Newsletter November 21, 2002 Newsletter November 21, 2002


The Performance tab on this Site documents that performance has been very strong, particularly in comparison to the market. Since the start of 1999, my own personal equity portfolio has returned 21% (an average of about 7% per year) while the TSX has fallen 24% over that period. A strategy of buying only my strong buys at the start of each year and moving to the new strong buys each new year, would have returned 29% in 2000, 14% in 2001 and was flat in 2002 to date, for a total return of 47% over the nearly three year period.

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Investors should always remember that totally unexpected and even unpredictable events can flatten the price of any company at any time. Planes can crash, lawsuits can arise, products can fail, management can turn out to be corrupt. The best protection against this is to both be vigilant in examining companies but to also diversify sufficiently, so that one disaster at one company or industry does not decimate your portfolio.


Did you ever notice that analysts focus on both trailing 4 quarters earnings and on the forward four quarters earnings. Yet companies don’t report that way. I can’t see much value in knowing the earnings for 6 months and 9 months, yet, by law, companies keep reporting that. I would much prefer if companies moved to reporting the last 12 months figures on a rolling basis. That way, we would have a sense of the current annualized performance. It seems clear that this would be a better system and yet we cling to the old ways.


It used to be that healthy companies always had cash in the bank. This was required in order to pay bills as they came due. A lack of cash was a danger sign. Also healthy companies would have current assets that well exceeded current liabilities.

I don’t believe that this applies today. It’s true that an unhealthy company often has little or no cash and that its current liabilities may exceed its current liabilities.

But today, the same may be true of extremely healthy companies. Today, strong companies have access to pre-arranged lines of credit at low interest rates. These credit lines provide the company with plenty of liquidity to pay bills.

Rather than letting cash sit relatively idle in the bank, companies can use cash to pay down longer term debts otr to invest in assets. Short term credit lines have a lower interest cost than does long term debt. Rather than having cash in the bank, companies often use lines of credit.

The end result is that a low or negative cash balance or an excess of current liabilities over current assets may not be cause for any concern at all. To judge a companies liquidity today, we have to look at it’s overall debt levels and at its access to lines of credit.

Recently Telus was showing negative cash, while CNR was showing current liabilities in excess of current assets. I believe that this is due to financing decisions rather than to a true lack of short term liquidity.


A close review of financial statements reveals that many companies recently faced little or no expense in association with their pension and benefit plans.

This may seem odd, given that these companies are typically responsible to contribute to these plans. These low pension expenses contributed to higher net incomes.

For a number of reasons, this is likely to reverse and to become a significant drag on earnings.

Consider the following examples from 2001 (all $ figures in millions)

Company Pension Expense Actual return on assets Assumed return on Assets – as used in calculating the pension expense Assumed percent return on plan assets Net Plan Surplus
Loblaw $4 gain $95 loss $65 gain 8% $9 deficit
CNR $13 gain $175 loss $846 gain 9% $242 surplus
Canadian Utilities $10 gain $29 loss $95 gain 8.1% $37 surplus

The pattern here is that companies are recording negative expenses for pensions due to fat pension gains during the 90’s which are still being amortized in and which are still assumed to be occurring at near double digit rates. But actual returns were negative in 2001 and likely will be negative in 2002. The biggest problem is that the expected returns on plan assets are very ambitious. Remember, these plans are typically at least 50% in fixed income. When (and not if) they adjust down their expected returns on plan assets we are going to see the emergence of large pension deficits and we are going to see significant pension expenses flowing to the income statement.

If that is not bad enough, think what is going to happen to the costs of other benefits like healthcare. I think any old economy company with a of of retired workers on its books is likely to see higher than planned costs for health care over the next decade. And the returns on plan assets designed to fund those costs will be lower than planed.

Research For Sale

Detailed company research reports are available for sale at a reasonable charge. I trust that you will agree that this honest independent research has value.  I am now introducing a plan that allows you to access all of my research reports for just CAN $10 per month. Or, you can purchase individual reports for CAN $5.00. Your support in purchasing these reports is greatly appreciated.

Portfolio Management Question:

Are you looking for or considering a Portfolio Manager? I am thinking about becoming licensed as such. Initially, I would be restricted to clients with a $100,000 minimum portfolio. The portfolio would be held in trust by a large financial institution. I would have trading authority and invest it according to guidelines you would set. This can include RRSP portfolios. If you have any interest in this, email to let me know (I have separately emailed a few of you, no need to respond again). This is just an exploratory question, I may not proceed with this.

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Shawn Allen