Newsletter August 22, 2003



Performance of the stock picks available to paid subscribers continues to be very strong in 2003. The market in general has been strong in 2003 and our stock picks have been much stronger than the general TSX market.


Perhaps you have been thinking about subscribing to our stock picks (if you have not already done so).

Right now, our reports include several strong buys. One is an auto insurance company that is highly profitable and yet selling at only 1.35 times book value and a trailing price / earnings ratio of about 8.1. With today’s high auto insurance rates does this not sound like a good business to own? Another strong buy is a highly profitable property development company in Alberta trading at under book value and with a trailing P/E around 6.

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At long last Canadian insider trading reports are available free on the internet.

Insider share transactions are now posted to a Web Site called SEDI.

This is not a very user friendly site and you have to dig down several pages to see the reports you need. The URL to the page you need is

Go to this page and then choose “issuer name” from the drop-down list in the box. Then enter the name of the company you want. Ignore the date range and scroll down to the equity section and check “select all”. Then scroll to the bottom page and hit search and your report should appear.

Note that data is only available starting in early June this year when the system finally went live.

I believe that these insider reports can be valuable. I get nervous about buying a tock if I find out the insiders are selling.

However, the exercising of stock options muddies the picture. There are some cases where insider selling may not be cause for alarm.

When an executive exercises stock options, he or she has to pay the option price to the company. In order to cover that cost he or she will typically sell at least some of the acquired shares to cover the cost of purchasing them. Typically in fact they sell all the shares. For example an executive exercises 100,000 options at $10.00 when the current market price is $30.00. The executive needs to pay the corporation $1,000,000 for the exercise price of the options. Most executives don’t have that kind of cash and so they are almost forced to sell at least the number of shares to cover the option cost. Since there is a profit on selling those shares, they need to sell even more shares to cover the taxes. So, it is not surprising that when executives exercise options, they almost always then sell most or all of the shares.

The result is that we should not get upset when executives sell shares in association with exercising stock options. But it should give you more comfort when the executive sells only some of the shares.

Executives also sell shares as part of planned sales. Their financial advisors might advise them to diversify and sell some shares. I still get nervous about this. In my mind if they were really confident about the company they would not be so eager to sell.

Insider buying can be a very good signal. When you see executives taking their own money and buying shares then that certainly adds to my comfort level in buying shares.

However this is also clouded, you may see insiders acquiring options. These are gifts and therefore mean little. Also insiders may be given shares by the company which also means little. You may also see stocks being purchased on a planned purchase basis. These could be purchases by the company and may mean little.

You may also see reports that the company itself is buying its own shares. I don’t take this as very much of a signal about the share price. The company may be delusional about the value of its own shares and may be buying them when they should not be.

You can also look at the net holdings of the executives. If the executive exercises options and then sells all the shares to hold no shares or very few shares, then I really have to wonder why I would want to hold any.

The bottom line, is that insider trading reports are a useful tool, but you have to look closely and interpret what you see.


Remember the 90’s when we almost all believed that the stock market could keep on gaining 15% or more per year? We tended to be oblivious to the fact that in the long run the stock market can’t grow any faster than corporate earnings (otherwise the P/E ratio keeps rising to infinity). And corporate earnings can’t rise any faster than the nominal GDP growth in the long-run (otherwise, corporate earnings eventually get larger than GDP, a mathematical impossibility).

My article on limits to growth argues that the overall stock market will not and cannot deliver more than about a 7 to 8% return given realistic forecasts for GDP and inflation.

Now as long as only a small percentage of investors uses value investing techniques, you and I and Warren Buffett can make higher returns than average by taking advantage of “ninnies” (see last newsletter) that are selling profitable value stocks to chase some hot stock that they don’t understand at all and which probably has no earnings or a P/E that is sky high. (We can’t make higher than average returns unless someone else is below average, that’s the way it works).

BOARDWALK EQUITIES – (Needs a Lesson In Basic Finance Math?)

Last year I was quite bullish on this company and in fact I made some money as the price rose. I felt that they should benefit because they own a huge number of apartments in Alberta and the economy here is strong and home prices are rising rapidly and rents have been rising. I expected to see rising profits and cash flow. I also felt there was a good opportunity for the company to maximize value by selling properties into an Income Trust.

But now the stock price is up but the expected profit increase has not arrived. I understand that they have put some buildings into a Trust but they have not yet sold the Trust to the public (nor announced any plans to do so).

I also have long been bothered by management’s focus on Funds From Operations rather than on free cash flow or net income. Management has long claimed that net income is not an appropriate measure of their cash flow generation (where have you heard that before? – think dot bomb and telco).

Even if I agree that net income understates their true cash flow generation then I would not use Funds From Operations. Funds From Operations essentially asks you to ignore the fact that a certain portion of their depreciation is a very real cash expense – in the form of maintenance capital spending. They are spending money on paint, carpets and appliances as they wear out. It is simply not correct to focus on Funds From Operations. (And I don’t care if that is the real estate industry standard way of doing things).

To learn more about cash flow measures see my article on that topic.

When you look at their balance sheet it is really quite pathetic. Assets are $1.74 billion, which is quite an accomplishment. However debt is about $1.3 billion so they mostly operate on borrowed money – which is typical for real estate companies. Share capital raised from the stock markets is $270 million. Retained earnings or the sum total of all their historic profits (less a tiny amount paid as dividends) is a paltry $37 million. I don’t like that ratio, $270 million raised in the markets mostly some years ago and only $37 million in retained earnings. Of course they will argue that net income is not an appropriate measure. And I agree to an extent, we can probably add on the $67 million in so called future income taxes. These are taxes that are not owing. If they were allowed to do their taxes on a cash basis this amount would have been added to net income. Even so we would be at about $100 million total historic earnings and that was based on $270 million raised in the markets, most of that quite some years ago now.

Maybe they are sitting on huge capital gains in their buildings. But if the buildings  are so valuable, then where is the cash and net income that such valuable buildings should generate?

They don’t seem to disclose the age of their building but I suspect the average age is well over 20 years. That means that many of these buildings are possibly getting out of date in terms of kitchen and bath sizes and layouts and these buildings could continue to require major capital spending.

In the latest quarterly report they brag about buying a building for 50% of replacement cost. I wonder if they understand that a replacement building would be brand new and ultra modern. They don’t tell us the age of this “used” building so why should we think 50% of replacement cost is a good deal?

Finally they brag that the dividend has just been increased to 30 cents per year. At the recent share price of $15.60 that is a yield of 1.9%. That is not that impressive for a company that claims to be generating lots of cash.

In the end they may be able to create great value by selling properties to an income trust. Or maybe a big increase in net income is just around the corner. In the meantime I am not sure that they understand what their own financials are telling them. I sold my shares because I don’t trust that they know what they are doing financially. I do think they have been very successful as building owners, they do a lot of things very well, I just don’t see the evidence that they understand how to generate cash for shareholders. Just my opinion. Maybe they will prove me wrong.

Understanding the Price To Book Value

Companies are valued for their earnings and not directly for their assets. Therefore it may seem that price to book value is not very relevant. But there are some fundamental finance relationships that investors should be aware of. A highly profitable company making a sustained 20% return on equity would be a great investment if you could get it for book value. But if you pay four times book value (which is hardly uncommon) then you are accepting an earnings yield of 20%/4 = 5%. This may be fine if the earnings are growing rapidly. But investors should understand that a higher price to book value ratio means that it becomes more difficult for the accounting net income to justify the price paid for the shares. The higher the price to book value then the higher ROE and/or growth in earnings per share that is needed to justify the price paid. To learn more see my article on understanding book value.


Shawn Allen

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