Tag Archives: Portfolio

New Page…Portfolio

I know that posts have been light these days. But I am having trouble keeping up the blog with the recent flurry of activity at work.

I have added a new portfolio page. You can view it and feel free to comment on it.

Thanks

Dean

PS. I have been selectively putting my cash to work in the market.

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Queue the top…

Pretty dramatic headline. I mentioned in a previous post that I would be doing something to minimize my exposure to the Edmonton housing market. I have already slowed down the pace of making extra mortgage payments in favour of investing in my RSP and TFSA. The only reason I post this publicly is because I wanted to allow for feedback and experiences to help be get a better understanding of what can go wrong.

I have decided to try the Smith Manoeuvre. It is really risky if you don’t understand the potential outcomes to your thesis. What I am essentially doing is borrowing against my house to invest. It is really a function of cost to borrow vs. total return. Right now the cost to borrow is 3.5% FOR NOW. We all now that it will move up. If I invest in a Canadian dividend paying company that pays a 3.5% dividend then I will have enough dividend income to cover my interest expense. This factors in tax deduction on the interest expense as well as the dividend tax credit at my marginal tax rate (36%).

Though this sounds simple enough, there are huge risks to employing leverage. For one thing my cost of borrowing can (and most certainly will) go up. I could also buy at a market top and suffer a significant decrease in my holdings paper value.

The biggest advantage I have is that my outstanding mortgage is only 20% of the appraised value of my house. Secondly the household income will cover the outstanding mortgage balance more than 2x in one year. A rise in interest rates won’t affect my debt load too much.

I have the following rules for my Smith Manoeuvre:

  • Outstanding balance will remain small relative to money that can be readily accessed (liquid securities).
  • Negative net value (LOC – securities) will not be allowed for more than a few months. If I have to stop putting money in an RSP and pay down some HELOC balance, then I will.
  • Dividend yields must be 4% or larger.
  • Companies must employ minimum debt and have a history of raising dividends.
  • An assumption that borrowing costs will be 5% in 3 years has be factored in to the model.
  • All purchases will be tracked against an index to monitor the author’s ability to pick stocks. The Smith Manoeuvre stocks will the their own separate portfolio that will be different from the “growth” names and bench marked accordingly.

I only plan on doing this while it makes sense. I doubt that it will make sense to do this for more than a few years. I have essentially planned a 4 year timeline where dividend income covers interest expense and I get the capital appreciation as a bonus.

I have read a ton of blogs (like this one) and articles on the fallacies of this type of investment. From what I can figure, most people lose on this investment because they bet the farm on it. They get a 350k house,  it goes up and then they maximize leverage at the wrong part of the cycle. Then they panic and sell at the worst time.

There are 2 things that give me confidence in this decision.

1) I feel that a methodical approach to picking stocks will give me enough margin  of safety to employ this strategy.

2) I haven’t changed my lifestyle even though my income has risen dramatically over the last 5 years. I mean value investing doesn’t just happen in the stock market. It transcends into the rest of your life.

Any feedback is welcome.

Dean

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2011 Performance and Thoughts

Another tough year.

I was down around 4%. Not too bad, but certainly not good.

Where did I go wrong?

The biggest issue was position size. I strayed too far and didn’t have any cash when the market tanked. I had to sell cheap to buy cheaper.

My ideal portfolio would have 3-5 core holdings making up 40-60% of my portfolio and 6-10 smaller positions. The core did OK in 2011. What I did was average down mindlessly. The two best examples are AEY and MGO.to.

AEY was kind of cheap when I first bought it around $3. Then I bought more at 2.75, 2.50, and 2.25. Not a bad idea, but I ended up overweight the company. Now I face the dilemma as to whether I should sell at this really cheap price or hang on. I still haven’t decided. Don’t get me wrong, I think AEY is a buy. But I only want 5% of my portfolio in at these prices.

MGO I also averaged down. I didn’t fully understand the risk of Chinese RTOs at first. Only after I turned my attention from operations to legitimacy did I made a mistake. Maybe MGO.to is a buy, but I only have so much room in the portfolio.

In order to prevent this in the future I have decided to make harder rules for position sizes.

The other factor was just my timing of adding to my portfolio. I was quite unlucky this year. Money was tight for a while as I was on parental leave for 3 months and also had some emergency house issues that required immediate attention. I seemed to add right at the peak and ran into liquidity issues at the wrong time. For example, when FES.to went below 10 I would have bought hand over fist. But I didn’t have the cash.

I have also learned to watch comps yoy. Really understanding where the company is on the industry map is important. Many companies are growing top line numbers, but with rising commodity prices have a lag in time before they can pass on costs. This is what is happening to HPS.A. They had some margin pressure, but have passed on higher costs. This means that 2012 comps should be better than 2011 as long as the top line sticks where it is at (or improves).

Let’s hope 2012 proves to be better.

Dean

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Yet More Updates…

I have been making some changes to the portfolio. To keep track I have been just spitting out one sentence reasons as to why. These positions deserve more than one sentence in the middle of a post. I will do a post for each sell after I have taken the action.

Why would I do this? I doubt people reading the blog care. I need to track my thinking at the time in order to monitor performance long term. I am still reluctant to post on anything other than investments. I did have a post on the housing market, but that was to track what the mentality was at the time of writing. I was ready to post/rant something on labor unions, but have decided against it.

Petty Cash is about helping me, and hopefully other beginner investors. I do better analysis when I know someone else can read it. There are enough blogs out there that provide more useful information than mine.

I will do a post for each WJA, FES and EQI (all on the TSX) outlining my reason for selling.

Dean

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2010 Performance and Thoughts

2010 is done and gone. There are some very important lessons that I learned. Before I get to that, I want to take some time to talk about how I look at performance.

First I wanted to say that I don’t go too in-depth when measuring my performance. I only have 2 methods I use.

Method #1 (Purchase Tracking)

First is my batting average. Every time I buy or sell a company, I take a look at how I would’ve done relative to the appropriate index. I include dividends for realized positions. This gives me a sense of how well I can pick stocks. Also, I track the sources of the investment idea (blog, screen, friend, etc.), this helps me see if I can pick stocks with or without outside sources. It lets me know if I should even be reading certain blogs, books, or analyst research. Since 99% of bloggers are more versed than me, seeing if I am able to pick up on any risks that have been missed. Even though my sources can be different, I perform due diligence myself on every company, so the ultimate blame lies in my hands.

How have I done? Quite well. I have tracked my picks back to when I really started taking value investing seriously, 2008. Pick that I have come up with have averaged 26% with an average hold time of 9.5 months. The reason the hold time is so low is that I have many positions still open that I had just started, and the run-up in 2009 led some picks to reach fair value in a short amount of time. Some winners were JNJ, KOF, NAL (tsx) and CWB (tsx). And some major losers were BLZ, MS, IDG and GAS (all on tsx). During that time the corresponding indexes have returned and average 16%. With ideas that I generated by myself the return jumps to just over 40%. This is a function of me concentrating on businesses that are close to home and that I can understand.

Method #2 (Overall Performance Tracking)

For this method I monitor my performance relative to what I would earn if I had a completely hands off portfolio. The hands off aspect tries to demonstrate if I should even be managing my own money. Maybe I could focus on other things and only manage a portion (or none) of my money.

The “hands off” portion is 3 different ETFs, CBQ (25%), XIU (50%) and SPY (25%), with no cash to try to market time. CBQ and XIU trade on the tsx. I started out the year with the same amount of money in my brokerage account and every time I contributed money, I would buy a predetermined mix of the 3 different ETFs. This mock portfolio takes into account dividends, transaction costs, currency fluctuations and “lumpiness” of contribution. I also rebalance annually. My thinking is that if in 3 years I haven’t outperformed, then I should consider handing over the reigns to somebody more capable.

This years results are disappointing. The market returned around 8% and I returned around 4.5%. Being 3.5% behind is not great considering I did have a few good ideas for 2010, but I guess my bad ideas could have been worse.

The contributions to my portfolio are lumpy. Sometimes I contribute (though don’t purchase anything) at market highs and sometimes they are at market lows. This method shows whether or not I can even find good ideas fast enough to prevent cash from building up. This year I contributed over 20% of my gross income and if my portfolio was flat, I would have added an extra 30% to my portfolio. So you can see that finding good ideas is paramount.

This method shows my ability to “manage” the portfolio. Position sizing, cash size, currency fluctuations are key. The positives have been MCB, FES, and MGO (all on tsx). While the negatives have been NTRI, the banks, and MHH. Taking profits when the Mr. Market is giving you the chance is huge. Waiting for an extra 5-10% for a fair value you thought would take years to reach is RISKY.

There are also some companies that have been purchased recently that are showing some minor losses due to volatility and frictional costs.

In 2008 I was down around 25%. In 2009 I was up around 60%. And 2010 I was almost flat. Volatility seems to be the norm.

Why do I not care about mean, variability, alpha, Treynor, or any other measurement? I buy my groceries in dollars, I pay my mortgage in dollars, not anything else. When I turn grey, or hit my mid-life crisis, I will by my muscle car with dollars. If a person can time the market and pick low quality stocks, does it matter in 20 years how they generated outsized returns..NO! What if it was a person who only really understood one or two industries, and he/she still was able to do better than the market? To me all that matters is dollars and cents. I don’t manage others money, and I dont’ have to worry about withdraws at the wrong time. I can focus on the portfolio.

The lesson of 2010 is to focus on managing the portfolio, not just picking stocks. I guess the portfolio is kind of like a tamagotchi pet; if you leave it alone too long you will have a mess to clean up.

Dean

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Excess Cash

What exactly is excess cash? To me it means cash that is on the balance sheet that is not needed in day-to-day operation of the business. Some companies have no excess cash and some have enormous amounts of excess cash. This post may seem like review to some, but a younger version of myself would have benefited from this insight.

What can affect the amount of cash needed for day-to-day operations:

  • How cyclical/seasonal is the company
  • Length in sales cycle
  • Whether the company does large amounts of contract work, making revenue and expenses lumpy
  • Customer concentration
  • Working capital requirements
  • Capital expenditure requirements
  • Access to funds (reasonable borrowing rate)
  • Dividend rate

Lets look at some examples:

Velan (VLN on TSX) manufactures and markets industrial valves. Revenue growth over the last 10 years has been slightly better than inflation. The company has a very long sales cycle, as evidenced from the CCC being over 200 days. Currently stated net cash is just over $5 per share. This seems extremely attractive to anyone buying the shares now (around $13). You can say that I am buying the business for $8 ($13 minus $5). Average EPS for the last 5 years is $1. So I am paying 8 times earnings, which seems very cheap. This of course is oversimplistic, but it proves my point. But wait a minute, over the last 10 years there has been at least $25 million in cash on the balance sheet (or about $1 per share). This may mean that there will always have to be $25 million cash on hand. Now your valuation goes to 9 times earnings, ($13/share minus $4/share in excess cash divided by $1 in EPS). Also we must consider that VLN has had revenues fall sharply during the recession and are not likely to return for quite some time. Working capital will need to be adjusted as well. Something that is very important is the voting structure of the company. The Velan family has voting power, which leaves almost no chance of activist involvement. The family can take the company private, but I am reluctant to speculate on that. I think there is little chance that the cash will be returned to shareholders anytime soon, meaning there is excess cash in the company, but I wouldn’t consider net cash in any part of my valuation. The cash position should be considered when examining balance sheet strength though. Buying this company at 13 time average earnings is not cheap, especially considering how far away average is from here.

Jewitt-Cameron (JCT on TSX) was originally analyzed by Adam over at ValueUncovered here. JCT has also been extremely hard hit by the recession. The company usually carries some cash on the balance sheet, usually a couple hundred thousand, against revenue (usually) in excess of $50 million. Recently, the company has come into a large amount of cash. Given the fact that the company doesn’t carry much cash usually, and isn’t afraid to use short-term borrowings, I think it is safe to include all net cash as part of the valuation.

Westjet (WJA on TSX) has been mentioned before. The CEO said on a conference call that he thinks the company needs around 40% of revenues in cash on the balance sheet. I think he is being too conservative. I think it is more like 20%. I will have a more detailed post on Westjet shortly. I think you can include some of the cash as part of your evaluation as management seems to be able to deploy it at attractive rates.

Many investors love to use enterprise value (EV) in their valuation, myself included. EV is equity plus debt minus excess cash. But determining that cash part can be very tricky. Lets run some numbers to give you an example:

ABC is at $10, have sustainable earnings of $1, net cash of $5. Net cash P/E is 5. Very cheap. You could consider “fair value” at 10x earnings plus net cash, making $15 a target. You are buying at 67% of fair value. What if the company was like VLN, meaning there is cash, but you aren’t likely to see it. Your 10x earnings plus net cash now yields a $10 stock, or current purchase price. You have NO margin of safety. What if the earnings are $0.75 and the company has $7.50/share in cash. Fair value is still $15 (10x earnings of $0.75, plus $7.50 cash), but now the valuation is 50/50 business and cash. If you are not going to see that cash, then fair value moves to $7.50, meaning that buying at $10 gives you negative margin of safety. I think you get the point.

A big thing to consider is how much of fair value is cash and how much is earnings power. In the previous example, $15 fair value was 67% earnings and 33% cash. If fair value is mostly cash, then I think there is an added element of risk that isn’t discussed enough. Most of the value is cash, then a simple return to shareholders is best, but the company can go on an acquisition streak at the height of a leveraged economic expansion. Buying back your own shares at a huge premium to book or earnings is not accretive, yet most companies to just this. My point is the larger the cash portion is of the total valuation, the better the company should be at deploying that cash. Makes sense, right?

It is up to each investor to determine what exactly is excess in the excess cash calculation. It is easy to punch some numbers in a spreadsheet and have it spit out a fair value, but investing is an art not a science. Despite what many think, the market is pretty efficient, and it takes some pretty big extremes to get outsized returns with little work.

Disclosure:

The author own share in WJA at time of writing, and would like to own shares of JCT (if it was cheaper).

Dean

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The Banks

The financial crisis was horrible for many. I definitely failed to realize how intertwined our financial companies were to the health of the economy. Given how many “experts” work for our regulators, it is very tough for me to even beleive that this kind of thing was possible. I know Wall Street is famous for creating bubbles, but I thought our central governments (on a global basis) would have been more in tune with what was happening.

I wanted to play a rebound in the banking sector. My thinking was to find some survivors and hold onto them until the financial markets stabilize. I wanted to be geographically diversified as each state has its own set of risks. Originally I was focusing on the upside and not the downside. This lead me to overpay for many of them.

The screening process started by typing in a few financial company metrics and ended up stumbling upon PlanMaestro over at Variant Perceptions (see blogroll). He has some excellent posts on financial company analysis here. All things considered, I would rather own a Canadian bank over the small regional banks in the States. Our banks have fared far better, but so have their share prices. During the height of the crisis, I put 15% of my portfolio into Canadian Western Bank (CWB on TSX). I knew they would survive, the question was would they have to do some major dilution to do so. Though it wasn’t the most undervalued company at the time, I thought the risk/reward proposition was in my favour.

I wanted to start with a quick screen:

  • Some insider ownership
  • NO insider selling
  • NPA’s stable of declining for at least 2 quarters
  • Good NIM, ability to earn their way out of trouble
  • Stable or improving Texas Ratio
  • Cheap on a price to book
  • Stable deposits
  • Not needing to dilute shareholders any further
  • 30-90 days past due are dropping

This meant I was likely to find companies who:

  • Took on TARP money
  • Share prices may have risen substantially already
  • Had headline risk as financial reform legislation was in progress
  • Share prices would be volatile

Of course, there was so many banks I didn’t know were to start. If you follow PlanMaestro on twitter, he talks about a few that he owns (or at least owned at the time). I picked the first 5 he mentioned and started researching.

For anyone who has not invested in bank stocks, they take a huge amount of time to research. Their 10-k and 10-q are very lengthy compared to many other companies. Enter Bank Reg Data. They have a huge database to help you crunch the numbers without combing trough enough reports to bury yourself. Best of all, the trial is free.

Since starting to “invest” in banks stocks, I have learned many things:

  • Their loan portfolio is a black box
  • Macro really matters
  • Sentiment really matters
  • There is an extreme amount of time required to properly understand just one company
  • Despite the problems in the industry, their executives get paid very well

I have decided to cut my losses and run. It turns out that my portfolio would be positive for the year without my US banks. I would also be outperforming my benchmark too.

Are there really cheap banks out there..Yes. Can I find them..Maybe. Will it be skill or luck…most likely luck. I don’t have an opinion on the sector as I don’t feel like I am well-informed enough to offer one. In order to manage 15% of my portfolio, I was spending over 50% of my time. There are going to be banks that double and triple, but if I can’t determine risk, I don’t feel comfortable. It is much easier for me to understand other companies and industries. There are other fish in the sea, and most of those fish didn’t need to take TARP money. Turns out I was speculating and not investing. Though I feel that normally (non-financial crisis world) I can understand a bank, the credit crunch threw too many unknowns in the picture. If capital needs to be injected, the common shareholder takes it on the chin.

Another thing that bugs me is that many bank executives still make a ton of money, despite the precipitous drop in their share prices.

You don’t have to make it back the same way you lost it.

Dean

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