Newsletter January 27, 2019

An Announcement

I am very pleased to announce that Zach Trease has partnered with InvestorsFriend as a contributor.

Zach is a recent engineering graduate of the University of Alberta. Zach is also a passionate self-taught investor and investment analyst who has been writing about and sharing his investment analysis for the past 3 years.

Over the years, I have been extremely cautious about including any outside content on InvestorsFriend. I would only ever have anyone else contribute if I was confident that they were following a logical and sound fundamental approach to investing and, perhaps even more importantly, I was very confident in their honesty and integrity.

I have known Zach since early 2018 and I have developed that confidence.

Like me, Zach follows a fundamentals-based approach. He thoroughly analyses the numbers but also puts a heavy weight on non-numerical considerations. He has had great success in identifying great companies that are selling at bargain or at least reasonable prices.

Zach’s contributions are now posted on our web site at the following link:

At this time, I highly recommend Zach’s review of his 2018 results and his outlook and stock ideas for 2019. Also, he provides some excellent material on how to be a successful investor. You can also join his newsletter list at the following link to get his latest thoughts on a timely basis as they are published.

How did Canadian, Tobias Lutke, age 38, become a billionaire?

Benjamin Franklin, in 1727, founded a weekly social club comprised of a small group of highly successful men. One of the standing items for discussion was in effect “do you know anyone who’s rich and do you know how they got that way?” Almost three hundred years later, that still seems like a good topic to look into.

Canadian, Tobias Lutke, born in 1980, is a billionaire by virtue of his 7% ownership of Shopify Inc. which he founded in 2004, at the age of 24, and which now has a market value of U.S. $18 billion or $24 billion Canadian dollars.

Shopify is a software company that enables new and existing businesses to quickly to set up an online retail store and provides the associated services and software. In the trailing year ended September 30, 2018, Shopify had revenues of just short of $1 billion and losses of $66 million. All figures are in U.S. dollars. The company is richly valued in the market based on its rapid growth and its expected future earnings.

Tobias Lutke, through Shopify became a billionaire by creating a service that was highly valued and needed and by being extremely ambitious in growing the company. As further detailed below, he made very astute use of both venture capital markets and the public equity markets.

The genesis of Shopify occurred when Tobias Lutke could find no suitable software to take his little snow board business online in 2004 and so he developed his own software and then decided to focus on providing that software and assistance to help other new and small businesses go online. Based on the success of the business, within a few years he was able to raise almost $100 million in venture capital. He had to give up 85% of the ownership mostly to venture partners. Being willing to give up that control certainly seems to have been an astute move, without which he would not have subsequently become a billionaire.

In 2015 when he owned 15% of the company he (and his venture and other partners) sold 11.7% of the company in an Initial Public Offering (IPO) that valued the company at $1.3 billion. Just prior to the IPO, the company had $64.8 million in equity and had accumulated losses of $33.6 billion. Therefore it had by then raised $98.4 million in early stage or venture capital. Most of this consisted of $87 million in convertible preferred shares raised in 2013. Tobias Lutke and his partners owned 66.7 million shares after the IPO. Therefore these early owners paid an average of about $1.48 per share. These shares today trade at $163 or over 100 times more. Turning a dollar into over a hundred dollars in a short period of time is a great way to get rich. Especially when there are $98 million dollars that each gain over a 100 times in value. Tobias Lutke, as the founder likely paid virtually nothing for his shares.

Subsequently, as sales grew rapidly and the stock price rose they sold an additional 29% of the company in four additional share sales, raising a total of $1.86 billion. At the IPO, sares were sold for $17. Subsequent sales were at $38.25, $91, $137 and $154. Each time shares were sold there was likely a temporary decline in the share price due the dilution. But, in my opinion, Tobias Lutke was very astute to raise what was probably far more cash than really needed at each stage. This reduced his, and his early partners’, ownership percentage but provided and continues to provide the company with more than ample cash to fund its ambitious and rapid growth. At this time, Shopify has a huge “war chest” of cash and is now free of any need to raise additional capital for a very long time if ever.

As a result of the equity it has issued for cash, Shopify currently has an extraordinarily strong balance sheet with cash and short-term marketable securities of $1.6 billion representing 86% of its assets. It has no debt. Its $1.67 billion in equity is valued in the market at $18 billion. The company is clearly valued for its future earnings, not its cash and marketable securities. Other than cash and marketable securities, its assets amount to $264 million. If we add back the $186 million in accumulated losses then the total of $450 million in assets other than cash and marketable securities are valued in the market at about $16.4 billion. The value created over and above the funds invested in the company is about $16.4 billion! This all resulted in Tobias Lutke becoming a billionaire.


The following is an article that I wrote and that was originally published two years ago in The Internet Wealth Builder, where I am a contributing editor.

Statistics Canada reported this week that Canadians have been contributing less to RRSPs in recent years. In part, this is due to the introduction of the Tax-Free Savings Account (TFSA). Disturbingly, it is also due in part to inaccurate “bad press” that RRSPs have received.

Yes, it’s true! RRSPs too have been the victim of “fake news”. Much of this bad press is spread by well-intentioned but unqualified and ill-informed people posting on various Internet sites. This is unfortunate because RRSPs remain the best retirement savings vehicle for most (although not all) employed Canadians. I will provide the math below.

Those contributing to the bad press often describe RRSPs as a mere tax deferral system rather than a tax reduction system. Those with more extreme views call RRSPs a “tax bomb” waiting to explode. These views are false and result from confusion. Far from being a “tax bomb”, an RRSP can usually result in net tax-free growth after properly considering both the initial income tax refund and the taxes paid upon withdrawal.

Why the confusion?

Here’s how the confusion arises:

Investments and savings in a TFSA, of course, grow completely tax-free. $100,000 in a TFSA can be taken out and spent at any time with no income tax payable.

Investments and savings in a taxable investment account accrue tax on interest, dividends, and realized capital gains and the tax must be paid each year. But $100,000 in a taxable investment account can also be withdrawn and spent at any time and the only additional tax payable would be on any capital gains that had to be triggered and realized in order to convert the investments to cash.

Investments and savings in an RRSP grow completely tax-free as long as there are no withdrawals from the account. But removing $100,000, in one year, from an RRSP would result in roughly a 40% to 54% tax hit, depending on your marginal income tax bracket, which increases with income and varies somewhat by province. (Your marginal income tax rate is the rate applicable to each additional dollar of income and is higher than your average income tax rate.) You can check your combined federal/provincial marginal income tax rate by province and taxable income level at the following handy link.

Even if withdrawals are kept much smaller and spread over many years, most RRSP investors will face taxes upon withdrawal of at least 20%, and 30% to 40% is probably more typical. Those in the highest bracket could face tax rates of 54% on RRSP withdrawals. RRSP withdrawals are taxed not only on the gains that the investments have made but on the removal of the original contributed amounts as well.

Based on the above, the argument is made that RRSPs are clearly tax traps and should be avoided. But the full math tells a far different story as the following example illustrates.

Imagine you earn an additional $10,000 and are in a 40% marginal income tax bracket. You will net $6,000 after tax, which you can choose to spend or to save. If that money is placed in a TFSA and grows at 8% annually then you will end up with $60,000 after 30 years. You will pay no tax on the $54,000 in growth.

Alternatively, you could invest $10,000 in an RRSP. This would be your own $6,000 plus a borrowed $4,000, which you will shortly repay with the 40% tax deduction that you will qualify for. If that money grows at the same 8% you will end up with $100,000 after 30 years. If you then face a hefty 40% marginal tax rate upon withdrawal you would net $60,000.

Notice that your net cost was $6,000 in both cases. In both cases, it was the same $6,000 in after-tax funds that were no longer available for spending. And in both cases your after-tax result in the end was $60,000. Your gain was $54,000 in both cases. If your net $6,000 in the RRSP grew to the same amount after tax as it did in the TFSA then the inescapable conclusion is that your $6,000 in the RRSP also grew completely tax free despite the 40% taxes paid on the withdrawal! Your $6,000 did not merely grow on a tax-deferred basis, it grew tax free!

How can this be? Well, in substance, in the example above the initial 40% tax refund effectively funded 40% of the RRSP or $4,000 of the original $10,000 contribution. Think of that as the “taxman’s” (permanent) share of “your” RRSP. The taxman’s 40% share subsequently grew at the same rate as your 60% share and fully funded the 40% tax upon withdrawal.

And, better yet, if your marginal tax rate upon withdrawal is lower than the marginal tax rate at which you contributed and obtained a refund, then the taxman’s share of your RRSP will more than fully fund the taxes due and your own net contribution to the RRSP will have grown to a net after-tax amount that is even larger than would occur in the TFSA. That is effectively a negative tax rate on the growth in your own net contribution to your RRSP.

The big mistake that RRSP investors make is to consider their RRSP to be worth 100 cents on the dollar. It never was. It only cost them, say, 60 cents on the dollar after considering the refund. It will only ever be worth 60 to 80 cents on the dollar depending on the marginal tax rate applicable to withdrawals.

On a properly constructed net worth statement it is simply incorrect to value an RRSP account at 100 cents on the dollar. It should be shown at a reduced value to account for the approximate percentage that will be lost to income taxes upon withdrawal. Sadly, those who count their RRSP account value at 100 cents on the dollar are poorer than they thought.

Not free money

If you contribute $10,000 to an RRSP and get a $4,000 refund, that refund is not “free money” and your net worth does not increase by $4,000, or at all. In substance, you have contributed a net $6,000 to the RRSP and the taxman has contributed $4,000. The taxman is, in effect, a permanent partner in “your” RRSP.

Upon withdrawal, the taxman will take back a share that is based on your marginal income tax rate. In most cases this take back rate or percentage will be lower than the rate or percentage that the taxman, in effect, originally contributed to your RRSP. Having a partner that contributes 40% to a fund that grows tax-free and who usually takes back somewhat less than 40% still leaves you with access to tax-free growth on your 60% share of the RRSP and, in that case, even lets you keep some of your partner’s 40% share.

If you forget that that the taxman originally funded about 40% of “your” RRSP then paying say 30% or 40% taxes upon withdrawal seems very harsh indeed. But if you consider that the deal is that your (say) 60% net contribution to the RRSP has grown completely tax free and that that all the taxman is doing is taking back his 40% share (and often he takes back less than that) then you will realize that investing within an RRSP has been very beneficial indeed.

Despite some bad press and fake news, RRSP investing is very beneficial and Gordon Pape has written a book called RRSPs: The Ultimate Wealth Builder if you want to know more. It’s available on Amazon.

Action now

Most people earning income from employment and who are in a marginal income tax bracket of at least 30% should absolutely contribute to an RRSP, particularly if they have already maximized their Tax-Free Savings Accounts.

Do not listen to uninformed people who refer to RRSPs as income tax traps.

As painful as it is, begin to think of your RRSP as having a value of 60 to 80 cents on the dollar. Ease the pain by remembering that you only contributed about 60 to 70 cents on the dollar and your tax refund effectively contributed the remainder.

Be wary of suggestions to cash out your RRSP investments early to avoid income taxes. That can make sense in rare cases where people face a period of extremely low income (and therefore very low marginal tax rates) and especially if the withdrawals are used to fund TFSA contributions. But in most cases it would not be a wise move. Be especially wary of any financial advisor who advises you to cash out an RRSP that is not invested with him or her in order to make investments that the advisor will then earn fees from.

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