Triaging My Way To Financial Success

Question: Dividend Milestone I

2009-11-18T06:00:00.004-05:00

In response to a recent post titled Dividend Milestone I reader Jeroen wrote,

"I was very impressed when I read your blog post and learned that you are currently receiving more than $8000 in annual dividends! Congratulations! This is very inspiring to me as I am around the same age as you are. At the same time, however, it raises questions. I currently get just over $X in annual dividend income...like you, I also decided to take on a conservative amount of leverage to take advantage of the many bargains that were out there during the painc at the end of 2008 and at the beginning of this year.

So my question really is 'How do you do it'? Can you give me an idea of how much you invest per month/quarter/year? Perhaps you can share some tips or give some advice on how I can also achieve such a goal? How long have you been investing in your DivG portfolio?"

First I will admit that reaching this milestone in my Dividend Growth Portfolio (DivG) didn't occur overnight. It look time, a lot of work, patience and an incredible amount of discipline taught to me by a number of individuals.

I do feel there is an important lesson hidden within my response to Jeroen's questions: "When investing we often look directly to the result instead of studying the process."

Warren Buffett is one of the greatest investors known in our time and he is a great example of far too much credit being given to the result of his investments instead of the process through which he got there. Understanding what contributed to any successful investment or portfolio is the foundation through which I learned to become the investor I am today.

How I achieved this milestone is simple: I saved, invested and saved some more. I had a certain amount of luck, skill and opportunities that others may not have had, but the key, as I tell everyone who asks, is the difference between what you make, what you spend and how much you can save. My family and friends often laugh and call me "cheap" but in reality I'm frugal and proud of it.

The key, to any success in life, is often how hard you work at something. My work ethic (whether as a business owner, Registered Nurse or investor) is very high and something I pride myself on. Investing takes skill, luck and time but when you're young the power of saving is something that many people lose sight of.

ThickenMyWallet made reference to this recently in a post titled, Observations from an investment seminar where he made reference to the fact that he and a friend were by far the youngest (in their 30's) attending the specific event. The scary truth is that far too many individuals wait until it's too late to allow compound interest (Rule of 72) to help advance their wealth in their own favour.

I started saving at the age of 11 or 12 when I began cutting grass in my neighbourhood for a number of elderly individuals. I would charge $15-20 per cut and each summer make around $2,000 tax free. By the time I began my business degree I was making enough money through a part-time job to support my living expenses and tuition while investing the money I had saved during all those summers. When I began my nursing degree I had another part-time job that paid me nearly double my living expenses (which were very low) and all additional savings each month went towards my investments.

By the time I created my first Value Portfolio in 2006 I had $20,000 to start the portfolio and another $20,000 in savings. For the first two years I was able to compound the investments in my Value Portfolio at an average of 65% leaving me over double what I started with when I closed that portfolio and created DivG. In restrospect I was taking far too many risks with the time horizon and type of investments I was making and what I was doing is something I would have difficulty doing again with the type of risk adversion I have now.

When I started working fulltime as a RN my monthly expenses were only 20% of my income and all additional funds went into savings and investments. Over the next year and a half my savings contributed nearly 30% of the new funds to my portfolio. The huge factor in the growth of my investments, even if you take out the returns of my first Value Portfolio, was how much I was able to save.

I didn't live like a hermit, but I was making more then I was spending. I drove a nice car, rented a room with a friend in a nice house and lived cheaper then I could afford. I kept a monthly budget and tracked all my receipts (something I still do today) so I always knew how much I was spending and saving.

When the credit crunch rolled around in the summer of 2008 I began investing heavily into the companies I already owned or had studied for years. I opened a line of credit (LOC) for $30,000 and used $25,000 to invest over the past year in companies such as Manulife (MFC), the Canadian banks I already owned (RY, TD & BNS) and a number of depressed preferred shares trading near $15 ($25 par value). I invested on a regular basis in each of my holdings with some near their 52-week lows and others at fair value to keep my portfolio balanced with each holding comprising 3-5%. I still owe a large sum on the LOC, but the dividends that are borrowed are paying off a considerable amount of my LOC each year moving forward. 50% of the dividends are invested directly back into the portfolio and the other half immediately used to pay back the outstanding balance on the LOC.

Having the intestinal fortitude, discipline and skill to invest in an environment of fear and chaos helped substantially, but any long-term investor needs to realize that what we've experienced in the last two years is normal and will happen again. The severity may change, but panic creates opportunities and as long as you understand the risk the reward at times can be proportional.

Today I certainly don't take risks I did with my money when I was younger, but back then I didn't know any better and those choices, in retrospect, made me a better investor today.

I can't stress enough the importance of living within your means and focusing on savings. When you're young its very easy to spend wildly and not take account of how much is going out. I've travelled the world and spent a lot of money on a beautiful home in the process, but my priority even now in life is saving for the future. We have a discretionary spending budget each month that accounts for 7.5% of our combined income. Setting a limit on spending and sticking to it makes a big difference. I walk to work each day (8-12 min) so we only need one vehicle. There are many changes anyone can make to their monthly budget to save even $100 that over the course of a year leaves you with $1,200 to invest for the long-term.

Remember that, "when investing we often look directly to the result instead of studying the process" and if you embrace that knowledge you'll find that your successes when investing over the long-term will increase considerably.

Disclosure: I have common share positions in all stocks mentioned in this post.

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Barriers to Investing: Price

2009-11-16T06:00:00.003-05:00

Over the weekend I found myself reading a thread on an investment forum I frequent (Financial Webring) where a number of members began discussing their views on How to determine a “Reasonable Price” for stocks.?

When I invest I tend to use a number of criteria when selecting a target price for a buy or sell as I’ve outlined in past posts. Determining price is a balance between the qualitative factors contributing to the operating environment of a business and its quantitative performance. The beauty of the markets is that at any given time there are individuals who believe a company is undervalued, fair valued and overvalued all at the same time. Those opinions make the market what it is and it’s our responsibility as investors to determine an opinion on an investment and invest accordingly.

When Charles first befriended me a number of years ago he would often give me an example when I struggled with determining a price for a company I wanted to own,

“Picking a price is like asking a hot girl to the prom; you can wait for the right moment but if you wait long enough someone else will take her and you’ll find yourself dancing solo to the last song of the night.”

I always think back to this analogy when my stubbornness takes over and I’m determined to stick to a target price only to miss out on an opportunity to own part of a great company.

Investors often hear the opinions of others or say themselves, “not at that price,” in a stubborn response to the current price of an investment. As a value investor myself I try my best to get the best possible discount to the intrinsic value of a company I can whenever I make a purchase. What I have to be conscious of is the realization that as a shareholder I am part owner of a business and begin participating in the operations, successes and profits of that company the day I buy my first share. A great company, one with enduring characteristics, sells services or products that have sustainable demand and may not be cheap on any basis for a number of years. As an investor I can choose to either participate directly in the financial success of that company or wait for an opportunity that might never come.

Investors need to be aware that everyone loves a deal, but price can be the ultimate barrier for making a smart long-term investment. A fellow member of the FWF (Taggart) made reference to the criticisms of Warren Buffett on frequent occasions. Buffett buys companies at a premium to what others view the current value of a company to be, but it’s the long-term value, earning power and competitive advantage those companies hold where the true value is rarely realized in the present.

Just as in life there are times as an investor when you sometimes get what you pay for and there’s often no replacement for quality.

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Dividend Income Milestone I

2009-11-13T11:00:00.002-05:00

Today when I increased my common equity position in Sunlife Financial (SLF) in my Dividend Growth Portfolio (DivG) I achieved a targeted milestone for dividend income in that portfolio.

Late 2008 and early 2009 were full of opportunity for investors with the dedication, discipline and focus for long-term investing. I was fortunate enough to successfully initiate a leveraged dividend strategy in my Canadian portfolio as well as make some very disciplined purchases of depressed investments when the market was full of panic and fear.

Earlier this year I had set a milestone for the yearly generated dividend income in my DivG portfolio at $8,000/yr with the intent to achieve that level by the end of 2010. Using a conservative amount of leverage, key purchases and a balanced approach to the management of my portfolio I'm happy to say that today was the first day that I broke through $8,000 in yearly dividends for my portfolio income even with cuts to the dividends of some key companies I hold (Manulife, Russel Metals & Husky Energy). The exact amount, for those interested, on an annualized basis at current dividend levels is $8,015.03 spread amongst 31 investments (common equity, income trusts & preferred shares).

The goal of this portfolio is to eventually achieve financial independence where the passive income generated by dividends supplements my working income to achieve greater financial flexibility. Ideally the increase in dividends will outpace the rate of annual inflation preserving my purchasing power as a consumer.

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Tough Job Market Tips:

2009-11-12T10:41:00.005-05:00

Carl Lavin, managing editor for Forbes.com, posed a question to a group of bloggers asking the following question,

“Recently, the U.S. Bureau of Labor Statistics reported a jump in the unemployment rate to 10.2%. Some economists think we could be looking at 10.5% by early next year.

Given these grim forecasts, how do you counsel recent college graduates and others entering the job market for the first time in this employment climate? Is there any advice or strategies you find particularly useful?”

When I graduated from university and received my license to practice as a Registered Nurse I had no problem finding full time employment due to the clear and obvious shortage of nurses that exists within the healthcare system today. But as a business graduate in 2004 I clearly remember the pressures many in my graduating class faced when attempting to find fulltime employment that was both meaningful and rewarding.

To state that this is a difficult employment environment is a bit of an understatement when many new graduates haven’t had difficulty finding employment in the past. Today they face a climate for employment that has them attending multiple resume seminars, pounding the pavement seeking job opportunities and adding their resumes to a growing pile of competition.

In my consulting business I’ve had the opportunity to work with a number of self employed individuals who started their companies out with nothing more than some savings and an idea. What I’ve learnt is that an idea, for a business or a career, can be a powerful tool in securing your financial future now and in the years ahead.

What I’ve decided to include in my response to the question posed by Forbes.com is to highlight five successful characteristics that I and many of my clients share in their individual and business successes.

Market Yourself

Just as Fortune 500 companies know the importance of marketing their products and services to their customers the unemployed of today need to learn the art of marketing. Learning how to market you as a valuable asset is just as important as how any company tries to sell itself to others. Marketing yourself is more than just how you dress, talk and walk; it’s the presentation of what you bring to a potential employer and how valuable that might be to their competition. Talent is a fiercely pursued commodity among companies and if you can succeed in marketing yourself as something valuable within an industry or group of companies then you stand a much better chance of securing employment over the short-term.

Innovate

The world moves far too fast with today’s technology and mobile capabilities for businesses (and their employees) to be caught standing still. Innovation is an important tool to the corporations of today and they seek employees with the tools to innovate independently and collectively with others. Products, services and competitive advantages are fiercely protected in the competitive landscapes of today. The ability of any individual to innovate or offer something innovative to a company raises their employment value tenfold.

Direct

As a young man my grandfather always told me that if you want something you have to directly pursue it with determination.

The employers and businesses of today don’t have the time or resources to waste on figuring out what you want as a potential employee. If you want to do, plan to do or know you can do something then tell them. Far too often in business the less direct you are the less successful you will be in what you plan to accomplish.

One of my core practices in business is to follow what I term as my 4-D Approach; Desire, Drive, Determination and Discipline.

This approach is derived from my belief of, “Think it, Say it, Want it, Do it.” If you want a job with a prospective company you need to be direct enough to tell them what you want and can accomplish as their new employee now and in the future. Demonstrate that you have the motivation to improve, succeed and achieve your goals. Show you have the passion and enthusiasm to attain your fullest potential. Dedicate yourself to persevere through adversity and uncertainty to achieve success. Explain you are committed to learning, you have the patience to lead and the control to accomplish what you want.

Work Ethic

Part of my reasoning for being direct is to demonstrate to a potential employer that your work ethic is above all other candidates. Very few people attained success in business without putting in the work and determination to get there. Large and small companies want hard working people who are committed to excellence because they know that their customers pay a premium for quality. They don’t want a job to be done at 80% efficiency and what businesses want, look for and spend huge financial resources on are finding their leaders of tomorrow.

Leaders of Tomorrow

Andrew Carnegie once said, “No man will make a great leader who wants to do it all for himself, or to get all the credit for doing it.”

Leadership is about achieving results through others. Possessing, understanding and portraying your skills in leadership to a prospective employer increases both your worth and usefulness to a company. Employers want to see an employee that demonstrates maturity, intellectual curiosity, knowledge and humility. Any employee has a steep learning curve once hired into a new corporate culture, industry or role. Companies want individuals who are flexible, adaptive and humble enough to know that learning is part of the journey. Great leaders never know everything but they do have the insight to know that achieving a goal is dependent on the performance of those they oversee. The ability to handle stress within a team, to follow direction and contribute in a meaningful way are all traits that companies look for in prospective employees.

Brad Ferris is President of Triage Capital Management Incorporated.

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Mail Bag: CML Healthcare (CLC.UN)

2009-11-02T06:00:00.007-05:00

In a blog comment posted in August reader Steve C asked,

“Is CML Healthcare on your watchlist? The trust hasn't done much YTD. It pays a solid 8% and its cash flow is steady and predictable. I would like to get your opinion on this stock since you are in the healthcare profession.”

CML Healthcare Income Fund (CLC.UN) is a Canadian operated income trust that is involved in the business of diagnostic services (laboratory and medical imaging) in five Canadian provinces (Quebec, Ontario, Manitoba, Alberta & British Columbia) and two states (Delaware & Maryland). In addition the company is currently closing an acquisition of Quarry Lake which will add to its operations in Maryland and expand their business into Rhode Island.

I am familiar with the company having researched it in the past, but at a quick glance I noticed a few newer items I’d like to highlight for readers:

The trust has come off from the lofty $17.30’s seen in early 2008 to currently trade in the $13-14 range over the past six months with a YTD return of 4.12% (not including distributions). The company pays out a monthly distribution to unit holders of $0.08927 ($1.071 annually) which yields an even 8% on a closing price of $13.38 (as of October 30^th).

In the most recent quarter, ended June 30^th 2009, the payout of the trust (calculated as total distributions as a percentage of distributable cash) was 92.5% for the first six months of the year versus 85.9% for the entirety of 2008.

The company’s Long-term Debt to Equity (D/E) has risen to 0.56 for 2008/2009 versus 0.40 in 2007. That’s not bad for a trust that is looking to expand through acquisitions but in this current credit environment I was not able to determine the price for the acquisition (or the financing) of Quarry Lake which when completed will likely impact this ratio further. Operating expenses were a key concern I had when looking through the company’s numbers this time around.

Operating expenses (operating, general & administrative) have increased 33% YoY in the most recent quarter after a 70% rise from 2007 to 2008. For a company expanding operations an increase would be expected as operations are added and more costs are incurred, but the concern I have (as I mention in my full SAML analysis of Coca-Cola) is with the pace of revenues for the company.

Operating expenses have risen faster than the pace at which revenues have risen and that trend, in any industry, is not something that is sustainable. Revenue for CML Healthcare only rose 48% from 2007-2008 versus 70% for expenses and revenue rose 24% YoY in the past quarter of 2009 versus 33% for expenses. This demonstrates to me initially that the company is having difficulty managing expenses in the face of lower revenues and begins establishing an unsustainable trend where expenses outpace revenues. The result is a compression on the company’s margins which management discusses in their most recent quarterly analysis. As frequent readers and readers who had access to the Coca-Cola analysis know margins are paramount in a company’s ability to secure a competitive advantage and at this time CML Healthcare looks to be undisciplined in this area.

The company’s management however does do an excellent job of explaining and outlining their growth strategy for the trust and are currently executing well on growth through accretive acquisitions.

To answer SteveC directly though CML Healthcare does not appear on any of my watchlists though for two important reasons; the first dealing with my Sustainable Demand Model and the other involving their exposure to external political risks.

My Sustainable Demand Model is a tool I developed and use when I analyse healthcare or consumer stocks for my portfolios. The basic principle of this model is closely tied to my guiding principle of Enduring Value and is best represented by Warren Buffett’s thesis for investing in Coca-Cola (KO). That thesis follows the basic principle that if Coca-Cola products are consumed 1.5 billion times today, were consumed 1.5 billion times yesterday and were 1.5 billion times the day before what are the odds that they will be consumed 1.5 billion times (or more) tomorrow? The odds are very good. Why?

Coca-Cola offers what consumers want or need on a sustainable scale. Sales may dip +/- 5% from quarter to quarter based on certain economic forces, but demand for their products is strong, growing and enduring.

I, as an investor, have two options for investing; I can choose to invest directly in the company or indirectly through a secondary investment. For my portfolios I choose to invest directly in companies that fit this Sustainable Demand Model because I wish to participate fully and to the fullest extent of an excellent company over the long term.

CML Healthcare I consider to be a secondary investment in this model because through its operations it uses diagnostic equipment and laboratory supplies manufactured by companies that I can purchase direct investments in. Companies such as Becton Dickinson (BDX) or General Electric (GE) provide products that CML Healthcare needs to purchase and use to meet client needs that provide sustainable demand. In this instance I would rather invest directly and diversify into these individual companies that supply the consumer demand for CML Healthcare than directly invest in CLC.UN.

As one example CML Healthcare operates 125 specimen collection centres across North America where BD products are likely used and in Canada as a whole it is estimated that over 35 million diagnostic medical laboratory tests are conducted each year in Canada (source: CLC.UN 2009 Annual Report). GE is a global leader in the development and sale of CT and MRI equipment for medical imaging. By investing in BDX I gain exposure to CML Healthcare’s client services, but also to the hundreds of other companies, clinics and laboratory uses of BDX products around the world.

CML Healthcare’s exposure to political risks is another reason why the company does not appear on my watchlist. When I conduct any Situational Analysis I first look to identify and compare any or all internal strengths, weaknesses, opportunities & threats with external political, economic, social or technological trends.

CML Healthcare operates within an industry that is heavily regulated, subsidized and overseen by various levels of government. As I wrote about recently in a post on Shoppers Drug Mart (SC) government involvement in spending or cost cutting can have either a direct or indirect impact on the profitability and operations of private companies. CML Healthcare may currently have a favourable operating environment in partnership with governments but the way they do business today may not be this way forever. Funding may change in response to difficult economic pressures and governments may be forced to reassess priorities in healthcare by either centralizing or further decentralizing various care centres or services.

Disclosure: I hold common equity positions in Coca-Cola (KO), Shoppers Drug Mart (SC) & Becton Dickinson (BDX) as well as a fixed income position in General Electric (GE)

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Mail Bag: Manulife (MFC) Part II

2009-10-22T23:00:00.001-04:00

In a recent E-Mail a reader asked,

Brad,

I know that you have always been a fan of Manulife as a DivG investment. Currently I don't own any shares and I am considering taking an initial position. As you are probably well aware MFC took a 50% dividend cut. I was wondering whether this action has changed your view of MFC as a good DivG investment.

Jeroen

I had an opportunity in late September to attend the Thursday session of the Scotia Capital Financials Summit as a guest of a client when new Manulife CEO Donald Guloien spoke on the future prospects of the business.

For the majority of the day a host of companies spent their time highlighting their current or new initiatives on risk reductions to calm anxieties over last years global financial crisis and Guloien's presentation was no different. A CEO is the face of a business and in many ways a corporate politician, but Guloien did take the time to discuss the current situation Manulife finds itself in. The big emphasis was on the availability of capital and strengthening an already dominant market position in life insurance products.

The main challenges I noted that the company faced dealt with the actual and perceived impact of equity markets on their variable annuity products, the low interest rate environment the company currently finds itself in and the capital they require to participate in adventagious acquisitions. I did enjoy hearing that the company intends to raise its margins and charge a higher premium for risk (something they failed to do in the past). I was impressed by the fact that Manulife is now the 4th largest global life insurer behind China Life, AXA and Generali putting the company in a good position to leverage their scale globally.

The company did lose their AAA credit rating (they remain AA+) and I wasn't impressed with the earnings guidance they presented for 2009/2010 because they chose to exclude any impact of market conditions on their segregated fund guarantees. Guloien did attempt to soften the unease of the company reducing its dividend by 50% by stating that the company's capital position now and in the future is better served by retaining more earnings within the business. It was quite clear to me (and others) that management within the company is still concerned of their exposure to equity markets and that cutting the dividend was a prudent decision to save the approximately $700 million for other purposes. The withdrawing of what the company terms "rich features" from products appears to be a conservative move but there was limited information available on a new line of variable annuity products Guloien mentioned in the presentation.

Not a lot changed with respect to the asset quality of their insurance assets (see Taking Stock in MFC) but I was concerned with a chart that showed the company still has considerable exposure to unrealized losses that could impact asset values if sold.

To answer Jeroen's question directly I am still a fan of Manulife despite the troubles the company faced over the past twelve months. I wasn't thrilled with the 50% cut in their dividend, but when capital is at the premium we saw earlier this year when companies came to the market to raise money prudent decisions are necessary. I don't expect the dividend to rise anytime in the next 12 months, but I have done well with the stock as I bought near the bottom of its 52-week low and the company continues to occupy a 3.40% position in my Dividend Growth portfolio (DivG).

I don't see any reason, at present, to overweight MFC as I did with the Canadian banks I hold but I still feel their strength of operations in insurance and annuities will help them smooth out the wrinkles left over from their foray into segregated funds; a lesson they will likely remember for a long time. MFC is likely to remain a good long-term investment that should reward investors with patience. It still remains at the core of my DivG portfolio, but a stock I watch much more closely than I did before.

Disclosure: I currently have a position in Manulife (MFC), Bank of Nova Scotia (BNS) and a life insurance policy with AXA

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Value Stimulus: Procter & Gamble

2009-10-19T10:00:00.000-04:00

I’ve made reference in a few posts now to a long held investing thesis of mine regarding healthcare companies and my reasoning for classifying certain consumer products companies in the healthcare portion of my portfolios. In essence I’ve had a single focus for the healthcare component of my investments and it follows this line: “I’m not targeting just the health of people here at home, but those all around the world.”

The reasoning for this focus is very simple and was outlined quite nicely just last week at the annual shareholders meeting of Procter & Gamble (PG) by new CEO Bob McDonald. McDonald made reference to a long-term growth initiative that the company has been focused on regarding investments in emerging markets (China and India) and the need to increase market penetration to reach more consumers.

Currently annual per capita spending (based on 2008 estimates) of P&G products in the US was roughly $100 per consumer. This contrasts with $70 per capita in the UK, $40 in Germany and $20 in Mexico. China and India combined account for spending of less than $4 per capita. McDonald made a statement that bringing per capita spending in both China and India to Mexico levels ($20) would boost sales at P&G by over 50%.

The math is pretty simple when you consider that new consumers in emerging markets will begin to use an increasing amount of personal care products (oral care) and cleaning products to improve their standard of living. The execution by Daniela Riccardi, President of Greater China operations, has been so far a slow methodical approach but over time companies such as Procter & Gamble and Colgate-Palmolive should begin to build up market share and increase sales at a quickened pace. This not only increases sales globally but differentiates operations for the companies so that slowed growth in one or two economies doesn’t drag earnings momentum as much as during this past recession.

Disclosure: I own shares in Procter & Gamble (PG) & Colgate-Palmolive (CL)

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Costco Connecting with Consumers

2009-10-07T13:00:00.002-04:00

Since initiating a position in Costco (COST) with a LO in August I’ve been both surprised and pleased with the performance of the common shares as I’ve watched them rise over 30% in the face of both good and bad news of weak consumer data and the relative performance of other retail stocks.
Costco released their Q4 and full year 2009 results today and I’ve been busy updating my spreadsheet to get a sense of what the landscape for Costco might look like come the release of their full year report in December.

The numbers were good by analyst estimates with Costco’s net sales down 3% to $21.9B as of August 31st, 2009. Net income for the fourth quarter was down $0.05/share or 6% YoY. These numbers, while down, illustrate the ability of management to minimize sales erosion during a recession and keep consumers in their warehouses buying products and using services.

I’ve tried for most of the morning to get some early numbers from the company on their gross margins so I can quickly compare their 2009 results with previous years. If readers remember my post on Costco from last year (Taking Stock in COST) there was a large portion dedicated to explaining the importance of how Costco doesn’t compete on price by staying committed to maintaining their margins.

Historically gross margins (as a % of sales) have averaged 10.28% with management improving this metric over the last five years to an average of 10.60%. When you compare these numbers to other retailers Costco has a clear advantage and one it protects very well with the type of business it operates (membership).

I did find in the numbers today that SGAE (selling, general and administration expenses) as a % of sales has climbed to 10.38% vs. a historical average of 9.56%. Hopefully this reflects an improved effort to reduce sales erosion by management rather than going lack on their long-term commitment to stay in control of costs. SGAE had been holding steady at an average of 9.80% over the past five years so an increase to nearly 10.4% does seem high despite the increased challenges a recessionary environment presents.

I was glad to see that Costco has increased their number of warehouses by nearly 9.4% to a total of 560 warehouses. This is well above their average yearly commitment of a 6% increase and will help to improve future earnings of the company by providing a larger retail footprint domestically and globally. Companies with strong balance sheets and high margins have both the cashflow and financial resources to expand operations in a recession in anticipation of better performance when the economy recovers.

The market in turn seems to be rewarding the company (and shareholders) for their consistent and effective operations in this economic environment where consumer spending has fallen and unemployment remains high. I know that with the purchase of my first home I've been an even more regular Costco shopper for all assortment of household needs, groceries and supplies.

Disclosure: I own shares in Costco (COST)

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Dividend Report: Shoppers Drug Mart (SC)

2009-09-28T12:00:00.006-04:00

I’ve been taking some time over the summer to update a number of my SA’s on many core holdings within my portfolios and came across the need to update Canadian drug store chain Shoppers Drug Mart (SC).

The return of the stock in my portfolio (excluding dividends) has been essentially flat for the past three years as questions on the economy, growth momentum and various other factors have limited the appreciation of the shares even considering the strong financial performance of the company in this environment. There are many demographic trends that currently benefit Shoppers and management has been keen to focus on reducing cost pressures to improve profitability.

But there’s a question that’s been nagging me as a dividend investor for the past 18 months; the fact that Shoppers hasn’t raised their dividend since February of 2007 when they raised it by 33%. There have been a lot of companies which haven’t raised their dividend due to uncertainty in the economy or their weak financial situation, but Shoppers is a company that has continued to thrive despite a weak economic environment. They have strategically placed locations that attract convenience-oriented consumers and even though their dispensing fees are higher than many competitors customers continue to fill prescriptions there for a variety of reasons.

the moneygardener stated loud and clear in a July post, “Shoppers Drug Mart should increase their dividend” and through my research over the past month I’m pretty confident that I’ve found the reason why they haven’t and might not until later in 2010.

Facts:

Prescription drug spending is a massive and fast growing healthcare expenditure that costs the healthcare system tens of billions per year.
According to the Canadian Institute for Health Information approximately 45% of drug costs in Canada are covered by provincial plans, 35% by private insurers and 17% by individual consumers.
The Canadian Association of Chain Drug Stores (CACDS) believes that as much as $11B will be saved by governments, private insurers and consumers as many popular drugs (Lipitor, Norvasc, Crestor, Plavix, Celebrex, Oxycontin, Exelon & Aricept) come off patent and can be purchased in generic form between now and 2014.
The Ontario government, due to the size of its ODB program (Ontario Drug Benefit) may receive savings of nearly $2B over the next five years from new generic drugs as Ontario regulations restrict the reimbursement of generics to 50% of the brand price.

In a public run healthcare system that costs billions per year to operate the incentive to save is clear. But understanding the pharmaceutical industry is an important step to understanding the new role of where governments want to be in relation to helping to set the pricing of drugs.

For years community pharmacies have received allowances from generic drug manufacturers that help to offset the costs of services not covered by government or private drug plans. Independent pharmacies traditionally lose money when dispensing brand name drugs because of higher costs so generic versions are often given to achieve a higher source of profit.

Bill 102, the Transparent Drug System for Patients Act, was passed in 2006 by the government of Ontario with the intention to attract savings to the healthcare system by using cheaper generic drugs when available. The bill allowed the government to negotiate prices of bulk purchases and allowed them to negotiate and accept lucrative rebates. Already a number of provinces have followed suit in an effort to cut costs despite that no public acknowledgement has been made by any government on the amount of money being saved.

The Impact:

The results from these events are straightforward and easy to understand. As provincial governments negotiate with drug companies for rebates previously allocated to independent pharmacies for the sale of drugs the same drug companies will no longer see the incentive to reimburse pharmacies for the sale of their drugs. This results in a direct loss of revenue and for many independent pharmacies a death sentence. The ability for these pharmacies to generate a profit from drug sales depended on the previous rebates and many (if not all) will be unable to make up the revenue loss to remain as a viable business. Communities will lose their independent pharmacies and larger chains will move in to pick up the market share.

That would appear to be a golden opportunity for chains such as Rexall Pharma Plus and Shoppers Drug Mart but the reality is that it’s a Catch-22 for both. For years the larger chains have also received these lucrative rebates from drug companies for offering specific drugs to consumers. Due to scale they will continue to earn a profit from dispensing medications, but it means millions in dollars of lost revenue that will instead move into the hands of the government.

I ran through the numbers on Shoppers Drug Mart in an attempt to determine the financial impact of the loss of these rebates. To say I was shocked would be an understatement.

In my most conservative estimate I determined that up to $180M in lost revenue could come from Shoppers Ontario operations alone and up to $300M lost nationally if the program was fully adopted by the remaining provinces due to the stronger presence of SC in Ontario and Quebec. If implemented by provincial governments I feel this would significantly impact the speed at which Shoppers expands westwards by eliminating a key source of revenue from operations that could only be recaptured through excessive cost cutting.

For confidentiality reasons I can’t publicly release the method or numbers of how I came to these results, but I can state that the generate equation I used came from a source within the pharmaceutical industry who has negotiated prices within the past year with these two large drug chains.

In my humble opinion this dark cloud hanging over the head of Shoppers management is the motivating factor for not increasing the dividend from its annual $0.86/share. I would lay a strong bet that Shoppers is aggressively lobbying the government in an attempt to negotiate a percentage of rebates from the pharmaceutical companies in an effort to preserve a portion of these profits. This is something I’ll be watching very closely and have highlighted in my Situational Analysis for SC. It won’t sway me to buy or sell, but likely I am content with my current holding of shares until a better sense of the financial impact of this develops.

Disclosure: I own shares in Shoppers Drug Mart (SC)

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Reliable Dividend Data

2009-09-04T06:00:00.001-04:00

In a recent E-mail Gary wrote,

“I have a problem getting reliable historical dividend data for Canadian dividend aristocrats and achievers. For example: Enbridge according to dividendinvestor.com has 9 years of consecutive div growth. When I check adviceforinvestors.com it shows only 4 years and dividend.com only gives the last 2 years. When I look at the charts of the US aristocrats it shows steady growth year after year. To select a sold blue chip US company that has increased dividends through thick and thin is easy; it’s just a matter of buying low. I am searching among the Canadian so-called aristocrats and getting conflicting dividend info. I know I could go to the Canadian company website and search for their historical dividend data; often it is hard to find and frequently incomplete. Do you know of a Canadian website that could help me with RELIABLE numbers?”

To first clarify for Gary:

Enbridge (ENB) has consecutively raised its dividend for 14 years at an average rate of 7.3% and cumulative raises since 1953 have averaged 10.1%.

Where did those numbers come from someone might ask?

As much as I’m a qualitative value investor focused on Enduring Value regular readers also know that I’m an individual who likes to focus on numbers. Past performance is no indication of future returns, but a strong quantitative history certainly places a company in high regard compared to an eager upstart.

When it comes to numbers, and I’ve stressed this point before in numerous posts, there’s really only one source that I look to for the best answers: financial statements. I can’t reinforce enough the importance for any investor who is interested in investing in individual equities to take the time and struggle through the most basic method of financial statement analysis. An introductory accounting text from your public library or a local community college will give an investor a very basic grasp of how financial ratios are calculated and what numbers are important to determine the financial health of a company.

The reason I always pull my numbers off the financial statements of companies I research or own is because all the information I need is right there and often I can save them in PDF to review at any time I wish. I track my own financial data on each company I own because I’ve found, through my own DIY journey, that far too many websites and resources have incorrect or contradicting data on companies. Where, when and how they get information from makes a big difference in the numbers they post. Numbers may not be updated for a year or more at a time and often the ratios they display use different methods of calculation.

The numbers on Enbridge (ENB) I posted earlier come directly from the 2008 annual report for the company and from an excel spreadsheet from the Situational Analysis that I keep on the company. This method works for me because I have access to a long standing history of financial numbers on the company that I can access whenever I want and I know they’re reputable because the numbers came directly from the company over a number of years. The effort I’ve taken in constructing these files is extensive, but so is my understanding of the companies I own. An investor can use third party research (investment websites) to give them a broad idea of a company’s financial health, but if an investor wants to conduct more thorough research or invest in that company I always recommend keeping and maintaining your own records. Another reason for considering accumulating your own information on CDN stocks is that very few websites provide the same extensive information found on US listed companies.

SEDAR is the site I use for researching Canadian companies and reading over Taking Stock in IGM Part II will help a reader navigate the site to reach an annual report, interim financial statements or other important documents.

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Where’s the Value?

2009-08-31T06:00:00.000-04:00

The summer of 2009 is drawing to a close and as a number of us return from holidays and vacations our attention can once again be directed towards the stock market, our investment portfolios and the prospects of investing over the remainder of the year.

The problem so far in 2009 is that despite a huge amount of volatility earlier in the year the rest has been...well...pretty dry. Stocks, corporate bonds and mutual funds have all appreciated off their lows and a lot of investors are scratching their heads wondering where the value is in this current environment.

When you look at most measures of quantitative value such as price to earnings (P/E), price to book (P/B) or dividend yield there are a lot of stocks that don’t appear cheap and the ones that are cheap are inexpensive for a very good reason; a poor investment.

It’s at times like this that I look towards my discipline of investing in Enduring Value for guidance of where to allocate my investment capital. As a value investor I am always conscious of the price I pay for any investment (the quantitative value) but Enduring Value focuses as much, and at times more, on the qualitative factors of a company. As I update my situational analyses on various companies as earnings are released I’m finding a number of companies I own are doing very well in key areas of value that I like to concentrate on.

The Spread

There’s a lot of focus right now on earnings and what companies are beating or missing their respective targets. Earnings are certainly important, but the EPS we’re seeing posted by many companies is of poor quality considering the economic landscape we’re in. Right now I’m not as concerned with earnings as I am with companies that are fiercely protecting their margins in the face of lower consumer demand and rising costs. Two companies, Costco (COST) and Coca-Cola (KO), have shown a longstanding commitment to not competing on price and they don’t sacrifice their margins in order to spur demand. Competing on price will rarely, if ever, move a company into a better position over the long-term and when the economy (domestically or globally) turns around a company wants strong margins to take advantage of. Cutting margins now is not the right move at this time and companies that have maintained or grown their gross margins and profit margins are maintaining their profitability in a very tough environment.

A Bigger Piece of the Pie

If margins are to be fiercely protected at this time then market share is the other side of the coin that companies must fight to protect and grow coming out of this recession. Enduring Value is a belief that in a recession the strong get stronger. With so much attention focused on the troubles in the US financial system our Canadian banks are taking their global competition to the cleaners; literally. Loan growth (consumer, business & government) has exploded over the past 8-12 months as businesses, investors and governments move their deposits, investments and activities to stronger financial institutions. Banks such as Bank of Nova Scotia (BNS), Royal Bank (RY) and TD Bank (TD) despite lower earnings have pulled massive amounts of business from their global competitors in anticipation of eventual increases in net interest margins. Taking additional loan loss provisions now is a small price to pay for the eventual reward of higher earnings as interest rates rise and traditional business growth booms.

How Can We Help You Today?

The core products and services that companies can offer their customers in this current environment help to determine the winners from the losers as the economy improves. When incomes are squeezed (corporate or consumer) customers will become increasingly targeted in their spending on products and services they want or require. This is not an environment where a company can be over diversified in the product portfolio or be offering services that aren’t in demand. Companies that can differentiate and focus their product/service portfolios to attract an increased amount of business from existing and new customers will benefit greatly. Companies such as Saputo (SAP), Becton Dickinson (BDX) and Thomson-Reuters (TRI) that focus on the essentials and necessities of their customers stand to grow their market share while maintaining attractive margins.

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July Update, 2009

2009-08-04T06:00:00.000-04:00

To say that I’ve been busy over the past month would be an understatement.

Markets:

Between hectic shifts at work, days off filled with landscaping/getting our new home in order and enjoying the first bit of good weather we’ve had here in South-western Ontario this summer I’m glad that the markets have been uneventful because to be quite honest, “this market stinks.”

The incredible buying opportunities that had me salivating from September to March seemed to have completely disappeared and the market appears to possess a split personality. I’m no technical analysis guru, but from my point of view we’ve hit a bit of a rut in the markets. The numbers of bulls and bears appears to have drawn even and everyone has an opinion on where the market will go next. I’ll add one more to the growing number of investors speculating on where we head next: nowhere.

The bottom line is this: stocks are no longer “cheap” by the standards I use when I examine the economic landscape and with unemployment (even as a lagging indicator) rising closer to 10% I don’t see a whole lot of reason for optimism going into 2010. I think the rest of this year and next will provide a range bound market until a more precise economic picture becomes clear.

The reason is pretty simple from my perspective. De-leveraging takes time and no amount of money thrown by governments will solve the problem in a hurry. Stimulus is one thing when there is obvious economic contraction but this contraction has been bigger than others and we need to put reality into perspective. I believe Canada is one of a few (if any) remaining countries who has not experienced a considerable decline in housing prices (and I’m not talking about 4-5%). Consumer debt levels remain high, incomes will not be rising to meet the higher demands of borrowing rates and high unemployment just paint a simple picture of grey for the optimistic economic guidance being given for 2010. That’s not to say that I don’t expect opportunities of value to present themselves; but the rosy economic picture being painted at this time doesn’t jive with the economic reality of a massive bubble of credit that burst when everyone knew for years that it simply wasn’t sustainable.

SAML:

I’ve decided to make a few changes to the Stock Analysis Mailing List (SAML) on the site for a few reasons. I still plan to offer the service to all existing free members, but I will no longer be offering a yearly subscription for a fee. I’ve had much more success selling individual analyses to date and holding myself to a minimum number of stocks to analyze didn’t make much sense if the demand wasn’t there. I still plan on publishing Taking Stock in Bank of Nova Scotia (BNS) before the end of September so I thank readers for being patient.

Vacation:

As many long time readers know August is a month of importance for me as I usually spend the majority of the month at the family cottage with my parents, siblings and our significant others. This year is no different and I will be away for likely the remainder of the month starting August 8th. I haven’t scheduled in any new or guest posts so feel free to email questions or comments and I will reply when I return.

I’ve promised Claire no Blackberry this year or internet although I will have my laptop with me as I plan to start writing the qualitative component of Taking Stock in Bank of Nova Scotia (BNS) and read/review a book by Sramana Mitra's titled, Bootstrapping: Weapon of Mass Reconstruction.

Portfolios:

Although July didn’t provide a lot of excitement in the equity markets I did do some rebalancing to my main portfolios to adjust for some aggressive buying I did earlier in the year. Taking profits at this point in the markets and re-investing those gains into lagging positions seems like a prudent and effective use of resources.

In my Dividend Growth Portfolio (DivG) I sold a portion of my holdings in Manulife Financial (MFC) and Royal Bank (RY) after they each grew to over 5.25% of the portfolio. 5.25% is the threshold I have for how large any individual position can grow to before I consider trimming it down. Ideally I like to keep all position within the portfolio between 3-5%. With the proceeds and numerous dividends I received from existing positions I added in small amounts to Canadian Pacific (CP), Shaw Communications (SJR.B), Thomson-Reuters (TRI), Metro (MRU.A) and Rogers Communications (RCI.B) to bring their weightings above 3%. Financials now only comprise 32% of the portfolio overall including all common equity and preferred shares I have in various banks, insurance and wealth management companies. Moving forward into August and September I’m looking to add to my positions in Empire (EMP.A) and Atco (ACO.X) and one other preferred share series to bring their allocations above 3.25%.

In my RSP I bought shares in Heinz (HNZ) and Kraft (KFT) and I’m currently waiting to add to my positions in TEVA Pharmaceuticals (TEVA), Proctor & Gamble (PG) and two ETF’s I hold (ADRE & VGK).

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Mortgage Rates are Rising

2009-07-28T08:00:00.002-04:00

In a post I made last month I made reference to an attractive 5 year fixed term mortgage
that I received from a peer of mine at TD Canada Trust with an interest rate of 3.64%.

That post generated a number of emails from readers and friends wondering what rate they could potentially receive on a 5 year fixed term mortgage and the merits of choosing a fixed over the historically better variable rate mortgage.

As I answered a recent email from a friend I took notice of the posted rates on TD's website for a 5 year fixed term; currently at 4.55%. That's a stark difference between their posted rate of 3.95% when I was shopping for a mortgage near the middle of May and works out to an increase of 0.60% or (60 basis points) over a period of only three months.

What made it more interesting for me was that there has been no change in interest rate policy from the BoC and no change in the posted rates for GIC's at the bank.

Now most of the time TD is able to discount their rates up to around 0.30% for preferred customers, but even then customers are looking at a 5 year fixed rate of 4.25% vs. the 3.64% I received. 4.25% is still a good rate on a historical basis, but the rise in posted rates at TD and other financial institutions is raising a few alarms for me. Rates moving 60 bps in only 90 days demonstrates to me a strong reaction from the banks to where they perceive interest rates moving over the next year.

The banks are still lending to customers, but the price has gone up considerably in such a short period of time with no change to interest rate policy or short-term investments. All investors know that interest rates have only one direction to go, but the speed and scale of these rate increases definitely should be something individuals who face a mortgage renewal in the next six months take note of and act accordingly to.

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Actively Trading Corporate Bonds

2009-07-20T10:00:00.001-04:00

An anonymous reader recently left the following comment on The Bond Guide – Investment Guide to Corporate Bonds

“Thanks for the great website and info on Canadian bonds. I’m a private investor, fed up with being wilfully kept in the dark about the genuine value of bonds.

From the link you provided to CBID I can now see my broker charges me something close to 2 basis points on bond purchases, which makes it very difficult to make capital gains when my bonds premium value goes up. I know you are probably not supposed to give advice but I was wondering what you think about private investors actively trading bonds (so buying investment grade at a discount and selling when the price goes premium)?

I ask because before reading all the great links you have provided I always thought of bonds as safe but rather boring as I believed one was always limited to the profit on the yields. I’ve noticed now that many bonds I have bought at discount are worth perhaps 7 or 8 basis points more now. I’m very tempted to sell those bonds with a nice capital gain, and just reinvest into other quality bonds at par or at a slight discount. Any comments would be appreciated.”

Writing The Bond Guide certainly opened my eyes to a lot of information and advice on corporate bonds that I hadn’t thought of or recognized before. One big issue for many retail investors is the premiums that brokerages charge for corporate bonds and the lack of availability of issues to investors. Certainly more transparency is needed and I’ve linked to articles on this blog in the past where regulators are looking into giving investors more transparency in fixed income products.

Corporate bonds and fixed income investments are different then equities, but certainly no investor can be faulted for selling an investment at any premium over their purchase price. We’re all invested to make money and even though bonds are often looked upon as long-term investments taking profits in the short-term because of advantageous valuations make complete sense. If you understand the risk when you invest then taking the reward becomes a very easy decision to make.

The difficulty with selling portions of your current fixed income portfolio at any point in time is replacing the issues you plan to sell with buying bonds of similar credit quality, interest rate risk and duration. There may be other corporate bonds that are currently trading at larger discounts, but those issues may be trading at those prices for specific reasons that may not appear at first glance.

One example would be if you’ve bought a bond from company ABC Incorporated and there is now another issue trading at a larger discount. With all risks being equal making a switch by selling your bond at a premium and buying another at a discount makes sense from a reward perspective. Why wouldn’t an investor lock in a gain and attempt to replace their investment with one of similar features and prospects?

The difficult task is when an investor looks to sell one bond and buy another from a different sector, different company or the bond has inherently different risks than what you previously held. The strategy that the anonymous reader is suggesting is similar to how many investors in preferred shares behave in the fall each year for tax-loss harvesting. By selling their preferred shares in one series to buy another series from the same company they often achieve a similar yield and end up crystallizing a capital loss against gains from other investments.

The choice between which bonds to sell and replace will depend on the individual investor, but certainly there is a strong case for protecting your gains by selling into strength and then re-investing into better prospects. I do this myself with individual equities and fixed income investments should be no different as long as an investor understands the costs and risk of their decisions.

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Protecting Investments from Inflation

2009-07-16T15:00:00.002-04:00

Today’s post comes courtesy of a question from The Personal Finance Clinic held by the moneygardener, Canadian Capitalist and Triaging My Way To Financial Success.

Vince writes,

My problem is as follows: I am an immigrant who has been in Canada for 6-7yrs and have no RRSP room to speak of, and can only count on a small CPP. All my savings and investments are in a non-registered account.

How do I protect myself against inflation? Do I buy short term bonds (XSB), real return bonds, or do I stay with common shares?

My allocation if I include property is about 60/40 FI/Equities.

Inflation is certainly a hot topic for many investors since every pundit in the media has an opinion of where inflation will appear and to what degree of severity with hyperinflation being a term that’s been thrown around far too loosely as governments attempt to stimulate economies.

Any conservative investor, regardless of risk or investment style, needs to concern themselves with inflation in all market conditions because inflation affects the real value of your investments. If your investment portfolio returned 4% after costs last year and the inflation rate was 2% your real return for the portfolio was only 2%. What an investor wants to do is achieve returns in their portfolio that outpace inflation over the long-term and provide them with equal or greater purchasing power in the future.

Investing for inflation is really not much different than wanting a raise each year that matches your increases in the cost of living. Essentially your portfolio should be giving you a raise each year in your income to offset the increasing prices of goods and services you use.

To answer Vince’s answer directly it’s not whether he should invest in only short-term bonds, real return bonds or common shares but how much of each to hold over the long-term.

Short-term bonds provide decent inflation protection at the expense of a much lower yield than a longer yielding bonds because you’re not taking on the same interest rate risk. Real return bonds maintain your investment from inflation and you only need to buy a weighting large enough for your desired allocation. Common shares, specifically ones that pay dividends, offer an investor a few advantages in terms of protecting against inflation. Companies that own/operate inflation sensitive assets such as real estate, commodities and infrastructure tend to fare better in valuation terms than other companies. Some dividends stocks pay a dividend and increase that dividend on a yearly basis above the annual rate of inflation then have already achieved your desired goal if the dividend continues to be paid regardless of the effect on share prices. Because dividends, for Canadians, are eligible for the Dividend Tax Credit in a non-registered portfolio the taxation of dividends is less than that of gains from interest (bonds & GIC’s) or from capital gains.

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ADT - Receive $200 Cash Back!

2009-07-13T06:00:00.005-04:00

As I mentioned in previous posts I purchased my first home in late June and have been busy moving, unpacking, fixing, updating and settling into the new digs during my days off. One condition of our move was my fiancées firm suggestion that I invest and have installed a security system in the home to protect ourselves, our possessions and home from theft, fire and flooding.

As a normally frugal (ok...I’m cheap) individual I wasn’t sold on installing a security system at first but I sat down and considered some of the pros and cons of the decision. Here is a quick list of some of the items I included in my table:

Pros:

I could save 10% on my home insurance with my current insurance company
When I work nights my fiancée sleeps worry-free
When I leave my home (for work, vacations, day trips, etc) I have the peace of mind that my possessions and home are protected
A home security system is a serious deterrent for burglars since an alarm attracts attention and silence is a burglars best friend
Available integrated CO (carbon monoxide) and smoke detectors as well as flood sensors in the basement
Battery backup for 24 hours in the event of a power failure

Cons:

Cost is roughly $37/month or $445/year (taxes included) for basic systems with most companies
No security system is foolproof or an absolute deterrent to theft
Good doors, windows and a well lit home can provide just as much deterrence
Fire, flooding and theft are rare occurrences in our current neighbourhood
Hassle of arming and disarming a security system when exiting and entering our home
Noise from an alarm arming and disarming on each exit and entry

For the most part the pros outweighed the cons when I took cost out of the equation. An $80 savings on my home insurance isn’t a substantial amount, but it helps and the alarm gives me a piece of mind when I’m away from the home whether the additional security is tangible or not. I took the time to research about a dozen alarm companies before I decided that ADT was the best fit for our needs. The company is considered by many to be very reliability in their monitoring, their system had the most user friendly equipment for our needs and the company provided some additional services that I was interested in. I also found in my research that ADT directly monitors our home themselves and does not use third party companies. The installation was about 5 hours for the size of the home we have and includes wireless features on all doors, windows and two keychain remotes. I was very impressed in how clean the system integrated into our home and the professionalism of all the staff I dealt with. I was even able to take advantage of a discount on the installation of the system that was better than the $99 special quoted on the ADT website (that I learnt only applies to a new hardwired system in your home). I’m sure many people have and enjoy hardwired systems, but wireless sensors made a lot more sense for me because I didn’t like the idea of wires running around every window and door. The $200 ADT mail-in cash discount on my a ADT system was hassle free and I actually received my discount upfront which was a great incentive instead of having to wait a few weeks for the delivery of a cheque in the mail. The code for the $200 ADT mail-in cash discount works anywhere in Canada or the US for home or business purposes and expires on September 30th, 2009. I did call the company and had them create a PDF file for the code that my readers can access 24/7 through Google Page Creator and I will be requesting they extend the discount beyond the current expiration date (I will update the PDF online prior to Sept 30th).
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The Competitive Analysis

2009-07-06T06:00:00.002-04:00

One of the most challenging areas that investors deal with when performing an analysis of a company is not with understanding the individual corporation but the competitive landscape in which it operates. Every company has competition and competition comes in a variety of forms. The importance for identifying competitors, industry trends and customer behaviour is the difference between becoming a reactive investor versus a proactive investor. If you are able to identify a trend before the market takes notice you can stand to better benefit from your investment decisions.

Today I’ll share some more insights into how I conduct a competitive analysis in my own stock analysis process.

From Taking Stock in IGM, Part I:

Whether big or small you want to take the time to see what the competition is doing and how that directly impacts the ability of the company you’re examining to operate and grow.

Frequently in this section of my analysis I’ll find a company or set of companies that are competitors to the stock I’m researching and any significant competitor immediately receives their own situational analysis. This is because any prospective competitor could either be a better investment prospect (after completing all the research) or a potential acquirer of the specific business I’m analyzing.

By creating a new SA on a competing company this helps to give me a broader perspective on the industry both domestically and globally. There have been numerous occasions where I thought one company was a market leader and attractive investment only to find out that a competitor traded at a cheaper valuation or had better long-term fundamentals. My own analysis of PepsiCo (PEP) prior to investing in Coca-Cola (KO) is one example of this situation where PEP’s product diversification actually hurts their profitability because it lowers their margins (both gross and profit).

A Competitive Analysis is an important tool for a number of reasons:

It assess the strengths and weaknesses of current or potential competitors
Allows an investor to put offensive and defensive strategies into context to assess opportunities and threats
Identifies competitive advantages/disadvantages within in industry/sector
Helps an investor understand the specific competitive advantages/disadvantages within an industry
Generates an understanding of where the industry has been, where it is presently situated and where the industry is going in the future.

Before you start a competitive analysis you want to make sure you have an adequate set of criteria for comparing companies in your selective categories. If you decided to compare management between two of more companies make sure you set an appropriate number of criteria that evaluates each corporations top leadership based on collective competencies, investors’ return on equity, years of previous/relevant work experience, education, percentage of ownership, accuracy with forecasting results and other important standards.

There’s a lot an investor can learn by focusing on the goals, mission statement and corporate culture of a business. If management is saying one thing and employees are saying another then an investor needs to scrutinize whether management has their fingers on the pulse of the business, are actively involved in the daily operations of the company and have shareholders best interests at heart. Simply stating a commitment to corporate culture or a mission of teamwork doesn’t cut it and actions always speak louder than words.

Assessing for a competitive gap is one of the more difficult or advanced items to a competitive analysis and not every investor will want to take the time to conduct this. Assessing for a competitive gap is looking at a company’s current or future products/services and determining whether demand from their intended target market (or another) will gain momentum after adoption in the product life cycle. Often new products and services don’t gain traction because they don’t adequately fill an underserved segment of consumer or business demand and rarely, in the case of Apple’s iPod product, there is a dramatic adoption by a market that grows into expanding global demand. Identifying these competitive gaps where a product/service exists for a company in the face of laggard competitiors takes a certain amount of skill and will also give you a much broader view of the industry and other prospective companies to invest in. If you choose to concentrate on a competitive gap you want to make sure that a product or service is scalable, distinctly unique, protected or is an experience or product that is easily replicated by its end consumer.

Some tips that I would suggest an investor use would be:

View each company in the competitive analysis as if you were a customer of the business: describe what you like, what other customers like, explain your experience(s), what you would improve/discard, etc.
Check the public filings: investigate public filings of the corporation and press releases by their media relations department to find out what they’re up to and currently pursuing.
Always assess for potential new competition: is there a company that offers a competing product/service cheaper, more effectively, faster or is there a competitive gap that is already served or underserved?

Remember that competition is fierce, unrelenting and sustainable for a company. A competitive advantage is rarely sustainable and a company may need to go to great financial lengths to protect their moat. Gaining a sense of exposure to competition is a vital component to a competitive analysis. An investor will also want to scrutinize:

Rivals within the industry
Customers
Suppliers
Product substitutes
Threat of new entrants

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Capital Losses in the Tax-Free Savings Account (TFSA)

2009-06-30T09:00:00.001-04:00

Today’s post comes courtesy of a question from The Personal Finance Clinic held by the moneygardener, Canadian Capitalist and Triaging My Way To Financial Success.

Stephan writes,

“My question is related to the TFSA. I am currently debating whether or not I should trade stocks within a TFSA or an un-registered account. I understand the benefits of having your ROE grow tax-free which is great. However, if I'm not mistaken, the TFSA doesn't allow you to claim your losses against your growth. Of course, I wish every trade was a winning one then the answer would be easy but that's not the case. I consider myself a swing trader so I do not normally hold long position except for a few ETFs. So the question is, is it worth it to trade within a TFSA?”

Stephan,

A TFSA (tax free savings account) is a relatively new savings option for Canadians and many investors are asking themselves this very question when trying to plan how to utilize various investment accounts such as registered savings plans (RSP’s), non-registered investments and a TFSA.

Capital gains are not taxed within the account, but on the other hand an investor is not able to capture capital losses like they are in a non-registered account. For a non-registered portfolio you can match a capital loss against a capital gain to cancel out any taxes paid on gains from a trade or investment. In a TFSA that privilege doesn’t apply so the question you really need to answer for yourself concerns risk.

Capital losses, when investing, are inevitable and every investor should realize this. Whether you lose money due to inflation, a decreasing price of an investment or fees there will always be many opportunities for you to lose a portion of your investment. What a conservative investor wants to do is minimize risk and exposure to losses within a TFSA and maximize the benefits that the TFSA offers.

My initial thoughts are that an investor wants to keep only conservative investments within the TFSA to avoid, as best as they can, any capital losses against that stock, bond, ETF or mutual fund since there’s no downside tax advantage for aggressive trading. This is where an indexed strategy (the couch potato) would perform very well. By investing in index ETF’s and mutual funds and rebalancing each year an investor is not concerning themselves with capital gains or losses but methodically applying a conservative strategy that moves gains from some funds to losses of another. Over time the portfolio grows tax free and your losses are kept to a minimum because you’re simply investing with the market.

If you do choose to invest in individual stocks within the TFSA I would encourage you to choose very conservative stocks that over the long-term have great investment prospects. Large cap companies in the insurance, telecom, utilities and energy industry might be good choices if you have the room in a few years to diversify your portfolio into 10-12 stocks. Until then I would advocate, as I have already, that a TFSA be used as a savings vehicle or for an indexed investment strategy.

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June Update, 2009

2009-06-24T10:00:00.000-04:00

June has been a hectic month both professionally and personally as a number of important changes took place in my life.

In June I bought my first house, came closer to the launch date for my new business, bought term life insurance for myself and Claire and had various wedding items to take care of that kept my attention away from the markets and left my portfolios running on autopilot very effectively. June also saw a very important milestone for myself and Triaging My Way To Financial Success.

Readers might have noticed that today the RSS feed count on the right side margin hit 300 for the very first time on this site; an accomplishment I am both proud and humbled by. When I launched this site over two years ago and re-launched the revamped template last summer I didn’t envision the following this website would create with readers from all around the world. For 300 people to commit to reading my content on a regular basis means a lot and I know that there are more who visit the site on a regular basis who don’t subscribe. A big thank you goes out to everyone who has helped support this endeavour.

I’ve also decided to launch TMWTFS on Twitter to help keep readers up to date on my investment related activities with regards to what stocks I’m analyzing, what investment articles I’m reading or other related content.

I also want to take a moment to toot the horn of some important people who’ve helped me this month:

I first want to thank Adrian Ionescu. Adrian is a Financial Services Representative for TD Canada Trust at the Wonderland Road branch in London Ontario that I frequent on a regular basis. Adrian was able to secure a 5 year fixed term mortgage for my first home at the best rate I could find in Canada, 3.64%, which was over 3% better than any rate I was quoted for from a mortgage broker. On a professional basis I respect Adrian very much and highly recommend him for anyone looking for banking, investment or mortgage related services. If anyone is interested in Adrian’s contact information please feel free to E-mail me.

Next I want to extend a big thanks to Glenn Cooke who is an independent insurance broker and owner of Insurance Squared Inc. Glenn was able to quote a very attractive rate for a 20 year term life insurance policy for both myself and Claire. Glenn is licensed to sell insurance in Canada in the provinces of Alberta, B.C., Manitoba, Ontario, P.E.I. and Saskatchewan and is another individual who I respect on a professional basis for his attention to detail, sincerity in recommending products based on each client’s needs and a disclosure of any conflicts of interest in the process of selling insurance. I found his services to be invaluable when comparing insurance products to cover the needs of my family in the future. Glenn can be reached at sales@insurancesquared.com and will be happy to provide any reader with a no obligation quote on a life insurance policy.

Triaging My Way To Financial Success was also mentioned in two articles this month published on the web at Million Dollar Journey and independentinvestor.info. The article posted by Frugal Trader on MDJ was an interview with an investor named John who retired at the age of 31 and talks about his process to achieving financial freedom. Among John’s most read list of financial blogs appeared TMWTFS.

My only two stock transactions to disclose to readers for the month of June was to double my equity position in Baxter International (BAX) at $47.80 and add to my position in Shoppers Drug Mart (SC) at $44.00.

Disclosure: I was not compensated for any referrals or recommendations in this post. I have a financial position in TD Bank (TD).

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ETF Investment Strategy & Board Lots

2009-06-22T06:00:00.000-04:00

Today’s post comes courtesy of a question from The Personal Finance Clinic held by the moneygardener, Canadian Capitalist and Triaging My Way To Financial Success.

Karen writes,

"The gist of my question: Does the concept of board lots apply in trading ETFs and why or why not?

I chose early 2008 to take direct control of my RSP portfolio and move it from a mutual fund company and separate GICs to a single TD online trading account. It turned out to have been a crazy year to implement that decision but I probably rode the losses with less stress than if I had still been wondering whether anyone was paying attention to my money. I knew that I was satisfied with my decisions long-term. My plan was to convert the portfolio from funds and GICs to ETFs. I am retired (early) with a pension and I’m no longer contributing to the RSP but not drawing income from it either. The trades to accomplish the switch had to be done within that closed system of the RSP account.

There was a learning curve but I found the niggling detail practicalities hardest to find information on. Portfolio strategy was the easy part. I set an asset allocation target and then planned sales of the mutual funds one or two at a time to fund purchases of the selected ETFs in quantities of no less than 100 units. I wanted to convert the modest portfolio (about $100,000.) with the fewest possible trades. Where I couldn’t free up enough money for my targets by selling a fund, I “parked” the partial amounts in TD funds which didn’t generate a purchase trading fee. (I still hold two of these waiting for several GICs to mature over the next two years.)

My plan is to hold about 8 ETF’s – perhaps more than I need for portfolio purposes but enough to keep me interested in reading the business section and paying the attention to my investments that I should have been doing long since.

As I continue the switch to ETFs or look at future rebalancing, should I be concerned at all over the number of units of an ETF that I hold (apart from the trading fees)? Do you have any other tips or advice on implementing the trades to convert a portfolio from funds to ETFs?"

Karen,

A board lot is usually a standard number of shares an exchange (TSX, NASDAQ, NYSE, etc) defines as a trading unit. For most equities and ETF’s that trade over $1.00 a lot is a minimum of 100 shares. The reasoning for advocating for a minimum standard number of shares is to improve liquidity and minimize the volatility in spreads (difference between ask and bid prices).

An odd lot is simply any number of shares below the standard board lot. Some brokerages do charge an additional fee for odd lot transactions, but in my experience with TDW I buy a lot of odd lots and have never been charged a penny more than needed. Often an odd lot can get you a better price than a regular limit order can because the odd lot is bundled with others to create a board lot. This difference can be only a few cents, but on 90 shares or so you can save yourself approximately $1.00-$4.00.

Your ETF strategy sounds like it has its roots in the couch potato portfolio strategy which includes, in the global strategy, four ETF’s. Eight is likely an adequate number if you want to diversify a little more, but the key component to follow that you’ve touched on is the rebalancing. This strategy is meant to be a very passive investment approach where regular contributions are made regardless of market actions and rebalancing moves profits from one area to build a stronger position in another. Over time this strategy has proven to be very beneficial to an investor with discipline and the ability to execute trades without emotion.

The only suggestion I would make initially is that you ensure your transaction costs (commission) are less than 1.5% of your purchase. If your trading fees are $20/trade then you want to ensure the amount you’re purchasing/selling is more than $1350. Ideally you want to keep your transaction costs (as a % of your trade) below 1% but setting a threshold is an important decision to help you limit your trading and executing on strategy. Obviously if you have a portfolio over $200,000 and you’re making a rebalance each year of $5,000 your transaction cost is only 0.4% but the principle I’m trying to outline still stands.

Your decision to implement the plan over time as your GIC’s mature will also help to build the necessary discipline to implement this strategy effectively over time. Many investors allow their emotions or impatience to win out and setting a plan will often yield higher returns than rushing into something you’re not fully prepared to initiate.

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Mailbag: TD Canadian Bond Index Fund (TDB909)

2009-06-17T10:30:00.000-04:00

Recently in the comments of The Bond Guide – Investment Guide to Corporate Bonds

Jordan wrote,

“Thanks for the great information. I have one question. I have owned the TD Bond Index Fund (TDB909) for a number of years. During that time, the fund is always close to book value. I would have thought that, as interest rates have fallen over the past months (many months) that the market value of the fund would have increased. Nobody has been able to explain this to me and I am starting to wonder why I don't sell them and purchase corporate bonds directly. I would appreciate any information.”

Jordan has a few concerns that deal with more than one question related to the TD Canadian Bond Index Fund (TDB909).

For readers not familiar with TD Bank’s index funds they are a series of low cost no-load mutual funds that track specific indices that can be purchased and sold through most investment advisors and there is an E-series of the funds available only through TD at a lower cost.

These funds include:

Canadian Equities (TSX)
TD Canadian Index - I: MER: 0.84%
TD Canadian Index - E: MER: 0.31%

US Equities (S&P500)
TD US Index - I: MER: 0.53%
TD US Index - E: MER: 0.33%

Canadian Bonds (TSX DEX Universe Bond)
TD Canadian Bond Index - I: MER: 0.79%
TD Canadian Bond Index - E: MER: 0.48%

International Equities (MSCI EAFE)
TD International Index - I: MER: 1.31%
TD International Index - E: MER: 0.48%

* Currency Hedged versions of both US and International funds are also available

The fund Jordan is referring to is TDB909 or the TD Canadian Bond Index-E fund which has an MER of 0.48% and is one of the most affordable methods of gaining access to a broad collection of high quality bonds for an investor seeking to invest in the fixed income allocation of their portfolio.

TDB909 is a very conservatively run bond fund focused on achieving monthly income for its holders and has traditionally paid out all distributions as interest with minimal capital gains. The fund is intended to target conservative investors looking to preserve their capital while achieving a modest return in the form of income. Investing in TDB909 and investing in individual corporate bonds are at two different spectrums of risk and investing in one or the other depends on risk tolerance.

When you look at the holdings of TDB909 you get a very clear picture of the fund and how it’s organized for investors. The fund has 50% of its assets in 1-5 year bonds, 18.5% in 5-10 year bonds and 30.4% in 10-20+ year bonds which means the fund is heavily weighted to longer term interest rates. We’ve seen a lot of movement in short-term interest rates, but not a substantial move in longer term rates and this is likely why you haven’t seen a massive price jump in the valuation of the mutual fund units. 50% in short-term bonds is substantial, but the fund is balanced enough to not move in one direction or another in any significant way to protect investors from interest rate risks.

When you examine the funds’ Top 25 holdings (36.4% of the portfolio) you quickly see that it’s dominated by government and Canadian Housing Trust bonds. Overall 46.7% of the fund is placed in Federal bonds, 27.3% in Provincial bonds and only 27.3% in investment grade corporate bonds. As James Hymas commented in The Bond Guide there is a trade-off on premium any investor takes for safety when investing in government bonds that can decrease the yield you receive for less risk and increased liquidity.

The performance of TDB909 over the past year has been pretty good considering the volatility in both interest rates and the markets since the credit crisis peaked. From August 2008 to May 2009 the fund was up approximately 3.9% (not including distributions) which matches its mandate of conservative management of fixed income assets. The fund has also handily outperformed the Canadian Fixed Income Peer Index over that same time period.

Bond funds trade close to book value because of the nature of how bonds are valued. For any specific company there is an intrinsic value based on assets and operations. A bond has a value based on credit quality and interest rates. Comparing the two different assets on their increases in book value isn’t an apple to apples comparison.

Corporate bonds certainly have the potential of achieving higher returns than very conservative government bonds, but there are proportionally higher risks an investor takes (company, credit, liquidity, interest, etc) that I spoke to in The Bond Guide that you are exposed to at a greater degree when you invest in individual corporate bonds.

Whether to sell your TBD909 holding and invest into individual corporate bonds for higher returns is a risk vs. reward question that I can’t answer for Jordan. His/her decision isn’t a simple one and understanding the risks taken with individual bonds should be seriously considered.

A corporate bond ETF (XCB) is one option for Jordan who is looking to gain passive exposure to corporate bonds without taking on all of the risk associated with choosing individual bonds.

Disclosure: I own units of TDB909 at the time of this post.

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Stock Tickers & Dividends

2009-06-15T06:00:00.000-04:00

Today’s post comes courtesy of a question from The Personal Finance Clinic held by the moneygardener, Canadian Capitalist and Triaging My Way To Financial Success.

Mark writes,

“I would like to see a lesson that explains how to use a basic stock ticker. For example, a step by step breakdown of what each of these terms and numbers mean (http://www.google.com/finance?q=ge).
I would like a simple lesson on how dividends work and how to search for funds/stocks based on dividends.”

Stock Tickers:

For a new investor looking at a finance website that displays stock information can be very overwhelming. For this exercise I’ll explain the information displayed within the red box of this image I’ve taken from Google Finance for GE on June 11th before the markets opened.

General Electric Company trades on the NYSE under the symbol “GE” or what is known as its “ticker”.

The price, $13.40, is the previous day’s close and beneath for most large US companies you’ll see a “pre-market” price that indicates where the stock intends to trade at the market open based on company information and investor activity during inactive periods of the market.

“Open” indicates the first price a share is traded at when the markets open on any given day. If GE announced an increase in profit of 50% this number might jump considerably above the previous day’s close or move in a negative direction for bad news.
“High” indicates the highest price a group of GE shares has been bought and sold at during the current market day.

“Low” indicates the lowest price a group of GE shares has been bought and sold at during the current market day.

“Volume” indicates the total number of shares that have changed hands (either bought or sold) from the market open. For Google Finance this number is displayed as million/day.

“Mkt Cap” stands for market capitalization and is the total value of all publicly traded common shares of the company. To achieve this number you take the total number of outstanding shares (10.59B) and multiply it by the market price ($13.40) to get $141.90B.

“52Wk High” & “52Wk Low” indicate the highest and lowest prices the shares have achieved in any 52 week period (1 year).

“Avg Vol” indicates the average volume (number of shares bought or sold) on any given day. If the volume for June 11th was 500.0M versus the average volume of 93.35M there may be a reason for the increased activity in buying and selling of shares (either good or bad).

“P/E” indicates the price to earnings ratio of the company based on trailing earnings for the past four quarters (1 year). You get this number by dividing the price ($13.40) by earnings per share (EPS: $1.62) to get 8.29.

“F P/E” indicates the forward price to earnings ratio of the company based on anticipated earnings of the company in the future.

“Beta” indicates the beta co-efficient of the shares and demonstrates how correlated the company is to the overall stock market. The market, in general, has a beta of 1.0 and individual stocks will have numbers above or below 1.0. Higher beta stocks (in either direction) tend to have more price volatility (higher degrees of price movements) than the overall market. If the market moves 3% in any direction an investor can expect GE shares to move 4.86% in that same direction.

“EPS” indicates the earnings per share (profit per share) that the company has achieved in the past four quarters (1 year). This number can fluctuate considerably depending on the volatility in quarterly earnings a company experiences.

“Dividend” indicates the yearly dividend (to determine quarterly divide by four) that the company pays out to investors holding common shares.

“Yield” indicates what percentage of the current price ($13.40) is paid to an investor as a dividend.

“Shares” indicates the total number of outstanding shares held by all investors (institutional, individual, etc).

Dividends:

Dividends are payments made by any company (public or private) to shareholders of common or preferred stock. A dividend is essentially an incentive for a company to retain investors by returning a portion of profits back to investors. Profit can be used to re-invest back into a business but many investors look to dividends as an essential component of investing as cash returned to an investor is tangible and companies realize that paying investors for the use of their capital helps to support a strong capital base for operations.

Some governments, such as Canada, offer tax incentives (dividend tax credit) that tax dividends at rates below income taxes providing a further incentive for investors to receive dividends.

Screening for dividends can be done easily in a few ways. For US based stocks Google offers a stock screener that an investor can use to track down companies based solely on their dividend yield. If I wanted to set a threshold (absolute minimum yield) at 3% I can set the screen to a minimum 3% and look at the 759 companies that pay a dividend of 3% or more on all exchanges or specifics such as the NYSE, NASDAQ or AMEX.

For Canadian based stocks globeinvestor offers a stock screener that works essentially the same. You enter the information on yield that you’re searching for and filter through the stocks selected for other criteria.

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Retirement Income Question:

2009-06-09T08:00:00.001-04:00

Today’s post comes courtesy of a question from The Personal Finance Clinic held by the moneygardener, Canadian Capitalist and Triaging My Way To Financial Success.

Don writes,

“I am a recently retired 72 year old living on income from a commercial mortgage that has paid 6% for four years. It is up for renewal this September and I am wondering if I should agree to renew or ask for payout and find an investment advisor or broker to try to at least match this income. I am only moderately experienced with investing so would not try to do it myself. I assume the mortgage could be renewed for at least 6%.”

This is a situation I think many retirees find themselves in when searching for income from any investment and the answer to your question depends on a few important decisions. The two most important questions you want to ask yourself are “What amount of risk am I willing to take for the income I need?” and “What alternatives do I have to maintain my income?”

A commercial property that is worth $1,000,000 and pays out 6% through a lease or mortgage could provide you with a pre-tax income of $60,000 per year. If the property is paid off (you own it), you have little in the way of maintenance or management and the property is of very high quality than continuing with leasing the property for 6% could be very desirable for your lifestyle. If you’re lending the mortgage to an individual or company than determining the financial strength of the individual paying the mortgage is very important in this economic climate and I would consider looking at their operations very seriously.

The difficulty I’ll convey to you is choosing between a single investment (your current commercial property/mortgage) and a diversified mix of investments through a financial advisor. A diversified portfolio of income paying stocks, income trusts and bonds would reduce your non-systemic risk (the risk of any single investment) versus what you currently have for income. If you were to hold onto your real estate property as your single investment than your portfolio would be directly exposed to the real estate market; whether it went up, down or sideways or directly exposed to the person you've lent the mortgage to. Your potential for capital appreciation is limited to that single investment and the property may require maintenance to maintain it in the future reducing your net gains or the lender may fail to pay and be foreclosed upon bringing legal fees with it.

In contrast a diversified portfolio through an advisor may expose you to higher fees and achieving a balanced 6% may be more difficult depending on your asset allocation. In an environment where safe government bonds and GIC’s pay very little interest corporate bonds do pay in excess of 5-6% but you’re taking on more risk than you may want for your age. At a 70/30 split between bonds and equity you’re still very exposed to the stock market which while showing strength recently isn’t a sure bet for significant future gains or safe income payments via dividends.

The other dilemma you want to consider is the potential for the mortgage to be renewed at a significantly lower interest rate. If the mortgage was renewed at 4% how would that impact your current income and decision to invest in a diversified portfolio since you mentioned in your question that you are living on the income from this property?

This is a situation where I think you would benefit from sitting down on your own (or with family) and discussing the pros and cons to each option. I would still recommend you seek financial advice from a reputable professional, but keep in mind what fits best for you for your risk tolerance, time and peace of mind.

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The Ultimate DRIP-folio

2009-06-05T06:00:00.001-04:00

There’s been a lot of action in the DRIP (dividend re-investment plan) environment recently with a large number of companies rushing to offer DRIP plans to investors and/or promote their DRIP plans with attractive discounts as conserving cash becomes vital.

In one example Canadian banks such as Royal Bank (RY), Bank of Montreal (BMO) and TD Bank (TD) have recently updated or initiated DRIP plans for their investors and an every growing number of Canadian dividend stock paying companies are following suit.

I want, with the help of readers and investors, to create The Ultimate DRIP-folio; a diversified portfolio of stocks that have eligible DRIPs. This portfolio could be the standard among all investors interested in constructing a portfolio that takes advantage of DRIPs and compounding returns over the long-term.

If you’re interested in participating submit in the comments section your top five CDN eligible DRIP stocks, with the details (discount, DRIP or SPP, etc), and I will compile a list and publish it on my site for future discussion of which stocks to include in The Ultimate DRIP-folio and why.

Here’s a list to get readers started:

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Where To Put My Retirement Investments:

2009-06-01T06:00:00.003-04:00

Thanks to everyone who participated in The Personal Finance Clinic during the month of May. We received a total of 27 questions that myself, the moneygardener and Canadian Capitalist will be answering over the next while.

Today’s question comes from Adam,

“I'd like to see a step-by-step on where to put my investments. Should I first max out RRSPs, then put it in the TFSA and if anything is left over (probably not) use a non-registered account? Do you have a ‘put your investments here’ guide as to where to place certain investments? I'm primarily a dividend income investor sprinkled with some index funds. I assume I should have all these in my RRSP until maxed and the put the remaining div. producing stocks in a non-registered. Is there ever a time where I should put div stocks outside of an RRSP even if I have contribution room?”

First Adam I’ll point you towards a post I wrote in April titled, Determining a Master Portfolio Allocation, which outlines my experience with developing a plan for investing, as a Canadian investor, in a Registered Savings Plan (RSP), Non-Registered Portfolio and Tax Free Savings Account (TFSA).

The first question you need to answer about maxing out your RRSP’s is what marginal tax rate your income is currently taxed at. If you make over $65,000 per year in 2009 and live in Ontario your marginal tax rate on income will be 32.98%. If you contribute the maximum amount you’re allowed, 18% of your 2008 annual income or $21,000.00, you can expect to receive a return from an RSP investment of approximately 32.98%. The benefit of contributing to a RSP is that your contributions are eligible for a tax rebate at your marginal tax rate, all gains are compounded on a tax deferred basis and US based dividends are exempt from withholding tax.

The main drawback, in your situation, is that any Canadian dividends you receive aren’t eligible for the dividend tax credit within a RSP. If you held all your Canadian dividends outside your RSP in a non-registered account you would only pay 7.45% tax on those dividends when making $65,000 versus 32.98% for ordinary income. This is a situation where even if you have contribution room you may want to consider holding Canadian dividend paying stocks outside your RSP or TFSA depending on your income. A great tool to use for calculating the various tax rates on your income is a calculator provided at Walter Harder & Associates. Building a non-registered portfolio of dividend paying stocks is one method I currently use in order to create a tax-efficient income stream for retirement that will hopefully outpace inflation.

Another consideration is if you currently contribute to a pension or will have pension income when you retire at age 65. If you have a pension at retirement you want to be cautious of contributing too much to your RSP early on as I’ve outlined in the post I linked to earlier. At age 71 you are required to convert your RSP into a Registered Retirement Income Fund (RRIF) that the government forces minimum withdrawals upon. If you’re an individual with a pension income of $35,000 and an RSP of $500,000 at age 71 when you convert to a RRIF you would be required to pull out $36,900 from your RRIF. That would bring your total taxable income to $71,900 and a marginal tax rate of 32.98%. The goal, for any investor building a RSP, is to contribute to a RSP when your marginal tax rate is high and pull from the RSP during retirement when your marginal tax rate is low.

I’m a strong proponent of developing a balance between RSP’s, a TFSA and non-registered portfolio depending on your situation. I will have a defined benefit plan (DBP) at retirement for the pension I currently contribute to and as I’ve shared in Determining a Master Portfolio Allocation I don’t intend to have too much money in any one account for reasons of taxation at age 71. Achieving both a balance and flexibility in my taxable income during retirement is one goal that I take seriously in my financial planning.

What I suggest any investor do is carefully consider your personal financial situation at this moment and your financial situation at retirement. Contributing to an RSP without any pension is a great way to build up savings for retirement, but the new TFSA will start to play a key role in future years as an effective savings vehicle and the opportunity for the Canadian dividend tax credit in a non-registered portfolio is something you will want to consider. What works best for you will depend on your unique situation and seeking professional advice to get you started may be a good option.

Adam: Take your time to consider all your alternatives and don’t be afraid to think independently and outside the box in order to find the right solution. If you have further questions please feel free to comment at the end of this post of contact me and I will follow up with another post answering your questions.

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