14 Year Track Record

 

Sacola                   176%

TSX                         76%

DJIA                        136%

S&P 500                  137%

Past trades total 29 wins and 3 losses with an average gain of 34%. The average holding period was 2.3 years.

Wednesday
Sep042013

EBITDA-One of Wall Streets Greatest Gags

               Bay Street must be getting desperate for business as  they have returned to issuing buy recommendations based on EBITDA (earnings before interest charges, taxes, depreciation and amortization).  This makes corporate earnings appear better than they actually are by taking profit or loss and adding back interest charges, taxes, depreciation and amortization.  EBITDA is a dangerous measure to rely on because it can make a money-losing company look profitable.  Specifically, since very few companies have zero debt, the ability to pay interest charges is a necessity and without doing so the company goes bankrupt. 

                More importantly, there is not one company that Revenue Canada (RC) has told not to worry about paying taxes.  In fact, all taxes owed must be paid before wages, debt charges, and suppliers.  Failure to do so will equate to interest charges on taxes owed and on any penalties imposed.  Plus there is a chance the bosses could get a trip to jail. 

                To base a company’s future on EBITDA is a waste of time.  We strongly suggest you avoid all buy recommendations based on this metric because management and brokerage houses are trying to make the company look better than it actually is.  More importantly, EBITDA does not conform to generally accepted accounting principles (GAAP), the industry standard for financial reporting. 

                Both Bay Street and Wall Street love to dream up special definitions to make themselves more money at the investor’s expense.  We will give the real meaning of some of a brokerage firm’s lingo and practices. 

SELL:     This term is only used when there is no possibility of hiding that the company is in completely dire straits and recommending the stock becomes a liability

NEUTRAL/HOLD:           This either means hold the security or sell everything.  This interpretation is up to the investor.

 BUY:      This recommendation can mean that it is a quality company.  However, on far more occasions than investors realize, it will mean that management has built up a holding in the security or the brokerage house is responsible for underwriting the shares and releasing them into the market.  The company’s shares can be sold through the firms’ mutual funds, individual accounts, or hedge funds.  A “buy” recommendation is often intended to get the small investor to drive up the price so Bay Street may sell their holdings at a profit.

                 There are a number of financial instruments that were created over time that have benefited us greatly.  However, most of them were intended for enterprise rather than the consumer but Wall Street has offered them to the retail customer. To be continued...

Friday
Aug162013

Investing: Part Three 

This brings us to the third issue most often asked about, “when do I sell”.  The answer is a tough one because every situation is different, so it requires constant updating. 

We divide stocks into 2 groups.  First, those stocks bought with the intention to holding them for years or even decades.  Why would one want to sell shares in a company that generates a good return on investment year-over-year?  These are companies that have a history of raising the dividend.  Most successful investors like Warren Buffett practice this technique, as do we.  

Most of our suggested holdings fall into this group.  For paying subscribers only  is up over 700% since 1991 and has raised the dividend for 41 consecutive years.  Plus, it has paid at least one 25 cent extra dividend.  Based on its first quarter earnings, the company will probably raise the dividend in January.  The company has a lengthy history of earnings that are consistent and reliable, so why would one want to sell the stock?  Today the dividend yield is 6.5% based on our purchase price.  For those who bought in 1991, when my father’s newsletter first suggested buying, the yearly yield is now 16% based on the first recommended purchase price. 

The second group are quality shares to hold for a shorter period, usually no longer than a few years, with the intention to realize a capital gain.  These stocks are most often described as cyclical meaning you have to wait for the stock to correct and then buy it, and then hopefully sell during the next upswing.  These companies should pay a dividend to reward the investor while holding, but rarely do they increase it.  One of the biggest companies listed on the TSX is Empire Life.  It has paid the same 50 cent dividend for close to three decades, but the share price does not increase as fast as those that increase their dividend.  These shares should be bought when the dividend yield is trading below its historical average and then sold once the dividend yield climbs above its average.

What signs are required to eventually put a sell on a long term hold?  One, if there has been no dividend increase in 2 years.  This is generally a sign the gravy train is over.  We recently suggested unloading Husky Energy at $32 and Great West Lifeco(GWO) at $28.  Both do not have a great record of raising their dividends.  When GWO does, it usually is by a penny or so, this is not enough to justify holding it over the long-term.  Both are quality companies but with limited upside potential.  We will probably suggest rebuying them both in the next down market. 

The second sign we look for is poor stock performance.  Every company has negative quarters.  This should be expected.  But, if these quarters start to occur more often it is time to revaluate the shares.  This change in direction is most often created by poor management or a troubled industry.

Sometimes you may have to sell stock to free up cash for reasons other than investing and when this occurs many investors tend to have a hard time deciding which one to sell.  My father (Brian) and I have somewhat varying views when it comes to answering this question.  It depends on the person.  Brian tends to favor selling some of his largest holdings in order to even out the portfolio weightings.  He recently had to free up some cash and sold some of his shares in for paying subscribers only.  Unfortunately, the price jumped by $3 per share shortly after.  His decision was based on the fact that the holdings in the stock had grown to 51% of the portfolio.  The negative outcome of this sale is that a hefty capital gains tax will ensue.

In 90% of cases (for paying subscribers only excluded), I prefer to sell a losing stock, or if one does not exist, the worst performing one because I hate seeing a loss on my portfolio statement and it triggers a capital loss.  The tax loss can be carried over until capital gains are triggered.  Furthermore, I feel selling a well performing stock creates opportunity costs and it does not bother me to have one holding growing to a majority of my portfolio.  My view is less conservative than Brian’s. Therefore, if you prefer to be on the cautious side one should favour my father’s strategy

 

 

Wednesday
Aug072013

Investing: Part 2

The second obstacle to successful investing is knowing when to buy a stock.  The truth is there is no such thing.  All one can do is to assess the company, industry, and the economic climate at the time of investing and predict what the future looks like for that company.  Assessing is nothing but an estimate which is the toughest skill to become successful at. But, thankfully you are reading this publication and we will list a few factors to look for when it comes to putting ones money to work.

Type of asset:  Avoid any mutual fund, ETF or any other investment vehicle created by Bay Street. These instruments rarely outperform the stock market and are designed to generate excessive commissions at the expense of your returns.  Stick to individual securities. 

History of profitability:  One can waste his or hers life savings trying to find a successful start-up that will become the next Microsoft.  Therefore, it is almost always preferable to invest in a company that is mature and has a lengthy history of increasing profitability. Even if the stock does very little, the risk of losing some of one’s capital decreases significantly.

Dividend Yield & History:  Dividends often account for more than half of a stocks return over time.  This is why the dividend yield is so important.  For example, a company with a lengthy history of paying a 2% dividend will return ones investment in 50 years, assuming there are no dividend increases.  Similarly, a share that offers a 4% yield will return the investors’ money in 25 years.  Again, this assumes there are no dividend increases.  A dividend increase will decrease the time needed to recoup ones invested capital.  Therefore, one should always look at the dividend history of a company and favor companies that have a history of increasing the dividend.

Valuation:  We use the dividend yield and price-to-earnings ratio (P/E).  If the dividend yield is below its long term average and the P/E high, it usually means the stock is overvalued and one should wait on the sidelines for both to revert to their long term averages.  Obviously, one wants to invest in the company when both are below the long-term norms.

Cashflow: Cash comes into the business (cash inflows), mostly through sales of goods or services and flows out (cash outflows) to pay for costs such as raw materials, transport, labour, and power. The difference between the two is called the net cash flow. This is either positive or negative. A positive cash flow occurs when a business receives more money than it is spending. This enables it to pay its bills on time.  A company can have a loss; however, if it is still generating a positive cash flow that is most likely sustainable, the stock is worth a look.  A perfect example is (for paying subscribers only)  were it released negative earnings for many quarters but continued to generate a positive cash flow and bank $100m quarterly.  Further investigation into the company found that the majority of losses where paper losses derived from the write-down of assets and amortization.  In this scenario, a stock is worth the gamble as long as the company can maintain a competitive advantage in an industry that has a positive outlook.

Industry outlook:  Does the industry have a long-term horizon?  This is important because the majority of wealth is realized by the law of compound returns over time.  Specifically, if a company can grow its earnings over time, the share price will most likely follow.  For example, if $10,000 is invested in a stock that generates a 15% annual return, it will grow to $20,000, then $40,000, and $80,000 after 15 years.  Most stock markets are lucky to average 7% annually. 

Economic outlook:  This is pretty much self-explanatory.

 

Our system of buying, holding and, collecting dividends is the easiest and cheapest way to invest.  It is also a method that generates returns that outperforms 99% of investment professionals.  But at some point in the future these shares will have to be sold. 

...to be continued

Sunday
Jul282013

Investing: Part I

"Twenty years in this business convinces me that any normal person using the customary three percent of the brain can pick stocks just as well, if not better, than the average Wall Street expert." 

                                                …Peter Lynch

 

Every investor has three issues to contemplate when it comes to putting ones savings to work in the stock market. The first is finding someone whose ideas and guidance you can trust and who has a proven track record; the second is knowing when to buy; and third, when to sell a security.

 

The first problem is much harder than you think.  The main reason it is so difficult is because the majority of professionals in the industry are employed by companies whose self-interest in generating commissions trumps that of the clients.  One of the main principals of investment advisors is the “know your client” rule (KYC).  This rule basically stipulates that as an advisor you must collect the important facts and financial objectives about a client.  The second specifies that any recommendations the advisor makes must be suitable to the client's objectives.

The KYC rule is humorous and the most two-faced principal of any profession because profit of the broker and the institution they work for comes first.  The majority in the investment business are told what to buy, and occasionally, what to sell for their customers.  In many cases, a brokerage house will issue shares for a company and it is then responsible for the release of the shares into the open market in order for the issuing company to raise as much capital as possible.  More often than not, the brokerage house is paid in shares of the issuing company at a discount to the issue price. Once the shares are ready to be released into the market, the brokerage house will issue a buy recommendation and its brokers will disperse the shares onto their clients.  The brokerage house will profit by its own shares realizing an instant capital gain and by the commission it charges for purchasing the shares for its clients even if the stock is not suitable for client.  This is contrary to the KYC rule.

Another common practice that goes against the KYC rule is a firm will load up on a security at a lower price and then get their sales force to recommend those shares to their clients.  The sales force would then receive bonus commissions for placing clients’ money into those shares regardless of whether it suited the needs of the client.  Most of the sales people, sorry, “Investment Professionals”, could only see a bonus commission.  This was common at the firm that my father once worked at.  He left after a few weeks because he was, and still is, against this type of business.  Fortunately, as my dad put it, “luckily, in about a year’s time, the firm disappeared”.  Breaking the KYC rule runs rampant in this industry.  Obviously a mutual fund salesperson will only sell the products created by the company they work for.  The same can be said about most ETFs and life insurance professionals.  As a result, it is rare for a client to receive a product that fully suits their investment needs.

An investor, if they have the time, can spend unlimited hours searching for an advisor they can trust.  With a bit of luck, they will cross paths with an individual that makes sense and gives honest opinions and suggestions on their financial wellbeing.  However, finding that individual is rare and we hope our readers and our clients find Sacola fills this need.

We have found about a dozen of these people (David Rosenberg, Jim Rogers, Patricia Croft and Warren Buffett, to name a few) whose opinion we truly respect.  While we may disagree with them at times, it is obvious they have done their own research and given serious thought to their conclusions.  Unfortunately, the truth is that the majority of people in the investment business do little research and understand very little about investing.  Yet, it is these people who most investors end up with.

...to be continued

Monday
May272013

Stock Markets - May 2013

          Six years ago, almost to the day, the Dow Jones Industrial Average (DJIA) traded at 18.3 times earnings and the S&P 500 index at 16.7.  Today, the DJIA is at 16.75 times earnings while the S&P is at 18.55, probably it’s all time high.  During 2007 the DJIA set 27 new daily record highs.  This year there has seen over 20 already.  The S&P set 5 new daily highs in 2007.  So far in 2013, the count is at 12.

          If history is to repeat itself, then we are either at the top, or within a few weeks of it.  Our reasoning is that corporate earnings are not growing as fast as the stock markets, nor will they for the rest of 2013 and 2014, and the markets are in expensive territory.  Furthermore, a good chunk of the growth in profits is paper, realized by share repurchases, rather than organic revenue growth. 

          When a company repurchases its shares it is spreading the profit over fewer shares, resulting in higher earnings per share (EPS).  For example; company A earns a profit of $100, and there are 10 shares outstanding.  As a result, the earnings per share is $10.  The company then decides to use some of its profit, or borrow funds, to purchase 2 shares.  Assuming the company made the same amount of profit, the earnings per share would be $12.50, or 25% higher.  Share prices usually increase as a result of the increased EPS.

 

          The Baltic Dry Index is off 14% from its 2012 high.  The index has been flat for most of 2013, a signal the world trade is doing very little.  In April 2010 the Index was trading around 3096.  For almost all of this year the index has been under 900, with it recently trading at 841.  This is a bad sign as it confirms what we have been reporting for months; there are surpluses of just about everything we produce. 

          The CRB Index has been flat for the past year which accurately foreshadows the world economy.  This is probably the best gauge for the world economy and how it is performing.  The CRB indicates the world economy is going nowhere for the rest of this year.

          Stock market gains this year are based on the attraction of some high yielding shares, low interest rates, as well as the hope that the American, European, Japanese and the Canadian governments will get their acts together and finally tackle what is destroying their countries’ economies. 

          Real estate is too expensive even with zero interest rates.  Plus, around the world there remains a surplus in all forms of real-estate.  Mutual funds are always a disaster for the investor.  Have you ever met someone who got rich holding mutual funds?  Hedge funds are too expensive.   Hedge and mutual funds are designed solely to transfer one’s wealth into the manager’s coffers.  With money market funds, one is lucky to break even after taxes.  After-tax wage gains are slightly positive, but probably less than 1%.

          Sadly the stock markets are the only game in town.  This alone is a negative because it is luring the inexperienced and the desperate hoping to make a little extra.  History proves these people make poor choices and end up losing because they buy horrible companies, and they panic sell, adding further downward pressure to sell offs.

          Dividends have saved us, but only because we bought at the right time and held the shares for years.  If we had not, we would be lucky to get a 4% yield today.  Most good quality companies yield 3% or lower.  Our recommendations are returning over 10% annually based on our purchase prices, one of the highest returns in the world for investing.  Some subscribers have told us they made over 10% last year.  My father’s Tax Free Savings Account, holding only this newsletter’s recommendations is up 92% in just over 4 years.

          Poland announced their gas fields, believed to be the largest in Europe, will not be developed for some time due to cost and competition from Cyprus’ reserves.  Between the two countries they will be fighting for market share, along with Russia, the biggest supplier.  Russia is trying to take over the Cyprus field, so they control Europe’s needs for years to come.  

          However, today Russia is worried.  They have decades of reserves already (probably over 200 years worth), but the gas would end up staying in the ground for decades if Poland and Cyprus both develop their fields.  We suspect Russia has bribed Poland not to develop their field for a few decades, because Russia and their mafia are in desperate need of cash flow.  Russia’s elite have robbed their country for years and continually need a fresh source of money, which shale gas provides in sales to Europeans. 

          If gas prices hit $1.50, which we believe will happen, it will be a financial disaster for Russia.  As a result, they will do everything in their power to keep the price from falling further.  Unfortunately for the corrupt nation, they will be unsuccessful at this because of the growing glut of reserves across the globe.  Continue to avoid the Natural Gas market.

          There are no buying opportunities available today.  In my father’s 48 year career, he has never sat on the sidelines for so long and held so much cash.   We do not believe in buying at the peak of the market, which we feel is where we are at today.  Stock markets are in expensive territory.  By the numbers, all stock markets are vulnerable to a sizeable correction.  Today we must wait for the stock market to come to us, which they will.  It might be a week from now or 6 months away, but it is coming.  The coming sell-off will be quick and substantial.   In the meantime we will be collecting all those lovely dividends each month and know we have X amount locked in safe money market vehicles.

Keep cash in money market investments, with no term longer than one year.