, geographically, sales were 66% in the U.S., 23% in Germany, 10% in China and with just 0.3% of sales in Canada.
ECONOMICS OF THE BUSINESS: The economics of the existing products appears to be reasonably good. The base business is profitable even after expensing research efforts. But the research aspect is quite risky in terms of the need to spend on research which may never materialise as commercial products. To a large degree, this company is something of a lottery ticket. But the shares are not currently pricing in any value for the potential pay-off from the research. So it may be something of a free lottery ticket.
RISKS: We suspect that the larger risks would relate to risk of spending money on developing products and processes that might never achieve therapeutic success or regulatory approvals or commercial success. There may also be risks due to product liability in spite of some insurance coverage. There may also be significant risks related to competition or to a reliance on just one key distributor (including possible bad-debt risk) and possibly on key end-use customers.
INSIDER TRADING / INSIDER HOLDING: As of July 8, 2023 there has only been no insider trades in about four years! Therefore the insider trading signal is neutral. It’s disappointing that a couple of new directors and a new Revenue Officer have not bothered to buy any shares at all. The CEO did exercise 150,000 options at ten cents back in July 2022 (lucky him) and kept the acquired shares and now holds about 1.5 million shares.
WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is  simple to understand and predict (Fail, because most investors would have no familiarity with the company’s products or its risks), has favorable long-term economics due to cost advantages or superior brand power (marginal pass), apparently able and trustworthy management (marginal pass at best given some concerns about disclosure despite the credentials of management and the Board), a sensible price – below its intrinsic value (pass although it is difficult to know), Other criteria that have been attributed to Buffett include: a low  debt ratio (pass), good recent profit history (fail) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) Overall, the company does poorly on these tenets.
MOST RECENT EARNINGS AND SALES TREND: It should be noted that as a research-oriented company the current revenues and earnings may not be the most important indicators of value. In addition revenues have been somewhat volatile due to timing issues and earnings are quite volatile due to revenue timing plus varying levels of grant funding and FX impacts. For  the full year 2022 revenues per share were up 10%. Unfortunately, revenues per share have recently plummeted. In the most recent four quarters starting with Q3 2023 and going back the decline has been 32%, 66%!, 43% and 6%. It may be that customers stocked in the first half of 2022. Earnings per share were up 31% in 2022 but earnings turned negative in the latest four quarters. In Q1 2023 earnings were negative partly due to a sharp increase in general and administration expenses due to some director stock options and a some unusual legal fees. In Q2 and Q3, lower revenues along with higher costs and unusually high legal fees led to losses. Earnings per share had been small and fluctuated around  zero but did increase sharply in 2020 to a reasonably attractive level and increased an additional 19% in 2021 and were up 31% in 2022 but then turned negative in the past four quarters.  Overall, the revenue and earnings trend is now extremely negative.
COMPARABLE STORE SALES  OR INDUSTRY SPECIFIC STATISTICS: Not applicable
Earnings Growth Scenario and Justifiable P/E: With negative profits in the trailing year and plunging revenues earnings provide no guidance to valuation at this time.
VALUE RATIOS: Analysed at a share price of $0.44. As a research oriented company, value ratios provide only limited guidance and in theory understate the value. After several years of GAAP losses, the company was nicely profitable in 2020 and again in 2021 and 2022 but has now reported losses in the last four quarters along with plunging revenues. It could be argued that (most of) its research and development expenses are actually creating valuable assets and therefore are more in the nature of investments than expenses – however that research never seems to payoff despite many years of promises. The P/E is now negative as is the ROE!  The price to book value ratio is, in isolation,  quite attractive at 0.42 particularly considering its cash which amounts to 15 cents per share or close to the current share price. There is  no dividend. Overall the value ratios indicate a highly speculative company. The price to book value ratio is the only attractive ratio.
TAXATION FOR SHARE OWNERS: Nothing unusual to note.  
SUPPORTING RESEARCH AND ANALYSIS  
Symbol and Exchange: CZO.V, Toronto Venture
Currency: $ Canadian
Contact: czo@jtcir.com
Web-site: www.ceapro.com
INCOME AND PRICE / EARNINGS RATIO ANALYSIS  
Latest four quarters annual sales $ millions: $11.3
Latest four quarters annual earnings $ millions: $(2.8)
P/E ratio based on latest four quarters earnings: negative
Latest four quarters annual earnings, adjusted, $ millions: $(1.7)
BASIS OR SOURCE OF ADJUSTED EARNINGS: Starting 2019 added back 75% of other income or expense which is mostly foreign exchange gains / losses Previously added back 75% (assumes 25% income tax) of plant relocations costs and foreign exchange losses or gains also deducted large periodic tax credits. Deducted a large income tax recovery in 2015. In 2018 adjusted for a gain on litigation settlement and gains on deferred taxes. Starting 2021 we are usually no longer making any adjustments because the earnings are inherently volatile and there is no real value to making adjustments. Unusual legal costs are added back in 2023. These were likely associated with a proposed merger.
Quality of Earnings Measurement and Persistence: Adjusted earnings have been volatile and positive in 2022 but then turned negative in the latest four quarters. Earnings may be under-stated due to the expensing of research and development. Non-refundable government grants are in some ways equivalent to earnings but are mostly accounted for as a reduction of capital costs or a reduction of research expenses. Cash flows in the past exceeded the earnings due the amortization of equipment and leasehold improvements as well as due to deferred income taxes in 2022.
P/E ratio based on latest four quarters earnings, adjusted negative
Latest fiscal year annual earnings: $4.4
P/E ratio based on latest fiscal year earnings: 2.8
Fiscal earnings adjusted: $4.4
P/E ratio for fiscal earnings adjusted: 2.8
Latest four quarters profit as percent of sales -14.9%
Dividend Yield: 0.0%
Price / Sales Ratio 1.11
BALANCE SHEET ITEMS  
Price to (diluted) book value ratio: 0.42
Balance Sheet: (as of Q1 2022) Assets are composed as follows: 53% is property and equipment (of which 36% is leasehold improvements and 37% is manufacturing equipment, 11% is equipment not available for use, and 14% is buildings but probably capitalised lease on buildings) , 27% cash, 13% receivables, 5% inventory, 1% prepaid expenses and 2% a longer term investment tax credit receivables. The assets are financed as follows: 90% by equity (of which 27% is retained earnings and 73% is equity raised by selling shares), 8% by capitalized lease liability, and 2% by accounts payable, 1% deferred taxes. This is a strong balance sheet with no debt  which means that the company is very unlikely to be in any financial difficulty in the foreseeable future.
Quality of Net Assets (Book Equity Value) With the company trading at 0.4 times book value (as of January 26, 2024) the quality of the assets or their realizable value could potentially  provide support to the share price independently of earnings. Given the cash, receivables and inventory the assets do provide good support for the share price at this point.
Number of Diluted common shares in millions:                                       78.3
Controlling Shareholder: No person or company owns as much as 10% of the shares and therefore the company is likely effectively controlled by management.
Market Equity Capitalization (Value) $ millions: $12.5
Percentage of assets supported by common equity: (remainder is debt or other liabilities) 88.3%
Interest-bearing debt as a percentage of common equity 0%
Current assets / current liabilities: 11.0
Liquidity and capital structure: Strong. The company now has no debt. And its cash position is strong.
RETURN ON EQUITY AND ON MARKET VALUE  
Latest four quarters adjusted (if applicable) net income return on average equity: -5.4%
Latest fiscal year adjusted (if applicable) net income return on average equity: 14.8%
Adjusted (if applicable) latest four quarters return on market capitalization: -13.4%
GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE  
5 years compounded growth in sales/share 6.9%
Volatility of sales growth per share:  Volatile
5 Years compounded growth in earnings/share negative past earnings
5 years compounded growth in adjusted earnings per share 33.8%
Volatility of earnings growth:  Volatile
Projected current year earnings $millions: not available
Management projected price to earnings ratio: not available
Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted)  earnings per share? No
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: 14.8%
More conservative estimate of compounded growth in earnings per share over the forecast period: 5.0%
More optimistic estimate of compounded growth in earnings per share over the forecast period: 12.0%
OUTLOOK AND AMBITIONS FOR BUSINESS: The potential merger with Aeterna has clouded the outlook greatly. Also, the outlook for the existing base business which has been profitable has recently become quite clouded due to a huge revenue decline in the past three quarters. In the medium to longer term the company expects to benefit from new products under development. It also has patents on a processing technology that it could potentially license out. It’s not clear that revenue will flow from these efforts anytime soon. However, it is possible that they would generate cash through joint venturing on the developments in some cases. Overall the near-term the outlook is for continued modest profits unless some kind of licencing deal emerges to boost earnings.
LONG TERM PREDICTABILITY: Given the technologies and development risks involved, this is not a predictable company.
Estimated present value per share: As this is an early-stage growth company it does not seem appropriate to attempt to forecast earnings.
ADDITIONAL COMMENTS  
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (pass due to the science required) No issues with powerful suppliers (pass). No issues with dependence on powerful customers (fail as sales are over 90% to one key wholesaler who then sells to dozens of customers), No potential for substitute products (marginal pass) No tendency to compete ruinously on price (pass). Overall this industry (the base business) appears to be attractive to a successful  incumbent in the industry – although the huge reliance on one wholesale customer is a definite concern..
COMPETITIVE ADVANTAGE: Ceapro has certain proprietary processes and intellectual property, some or all of which are protected by patents. We had understood that in some or most of its products it is the sole commercial provider. That assumption has come into question give the revenue decline in 2023.
COMPETITIVE POSITION: We did not see any information or discussion regarding its competitors or its market share. They have claimed they are the only supplier of some of their products. (Lately with their revenue plunge that is coming into question)
RECENT EVENTS: In a VERY big development, the company is proposing a merger with TSX- and NASDAQ- listed Aerterna Zentaris. Ceapro would become a subsidiary of that company and existing Ceapro shareholders would own 50% of Aeterna. The company explored but abandoned some kind of significant business opportunity in Q1 of 2023 but it was not clear what this was. In Q3 they mentioned they had canceled an engagement with an international consulting firm and that may be what the referred to in Q1. It appears that they may no longer be receiving government grants. In late April 2023 they announced the hiring of a Senior V.P. technical Operations which was indicated to be in part in preparation for commercialization of some of the companies research efforts. In 2022 they appointed a chief revenue officer which could mean that some progress in terms of licencing revenue is more imminent.    The company continues to work on various product development initiatives involving scientific research and clinical trials. Unfortunately despite several potential products, nothing appears to be imminent at all. In the 2021 Management Discussion and Analysis there was almost no discussion of the outlook for its various research efforts. As of Q1 2023 there is jargon-filled discussion of progress on various research fronts but no clarity on when any revenue will result which appears to be at least 18 months away unless a licencing deal occurs.
ACCOUNTING AND DISCLOSURE ISSUES: Overall the disclosure is quite poor. In Q3 2023 they gave what looked like an implausible reason for the big revenue decline blaming it on a lack of orders from a Chinese customer but only 9% of their sales are to China! They announced that the GM “of their subsidiary” had retired with no explanation of what part of the business they referred to.  The company tends to use excessive jargon in its reports as opposed to even attempting to use plain language. Due to accounting rules and the nature of the business there are some complexities in the accounting which make the net earnings a less reliable figure than usual. On the one hand, earnings may be under-stated due to the expensing of research and development that is intended to benefit future earnings (it arguably creates an asset).  We were impressed with the candid disclosure of government funding. However this government funding  causes the asset values to be lower than their true cost and in our view lowers the book equity and increases the reported ROE (when there are profits).  Grants are netted against the R&D expense which obscures the level of those expenses. The company should probably report in U.S. dollars since its revenues are largely in U.S. dollars. And the disclosure of the results and especially the potential of its various research efforts seems poor.
COMMON SHARE STRUCTURE USED: Normal, one vote per share.
MANAGEMENT QUALITY: Management appears to be high quality in terms of the science involved and also in terms of having built up cash and a strong balance sheet. Whether they have the skills to commercialise the science efforts remains to be seen and is looking increasingly doubtful.
Capital Allocation Skills: This remains to be seen. The determining factor will be how its investments in research pay off. The 2017 acquisition of “Juvente” appears to be a mistake given that in Q4 2018 it wrote off approximately the entire amount it paid. The assets acquired were almost entirely intangible plus a small amount of inventory. Sales from the division since 2018 have been very modest. The company downplayed the write-off as “non-cash” – and still believes the subsidiary is valuable. Yet it indicated in 2021 that the division is immaterial.
EXECUTIVE COMPENSATION: (Based on 2022 figures released in Spring of 2023) The CEO’s compensation is arguably relatively high at $0.56 million for the past two years. The CFO’s compensation is reasonable at $0.2 million for those years. The CEO’s salary was paid to his corporation as a consulting fee which is unusual and may have been an attempt to avoid or defer personal income tax. It is disturbing that the company would agree to this. There are only these two named executives.
BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. (Based on the Spring 2021 circular)  The six directors appear to be highly educated including relevant technical education as well as financial education and knowledge. Two longer-standing directors own 1.1 to 1.7 million shares each. The other two long-standing directors hold 102,000 and 78,000 shares respectively.  Two newer directors elected in 2022 have not bothered to purchase any shares. Overall this appears to be a strong Board of directors. However, they may not be aggressive enough in seeking better results for the company.
Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed  analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry.
DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.
© Copyright:  InvestorsFriend Inc. 1999 – 2024.  All rights to format and content are reserved.

 

 

TFI International Stock Report

TFI International Inc. 

This chart speaks for itself showing very strong growth.

TFI International Inc. (TFII, Toronto)  
RESEARCH SUMMARY  
Report Author(s): InvestorsFriend Inc. Analyst(s)
Author(s)’ disclosure of share ownership:  The Author(s) hold shares
Based on financials from: Dec ’22 Y.E. +Q1 ’23
Last updated: May 9, 2023
Share Price At Date of Last Update:  $                                141.57
Currency: $ Canadian
Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): Buy at $141.57
Qualifies as a stock that could be bought with confidence to hold for 20 years? Yes
Has Wonderful Economics? Yes, despite price competition
Has Excellent and Trustworthy Management? Yes!
Likely to grow earnings per share at an attractive rate over the next decade? Yes
Positive near-term earnings outlook? No, due to current slow down
Valuation? Attractively valued
SUMMARY AND RATING:  The graph of revenues per share (red line) shows strong and steady growth. The adjusted earnings per share growth (purple line) has been very strong indeed. The Value ratios (looking backwards) would easily support a (higher)Buy rating. Management quality is very strong. The insider trading signal is neutral. Executive compensation does not seem excessive, although the CEO is very well compensated.  The outlook for 2023 however is for an probable modest earnings decline due to a divestiture and weaker freight levels. The long-term outlook seems good.  It does not appear to have strong competitive or cost advantages other than scale and its very excellent management ability. The economics of the business are strong despite being subject to stiff price competition. It is possible that Amazon’s move into trucking could harm their business somewhat. Overall we would rate this  a Buy at $141.57. Due to the probable earnings decline in 2023 it would be best to accumulate this more slowly and not rush in.
MACRO ENVIRONMENT:  Sharply higher interest rates and a probable looming recession are headwinds. Volumes are down in the trucking industry in 2023 compared to 2022.
LONG TERM VALUE CREATION: (Updated March 13, 2022) The long-term value creation is exceptionally strong.
DESCRIPTION OF BUSINESS: (last updated Q3 and Q4 2021) TFI International is a trucking and delivery company with total annual revenues of over $9 billion dollars. TFI is focused on acquisitions as well as very efficiently managing its operations. Since 1998, the company has acquired more than 180 companies. Acquired companies continue to operate under their same names and management teams in a decentralised structure.  It has the largest trucking fleet in Canada and a presence in the United States. It has 233 terminals/facilities in Canada and 316 in the United States and 12 terminals in Mexico. It has 28,900 employees and another  9,857 independent contractors (presumably mostly driver/owners of trucks). It owns 13,433 power units (tractors) and 48,612 trailers. The breakout of revenue by segment for 2021  was Package and Courier (which subject to check operates only in Canada) 9%, Less-Than-Truckload 37% , Truckload 29% , and Logistics and Last Mile 25%. Revenues in 2021 were 33% from Canada and 67% from the U.S and 0.3% from Mexico. TFI has become primarily a U.S. operator with its recent large UPS acquisition.
ECONOMICS OF THE BUSINESS: The economics appear to be VERY strong.  TFI’s success in managing costs contributes to its strong overall economics.
RISKS: See annual report for a full discussion of risks. Earnings fluctuate with the state of the economy. Some of the important risks include accident liabilities, competition based on price and competition for drivers.
INSIDER TRADING / INSIDER HOLDING: Checking insider trading from May 1, 2022 to May 9, 2023: The founder and CEO exercised options and sold several hundred thousand shares regularly most months but he maintained his ownership and increased slightly to 4.35 million shares. There were several insiders exercising options and selling and some outright share sales with one sale at $173. The company itself was buying back shares fairly regularly through the year ultimately paying as much as $159 (but mostly lower)  which is a vote of confidence. Overall with a share price decline to about $142, the insider selling signal is neutral.
WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is  simple to understand and predict (pass given that trucking is relatively simple business) , has favorable long-term economics due to cost advantages or superior brand power (marginal pass – perhaps its high ROE is evidence of some advantage of scale), apparently able and trustworthy management (pass given the profit history and the general tone of its reports), a sensible price – below its intrinsic value (pass given its value ratios), Other criteria that have been attributed to Buffett include: a low  debt ratio (pass), good recent profit history (pass) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (marginal pass)
MOST RECENT EARNINGS AND SALES TREND:  The recent growth trend turned negative in the latest quarter after a long period of stellar gains. The adjusted earnings pers share gain in 2022 was 53% but revenue per share growth was just 6%. The adjusted earnings per share growth in 2021 was 59% and the revenue per share growth was 83%!
INDUSTRY SPECIFIC STATISTICS:
Earnings Growth Scenario and Justifiable P/E: With a dividend yield of 1.3% and a payout ratio of just 18% of adjusted earnings, the stock is pricing in growth of only about 5% annually at its current P/E of about 14. It’s historic growth has been far higher.
VALUE Ratios: Analysed at a price of $118.33. The Price to book ratio appears somewhat high at 3.5 and note that the company itself has paid very significant premiums in acquisitions. But that may be well justified by the high ROE. Due to the relatively high price to book ratio, and the low 18% payout ratio, the dividend yield is quite modest at 1.3% despite recent dividend increases. The adjusted P/E ratio is neutral in attractiveness at 17.4. The ROE is exceptionally strong at 29% and that is in spite of the premiums paid in acquisitions and in spite of the impact of the pandemic. The adjusted earnings per share have grown at a compounded average rate of 40% in the past five calendar/fiscal years. Intrinsic value is calculated as $144 if earnings per share grow at 5% for five years and the P/ E  remains at 14 (very conservative) and $208 if earnings grow at 9% annually and the P/E increases back to 17. Both estimates use a 7.0% required rate of return. Overall, the value ratios would easily support  a rating of (higher) Buy – but note the potential for an earnings decline in 2023.
TAXATION: Nothing Unusual.  
SUPPORTING RESEARCH AND ANALYSIS  
Symbol and Exchange: TFII, Toronto
Currency: $ Canadian
Contact: 647 729-4079
Web-site: www.tfiintl.com
INCOME AND PRICE / EARNINGS RATIO ANALYSIS  
Latest four quarters annual sales $ millions: $11,289.7
Latest four quarters annual earnings $ millions: $1,072.2
P/E ratio based on latest four quarters earnings: 11.7
Latest four quarters annual earnings, adjusted, $ millions: $940.4
BASIS OR SOURCE OF ADJUSTED EARNINGS: With a few exceptions we used managements figure for adjusted earnings from continuing operations. In 2020 we deducted the after-tax benefit of the Canada Emergency Wage Subsidy because there was no indication that the money was used to keep people working. It appears that in 2017 management had not adjusted for gains on asset sales but started to do so in 2018. For the calendar years prior to 2015, we did not have that figure but used management’s figure for adjusted earnings except that we deducted gains on dispositions (less a tax impact).
Quality of Earnings Measurement and Persistence: The adjusted earnings seem relatively reliable. Depreciation is an estimated figure and is relatively large in relation to earnings and so the earnings are relying on the accuracy and sufficient conservatism of the depreciation amount.  Depreciation does seem to be conservative as evidenced by the frequent sale of assets at a gain. Certain transition costs have not been added back in adjusted earnings. Overall the earnings and adjusted earnings appear to be conservatively stated. And we deducted the after-tax benefit  of the Canada Emergency Wage Subsidy so that it would not inflate earnings.
P/E ratio based on latest four quarters earnings, adjusted 13.4
Latest fiscal year annual earnings: $1,121.0
P/E ratio based on latest fiscal year earnings: 11.2
Fiscal earnings adjusted: $996.3
P/E ratio for fiscal earnings adjusted: 12.6
Latest four quarters profit as percent of sales 8.3%
Dividend Yield: 1.3%
Price / Sales Ratio 1.11
BALANCE SHEET ITEMS  
Price to (diluted) book value ratio: 3.56
Balance Sheet: (last updated for Q3 2020). Assets are comprised as follows: 41% is purchased goodwill or the equivalent, 21% is rolling stock (trucks and trailers) 6% is land and buildings, 1% is equipment) and 22% is current working capital most of which is trade receivables and it currently has a large cash holding and 9% of assets are capitalised leases. The other side of the balance sheet which supports these assets is comprised as follows: 26% debt, 46% common equity, 11% current payables, 9% capitalised lease liabilities, 6% deferred income taxes,  and 2% provisions and other liabilities. Overall, the balance sheet appears relatively strong assuming that the goodwill is solid which the 17% ROE indicates is very much the case. Debt is relatively modest in relation to earnings and cash flow.
Quality of Net Assets (Book Equity Value) Measurement: (Updated Q3 2020) About 41% of the assets here are purchased intangible (goodwill and the equivalent). At the time of this analysis the shares were trading at about 2.7 times book value. The company is valued for its earnings not for the value of the assets. Based on earnings and frequent sales of assets at gains, the assets are worth more than book value.
Number of Diluted common shares in millions:                                       86.6
Controlling Shareholder: As of Spring 2019, no one or no fund owned more than 10% of the shares . The long-time CEO owns about 5% of the shares.
Market Equity Capitalization (Value) $ millions: $12,257.4
Percentage of assets supported by common equity: (remainder is debt or other liabilities) 46.0%
Interest-bearing debt as a percentage of common equity 51%
Current assets / current liabilities: 1.3
Liquidity and capital structure: The debt level is relatively modest at 51% of the book equity level and in relation to earnings and cash flow.
RETURN ON EQUITY AND ON MARKET VALUE  
Latest four quarters adjusted (if applicable) net income return on average equity: 28.7%
Latest fiscal year adjusted (if applicable) net income return on average equity: 31.2%
Adjusted (if applicable) latest four quarters return on market capitalization: 7.7%
GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE  
5 years compounded growth in sales/share 16.5%
Volatility of sales growth per share:   Steady Growth
5 Years compounded growth in earnings/share 49.1%
5 years compounded growth in adjusted earnings per share 40.0%
Volatility of earnings growth:  Steady Growth
Projected current year earnings $millions: not available
Management projected price to earnings ratio: not available
Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted)  earnings per share? Yes
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: 25.8%
More conservative estimate of compounded growth in earnings per share over the forecast period: 5.0%
More optimistic estimate of compounded growth in earnings per share over the forecast period: 9.0%
OUTLOOK AND AMBITIONS FOR BUSINESS:  The outlook appears to be for a modest earnings decline in 2023 due to a divestiture made in 2022 and due to lower volumes in the trucking industry and a potential recession.
LONG TERM PREDICTABILITY: It seems reasonable to predict that the company will continue to grow its earnings over the years however its earnings are subject to year to year volatility.
Estimated present value per share: We calculate  $144 if adjusted earnings per share grow for 5 years at the more (very?) conservative rate of 6% and the shares can then be sold at a P/E of 14 and $208 if adjusted earnings per share grow at the more optimistic rate of 9% for 5 years and the shares can then be sold at a P/E of 17. Note that these values assume that the P/E ratio increases from the current low level of 10. Both estimates use a 7.0% required rate of return.
ADDITIONAL COMMENTS  
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Has barriers to entry (marginal pass as capital is likely the largest barrier but scale is also important). No issues with powerful suppliers (pass). No issues with dependence on powerful customers (pass as the largest customer is less than 5% of revenue), No potential for substitute products (pass) No tendency to compete ruinously on price (marginal pass as the industry does compete on price). Overall this industry appears to be marginally attractive to an established large incumbent. It may be attractive for the lowest cost incumbents.
COMPETITIVE ADVANTAGE: The company indicates that competitors compete primarily on price and reliable service. Therefore cost management and scale are presumably very important.  It likely has some competitive advantage in Canada due to scale as it is the largest trucking company in Canada. It’s not clear that it would have any special advantages in the U.S. market. They do appear to be particularly well managed and are skilled in cutting costs when needed.
COMPETITIVE POSITION: The company has the largest trucking fleet in Canada as well as a significant presence in the U.S. market. It is a fragmented industry.
RECENT EVENTS: The company continues to make fairly numerous acquisitions for growth.
ACCOUNTING AND DISCLOSURE ISSUES: A recent change to reporting in U.S. dollars was warranted but complicates comparisons to the past results. Some required accounting changes a few years ago to revenue recognition and lease accounting have affected the comparability of earnings. We found the disclosure to be reasonably good. However the practice of presenting adjusted earnings from continuing operations troubled us in that the numbers change retroactively when it sells a division. We would have preferred an adjusted earnings figure that was not subject to retroactive change. They may have been aggressive in not deducting the Canada Emergency Wage Subsidy in adjusted earnings given it may have amounted to a windfall. Frequent gains on sales of assets create a situation where adjusted earnings constantly differ from GAPP earnings. Certain derivatives and hedges impact earnings. The fact that about half of the earnings are from the U.S. contributes to earnings volatility as the exchange rate changes. Like most companies, they mix purchased customer relationships with software , and the amortization of, which are both intangibles but of a vastly different nature. They are conservative in not adding back certain acquisition transition costs to adjusted earnings. The income statements has the fuel expense in the same line item as subcontract expenses and since both of these items are large it would be preferable to show them separately.
COMMON SHARE STRUCTURE USED: Normal, one vote per share.
MANAGEMENT QUALITY: The chairman and CEO, Alain Bedard has led the company since 1996. Management quality appears to be extremely high. Listening to the conference call, the CEO is extremely open with his thoughts and is very knowledgeable. He knows his numbers. In addition, this management has shown excellent ability to trim costs when needed in response to revenue declines. And they have jettisoned less profitable business. It is a rare management that is willing at times to “fire” customers. It seems they don’t to waste time and energy and resources on customers that are insufficiently profitable. We were however surprised to hear that he would base getting into or out of certain leases on the accounting rules, when the underlying economics would be the same either way.
Capital Allocation Skills: This skill is particularly important for TFI which has a stated major goal of adding value through acquisitions. It has a very strong track record. It may have made a very wise choice in divesting certain weaker lines of business  several years ago. It has made some extremely good acquisitions and particularly the ground operations of UPS.  Its aggressive share buy back program has apparently been a good use of capital even at a time when the company was also very active in making acquisitions. The move towards a more “asset light” approach appears to have been wise.
EXECUTIVE COMPENSATION:  In 2019 the CEO received total compensation of $10.8 million. The other four named officers were in the $1.1 to $1.1 million range. This level of compensation is arguably not excessive or a concern given the size and success of the company. It does, however look somewhat too heavily weighted to the CEO although the CEO as the only man on the conference call is a VERY hands on CEO.
BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. Here the Board consists of ten members, mostly retired executives (from banking, federal cabinet, industrial products distributor, food, and trucking) . There appears to a good level of business knowledge and the members are likely wealthy enough not to be unduly influenced by their compensation at TFI which is modest at about $120k per year. It is disappointing to see that five Board members (albeit four are very recent directors) could not be bothered to buy any shares. They all receive and hold deferred share units.
Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed  analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry.
DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.
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