Wednesday, November 13, 2013

Money Show 2013 - Norm Rothery

Norm Rothery is the founder of and publisher of The Rothery Report. His talk was entitled "Balance, Dividends and Value".

What is going on with US banks? Citi still has problems and is still owned by the government. J.P. Morgan is being fined. Worldwide banks are having problems (US, EU and elsewhere). What is happening to their customer base? They have all-time record cash with the Fed because having more cash is more effective than lending. They are sitting on cash and are not loaning it out. Banks are currently in strife now as are their customers in strife.

We had this problem before in the 1970's and 1980's. Inflation was in the double digits and banks were not lending. The US government past legislation so non-banks could loan out money. From the 1980's to now these companies formed an interesting part of the market place and are taking advantage of the current situation.

There is better banking by companies like Hercules Technology Growth Capital Inc. (NYSE-HTGC). It is a specialty finance company investing in technology, biotechnology, life science, and clean-technology industries at all stages of development. They not only lend money, but buy into companies. When a firm comes to market, they get their loans repaid and cash in their stock. Companies they invested in where Google and Facebook. They provide counseling to companies and they also advance their clients causes with the government.

Forget about fracking. We have seen benefits of fracking to get oil and gas. There is also environmental damage, whether or not it has been proven. These companies are taking on additional liabilities. What can go wrong? Paying high dividends and threaten by future liabilities these companies can have problems going forward.

There are alternatives to fracking. Fracking goes back to the 1940's, but it has only been popular lately. You should look at Kinder Morgan Energy Partners LP (NYSE-KMP). This stock has a yield of 6.5% and their oil extraction method could get much more oil than from fracking.

It is called EOR (Enhanced Oil Recovery). It is injecting carbon-dioxide or CO² into shale. The CO² lubricates the oil to come out. Problem is that they get lots of water with the oil. At first they could not separate the oil and water. Now they have a process to separate the oil and water and this processing is starting to get deployed.

How do you get CO²? Kinder Morgan is effectively in the pipeline business. They have rights to fields that produce CO² and are shipping it to Texas. Now they are partnering with companies that produce CO², such as refining companies, power generation companies that are creating lots of CO². These companies now must capture CO² and they can sell it to Kinder Morgan. This will be better than fracking.

The train wreck in Lac-Megantic was hell on earth with the crude oil fire. There are not enough pipelines in North America. There are pipelines to take oil from ports inland. Trains are much more expensive than pipelines, but if you can get a higher price for oil it can become viable to use railways. If a train that is carrying oil leaves the track, it will explode.

Enbridge Inc. (TSX-ENB, NYSE-ENB) owns 50% of Seaway pipeline. It got approval to turn pipeline's direction. It also has a right of way to build a pipeline beside the old one.

You can see Williston, North Dakota from satellites because it is so bright. It is illuminated because it is burning off natural gas. It is cheaper to burn it away than transport it away. If Cheniere Energy Partners LP (AM-CQO.A) could export it to the EU or Mexico, they could make money. However, it is illegal in the US to sell gas abroad. The government has now given a company a permit to export natural gas. This company is Teekay Shipping, part of Teekay Corporation (NYSE-TK) and this company can now ship gas.

Mutual Funds are a drain. Mutual Funds charge fees of 0 to 3%. All things being equal go with the lowest fees. Capital gains are taxed. For a $50 gain, the tax would be around 23% or just above $20. This is comparable to 2 to 2.5% mutual fees. Investors should take advantage of RRSPs and TFSAs.

Mutual Fund investors have terrible timing. The 10 year average returns for investing in different mutual funds are show below. The first column shows what the return on the fund was. The second column shows what the investors in these funds actually made. It has been documented many times that investors in mutual funds make less than the funds they invest in.

Fund Fund's Return Investor's Return Difference
US Equity 1.59% 0.22% -1.37%
International Equity 3.15% 2.64% -0.51%
All Funds 3.18% 1.68% -1.50%
Balanced 2.74% 3.36% 0.62%

Why did balanced funds do better? Investors tended to buy high and sell low in the more volatile funds. The timing effect was lower in the balanced fund. What investors should do is keep fees low, keep taxes low and manage timing. This will minimize regret. We are better off with one Balanced Fund. Humans hate loss twice more than they like gains.

If you are opting for a Balanced Fund, here are some

Fund Fee Bond/Stock Management
Mawer CDN Balance .98% 40/60 Active
Mawer CDN T.E. Bal. .99% 40/60 Active
PH&N Balanced .90% 40/60 Active
Steadyhand Founder .69 - 1.64% 40/60 Active
TD Balance Index .89 50/50 Index

You might be better off for the bond part of your investments to be in a GIC account or for you to buy bonds. For the stock portion of your investing, buy a stock index fund. You might be tempted to do dividend investing to growth your income via dividends. The advantage would be a steady income, a likely return boost, there are potential tax advantages and you can apply withdrawal discipline. You could earn 4% in dividends.

The things to watch for are very high dividends (often a sign of distress), foreign dividend taxes, high fee funds, dividend cuts (as dividends are not guaranteed) and the Canadian dividend advantage. If you look at the TSX from 1977 to 2013, the stocks that outperformed the market are high yield stocks. They outperformed the TSX. Low yield stocks tended to perform lower than the TSX index and no yield stocks were the lowest performers. (Franklin Templeton has a bulletin on the case for dividend paying equities in today's market that illustrate this point.)

In the US market, the high yield dividend stocks performed the best, with the highest yield stocks the 2nd worse performer. The stocks with no yield were the worst performers. Stocks with medium and low yields did fine. The stocks with the lowest yields did 3rd worst.

You can buy dividend Exchange Traded Funds. Examples are iShare TSX Canadian Aristocrats (TSX-CDZ) with fees of .66% and Vanguard FTSE CDN High Dividend Yield (TSX-VDY) with fees of .35%. For US stocks you can get Vanguard High Dividend E.T.F. (NYSEZ-VYM) with a .10% fee and Vanguard Dividend Appr. E.T.F. (NYSE-VIG) with a .10% fee. You can get Canadian version of the American ETFs called Vanguard US Div. Appr. ETF Cad (TSX-VGH) and Vanguard US Div. Apprecia. ETF (TSX-VGG). Both the Canadian versions have fees of .35%. In the past, Vanguard has lowered its fees in the US.

A simple method of dividend stock selection is to use the Dogs of the TSX. Start with the 60 largest TSX stocks in the TSX60 Index. Buy the 10 with the highest yield. By this method you would get individual dividend stocks that have positive average yields, dividend growth, financial growth and earnings growth that will growth dividends.

The negative factors for the Dogs of the TSX are that stocks with extra ordinarily high yields can be derivative products. Stocks with negative momentum, that is stocks that have recently gone down a lot tend to continue to move down. You need to look for value by buying stocks with a margin of safety.

The Advantages of the Dogs of the TSX are that you get potentially high returns, they often are less volatile and it is a simple valuation method. Things to watch for are the fact that Canadian stocks can be hard to follow and you might be forced to sell them.

Stocks with low P/E Ratios tend to outperform the market while stocks with high P/E Ratios tend to underperform the market. Stocks with low P/B Ratios tend to outperform the market and stocks with high P/B Ratios tend to underperform the market. The best stocks, of course, have low P/E Ratios and low P/B Ratios. The best stocks would have low positive P/E Ratio, P/B Ratio, P/S Ratio and P/CF Ratio.

You want to look for companies with financial strength, that have dividends with dividend growth and that have low liquidity or are small neglected stocks. (Liquidity here refers to how liquid the market is for a stock, that is how often it trades and volume of its trades.) Warning signs for companies are negative momentum, value traps and Vampire Squid management (that is too many managers).

For the US market, the P/E rating is rather high so very low return is expected from stocks at the moment. For the US Bond Market, we are at the lowest point in history since 1880. However, interest rates were also quite low in the 1940's and 1950's.

A copy of Norm Rothery's slides are available here. ? You can subscribe to the Rothery Report.

This blog is meant for educational purposes only, and is not to provide investment advice. Before making any investment decision, you should always do your own research or consult an investment professional. See my site for an index to these blog entries and for stocks followed. Follow me on Twitter.

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