Newsletter January 24, 2004



Holding mostly higher quality stocks in your portfolio is a good way to preserve wealth. Higher quality companies tend not to be too tiny and tend to have reasonable price/earnings ratios (under 20 and ideally under 15). They often are dividend paying stocks. There are no hard rules that every stock with a P/E under say 15 is a conservative high-quality stock, but on average, lower P/E ratios lead to a more conservative portfolio.

The P/E ratios of your portfolio can easily be tracked by entering your portfolio in Yahoo finance or other sites that allow you to track your portfolio. If you see that much of your wealth is tied up in stocks with no earnings or in stocks with P/Es well over 20, then your portfolio is definitely risky and most likely would not preserve your wealth in a market down-turn.

My experience has been that conservative high-quality stocks like most banks, insurance companies and utilities can often provide excellent returns while also offering superior stability and wealth conservation in a market down-turn.

As your portfolio grows to be a multiple of your annual wages, it is even more logical to protect your wealth in this manner.

The market has risen a lot lately. Tech stocks in particular may be significantly over-valued. You don’t want to be left holding a lot of those if the market starts to turn down.

Shaw Communications

I have not analyzed Shaw Communications. It may or may not be a good investment. But I would tend to avoid it on principle. The principle here is that I like to avoid investing with management that I don’t trust.

Shaw trades at about $22.00 and just substantially increased its dividend to 20 cents per year, for a yield of less than 1%. I consider that to be a pathetic yield from a mature company with cable assets that in theory generate high cash flows.

The company also recently reported a quarterly profit of $19.9 million or 13 cents per share. This was its first profit in several years which again is quite pathetic. The loss for the year was $43 million.

Apparently this performance was cause for some huge bonuses. The CEO, Jim Shaw got $4.0 million which is fat but perhaps forgivable. But the Chairman and founder JR Shaw got $6.5 million. It is unusual for a non-CEO chairman to get a bonus that is larger than that of the CEO. Another one or two executives with the last name of Shaw got over a million as well. Laughably, the company said the bonuses were for retention to insure that these family members don’t leave the family firm. These (arguably) obese bonuses were for fiscal 2003 when the company lost $43 million, although it did have $105 million in free cash flow (a term which has no standard GAAP definition)  This seems ridiculous to me. Chairman JR Shaw should by now be getting his money through dividends, pro-rata to other shareholders. I simply can’t trust management that does this. They don’t appear to take seriously their stewardship of shareholder money.

In many cases there is little to prevent majority owners and/or management from looting shareholder wealth through arguably obese salaries, bonuses and perks. It is therefore essential to invest with management that you consider trustworthy. Perhaps you consider the Shaws to be trustworthy, I don’t.

Avoid Short Term Thinking

Truly successful investors have generally focused on investing in great businesses and then holding those stocks for many years as the company grew. This is particularly true in taxable accounts where taxes can be deferred for many years by holding stocks and where short-term trading leads to far bigger tax bills.

Given this, it is truly amazing the extent to which investors focus on the extremely short term. At the end of each trading day, CNBC and other financial news networks will show you graphs of how the DOW and various stocks varied minute by minute during the day. I generally don’t use graphs much at all. But when I do, I look at the trend over at least one year. It boggles my mind that anyone is much interested in minute by minute price variations, particularly after the market is closed.


High car insurance premiums have been much in the news…horror stories of upstanding citizens having to pay $4000 per vehicle just because of a few minor traffic tickets or even just because they moved to a different province…stories of people afraid to claim the costs to repair their car after an accident for fear their premiums will skyrocket.

Astute investors might sense an opportunity to invest. But where are the publicly traded Canadian car insurance companies? Many of us buy our car insurance through American companies like AllState and State Farm or through Cooperative and other non-trading companies. Subscribers to our Stock Research service are aware of two companies they can invest in to take advantage of this situation. And they are aware of the financial condition and some of the risks of these companies. If you are not yet a Subscriber, click here to learn more.

StockHouse provides the best bulletin board system for Canadian stocks. There you will usually find dozens or even hundreds of comments about any particular Canadian stock that you are interested in.

Unfortunately, there is usually a lot of chatter and noise and very little useful insight. I don’t mean to disrespect the people who post there, they are often desperate for information. But it often tends to be a case of a lot of uniformed people chatting among themselves. Nevertheless it can be worth a look particular regarding small speculative stocks.

Research in Motion’s Smart Stock Issue

Research in motion recently issued 12.1 million shares at U.S. $78.25 to raise U.S. $907 million.

This was a very smart move and one which other companies have failed to do in similar circumstances.

RIM shares has been as high as about  CAN $250 in 2000 before plunging all the way to about $15 in late 2002. During 2003 the stock gained steadily to about $60 and then recently spiked to $90 and then $110.

As RIM’s share rose from $15 to $90, the market value of the company (based on about 79 million shares outstanding) rose from about $1.2 billion to $7.1 billion. But this good fortune had zero impact on the company’s balance sheet. It meant that the market was indicating that the company was worth a lot more, but it did not put a dime into the company’s hands. RIM was in reasonable shape financially with about $U.S. 341 million in cash and cash equivalents and essentially no long-term debt. But RIM had only recently reached profitability and might still need cash to fund its product development. Also RIM was well aware that share prices can sometimes fall hard and fast.

RIM shares had a book value of about $U.S. ($745.5 / 79) $9.44.

RIM wisely decided to do a large share issue. By raising $907 million, the company now has a huge cash hoard. This makes the company essentially bullet proof. No matter what happens to its share price or its profits or cash flows over the next few years, the company is protected from financial adversity. The company would now have to spend or lose a huge amount of money before it could run into difficulty.

After the share issue, RIM’s book value per share will increase to about ((745.5+907)/(79+12)) = $18.16

The usual view is that this share issue is dilutive because future earnings will be spread over more shares. That is true. But the share issue is accretive to book value per share. It puts a lot of cash in the bank and raises the book value per share substantially. This puts a floor of value under the shares. If RIM’s shares were to once again nosedive, it is likely that this floor of cash value would prevent the shares from going back to the $15 level.

So… although RIM has caused some dilution in future earnings, they have made their balance sheet essentially bullet proof and amassed a large cash position. They have also increased the floor value of their shares. Overall, this seems like a very smart move.

In contrast is seems that Nortel did not issue any significant amount of shares for cash when its shares flew high. Instead they were issuing shares for immensely over-valued companies that they acquired. Nortel then found it self in the position of getting into financial difficulty and ultimately issuing shares at very low prices. I have not done a detailed analysis, but on the surface it seems immensely stupid of Nortel to have failed to issue shares when the price was flying high and to have used the proceeds to pay all debts and to make themselves bullet proof as RIM has done. That would not have prevented their share price from collapsing, but it would have limited the collapse and would have meant that the survival of the company would never have come into doubt.

One reason that Nortel and others may have been reluctant to issue shares when the price was high is that a share issue often causes the market price to fall. In RIM’s case the price momentum was so high that the share issue appears to have little affect on its price. But even if its share price had fallen, RIM was wise to make the share issue. Contrary to popular belief a company should put its long term viability ahead of short term share price considerations. This is generally good for shareholders in the long run.


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