Sunday, April 29, 2012

Do something simple and profitable; do it over and over again!

That is something Ed Davis, a Calgary Entrepreneur told me in a presentation many years ago. “To get rich, you do something simple and profitable and then you do it over and over again” That is not exciting in the view of many retail investors who think they get rich by discovering the next Google, Facebook or the next Microsoft (for us old computer nerds).
But really, what did Microsoft do?  It made a piece of software (Windows) and sold it over and over and over again!  What does Google do? It helps you find something on the internet and you have to look at a Google ad over and over again!  How does that differ from Coca-Cola who puts some syrup in water and sells it throughout the world, over and over again?
As a geologist, I do the same thing. I learned how to evaluate oil and gas pools. The more I do it the better I get at it and…  I do it over and over again in return for a nice paycheque. You may say, “But that is boring and not risky!  It is risk and reward that makes the money!” My answer: Wrong, you are dead wrong!
In the book “The Millionaire Next Door”, the typical millionaire next door is a very boring guy or gal who is a small business owner for many years, or a teacher, or an engineer. They live in modest but good houses, are married and never divorced. They live below their means and they often reside in small to middle sized towns, like Omaha (Nebraska) – get it?.
Yes there are people that get rich investing in fast growing, revolutionary companies – their founders (one in a million) and the stock promoters they get rich! Wall Street legend Peter Lynch and long before him, the father of value investing: Benjamin Graham already told us that investing in stocks is like owning a business. Owning a business is boring because the good ones do something simple like selling toothpaste or razorblades and they do it over and over again. They are profitable year in and out, they reinvest a bit of their earnings to update their manufacturing facilities or to expand; the rest is paid out to investors as ever increasing dividends and stock buybacks.  Really, in the old country we used to say (in Dutch): “Better one bird in the hand than 10 in the air” (the original text is available free of charge plus a $10 shipping fee J). In fact, just like collecting dividend, this expression is so valuable it can be found back throughout the world including in common wealth country where it is distorted into “A bird in the hand is worth two in the bush”.
That reminds me! Did you know that Santa Claus is copied from the Dutch Sinterklaas?  O yeah! And… even worse, the concept of original Canadian main stay goods such as Tim Horton’s donuts is copied from the Dutch ‘olie bol’ or appel beignet ( Never mind that ‘beignet’ is a French word. J
Where were we?  O yes: “Boring”. What can be more boring than David Chilton’s “pay yourself first”, i.e. put the first 5 to 10% of your paycheque in a savings account before spending the rest!  Wow, now that is boring! We could spend that money on booze or a hockey game or on a nice exciting trip to Las Vegas for some action!  Saving? Yuck!
Yes saving… and while we are at it, add your annual Christmas bonus and your tax refund and family allowance to that. In a short time, this becomes such a habit that you don’t even notice it in your daily life.  So how much are we talking about?  Well if you take someone with an annual income of $60,000 and a 5% Christmas bonus the savings are around $3750 from the pay cheque and another $3000 bonus. Total savings are $6750 per year. Put $5000 in a tax free savings account (TSFA) at a discount broker and the remainder in an ING savings account. Invest the TSFA money in a dividend paying ETF e.g. Claymore’s Canadian Dividend Fund or in a MIC (mortgage investment corporation). And… forget about it until next year. Do this over and over again!
A number of months ago Gordon Pape recommended a MIC that trades on the Toronto Stock Exchange  It has done well for me to date. The MIC is Firm Capital Mortgage Investment Corporation (symbol FC-T) and it pays currently a monthly interest distribution at an annual rate of 7%. An example of a dividend paying ETF, also a recommendation of Gordon Pape if I remember right: iShares (formerly Claymore) S&P/TSX Cdn Div Fund (symbol: CDZ-T).  CDZ has a dividend yield of 3.2%. Here is a link to its data:
I mention these two investments because they create a lot of cash flow. Every month you get a bit of bird. If you invest equally in FC and CDZ, your monthly tax free income is 5.1% not to mention appreciation.  So a year later you'd have $5000 + appreciation plus $255 in distributions + $1703 (incl interest on ING) plus another $6750 saved. He… you accumulated at least: $13708 plus appreciation. How much appreciation? Who knows, 5 to 10% could be a reasonable assumption.. so add another $500 for a total of $14208.
Now, supposed you rented an apartment for $1000 per month. Then after year 2 you could use $14208 as down payment for a $142,028  CMCH insured first-time-home-owner apartment. So let’s play this out a bit further. At the start of year 3 you buy your apartment with 10% down and condo fees of $250 plus (assuming a 35 year amortized mortgage at 3% plus $800 property taxes) that would be: $835 per  month. Oops, you’re paying $175 per month less in rent – savings!. If your place appreciates 3% per year, you made at the end of year 3:  $4200/14208 = 30% profit plus… yes there is a plus because you paid that year down your mortgage by $2,223 and you saved another $6750 (not counting salary increases).  Oops: after three years your net worth is: $22731.  All tax free!
If you can do that in three years, wouldn’t it be boring to keep this up for the next 40 years?
Before I forget! If you are working for a large corporation, chances are that there is an employee savings plan where you can contribute typically up to 10% of your gross income. So each month, they deduct 10% of your gross income from your paycheque, i.e. $6000 per year…. And your employer gives you a dollar and sometimes even a dollar and half contribution for each dollar that you saved!  Yes, Yes! That means, you save $6000 per year and your employer adds another $6000 to $9000 from their pocket! You’re total annual savings are... between the $12,000 and $15,000. Now don’t tell me that ‘boring’ is not exiting!
It is all so simple and the only thing you have to do is: doing this profitable thing over and over  again!

Sunday, April 22, 2012

I lost so much money! Really?

 I have been promoted, or better suckered, into becoming president… of the board of directors of a small condominium corporation. Somehow, I always fall for those jobs. Maybe because I am a control freak who cannot keep his mouth shut and who cannot say ‘yes and amen’ to everything the condo manager tells us. Yes, it is a weakness but alas… we all suffer our curses.

One of my co-owners is quite a likable fellow, but like all investors he grumbles (complains). We’re nearly like farmers – only worse. “Oh this real estate is so terrible! I barely made any money over the last couple of years’.  That is probably true, but he forgot to mention that in the tree years prior to those lousy years his property value doubled and that he got a monthly distribution of $400 or more each month until things went south for a while. Right now, we once again have no vacancies, the rents are slightly on the increase and we’re standing at the start of an upward pricing trend. In fact, it is pretty tough to buy a good rental property in Edmonton right now because they have ‘all been sold’. Yeah, that is if you only want to pay last year’s prices and assume last year’s rents and high vacancy rates. But as usually, I digress…
So here is a simplified internal rate of return calculation (akin to return on investment - ROI) based on the cash flow stream over the last 7 years when the unit was bought. The initial purchase price was $60,000 and even after a significant value drop from the peak in year 4 followed by a minor recovery, today’s value is around $110,000. There was also a $7000 renovation involved (the unit was trashed by a tenant) and the condo corporation did a special assessment of $2300 in year 6. Also there were a lot of vacancies during the ‘bad years’.
The annual rate of return (IRR) was a devastating… 12% compared to Warren Buffett’s 5.2% over the same period! Oooohh… that hurts! J

Worse, my co-owner probably had a mortgage. Assuming he had the standard 20% down payment, 35 year amortization and an interest rate of 3.25% his cash flow would have been:

Ohh my G! Sorry, OMG, OMG! That looks awful. The rate of return (IRR) on this disastrous, calamitous case was… 32% per year! Poor, poor little investor, I feel for you! (I can't keep my face straight.)
When you look back at an investment from what it was at the top of the market, especially when you just went through a down turn, things look often much worse than they really are. It may tempt you to do rash things. So always look over the life of an investment before jumping to emotional conclusions. To be honest, I tend to fall for this myself. It is an easy mistake to make and it may have you throw away a terrific investment because of your emotions.

Nibble, don’t buy at once!.... Oh Yeaaaah!... Nibble, nibble, nibble!

Retail investors cower in the shadows of their cash piles afraid of risk. However, those who take ‘least risk’ tend to follow the herd and often get hurt when the herd stampedes. This is often true for many aspects of life; it is the calculated risk takers that get rewarded while those who avoid risk at all costs get hurt. Live is about taking risk, the car driver takes a risk and so does the bicyclist; even the pedestrian is exposed to risk. However, the ‘lowest risk taker’ the guy or gal who never leaves the house runs most risk – stagnation; becoming a living dead, getting in poor physical shape; and rotting teeth since he or she doesn’t even visit the dentist!  J, you get my drift.

Right now everyone is so afraid of taking risk that oil and gas stocks are incredibly cheap. They are trading at valuations comparable with the depth of the recession. Dividend paying stocks and right now financial stocks are popular herd instruments and I don’t predict their demise, but I do predict moderate or mediocre performance.  Eric Nuttal of Sprott Asset Management foresees a very poor summer for gas prices and a capitulation phase for gas stocks followed by a 'buying opportunity of the decade'. I don’t disagree with the idea of a rough summer for gas producers, nor do I disagree with the possibility of market capitulation but I do disagree with market timing and trying to aim your investment purchase at the perfect market bottom. Oh, and I have seen over the last five years so many 'buying opportunities of a decade' that it makes me sick.
Like stated in last week’s post, nibble don’t buy everything at once! Can we make that into our team song? “Nibble, don’t buy at once!.... Oh Yeaaaah!... Nibble, nibble, nibble!”

Investors don’t like the petroleum industry because of all the real and perceived issues: Obamah, Keystone, Gateway, landlocked, political risk premium, cost overrun, shortage of skilled labour, high rail transportation costs, the weak U.S. dollar, the strong U.S. dollar, the high oil prices that can’t last, the low gas prices, the environmentalists, the chance that governments raise royalties, legislaton, eh…eh….. the financial crises, the lack of investor enthusiasm….

It is so easy to find a reason not to take action. But the petroleum industry is basically booming in the oil sector and their corporate evaluations show numerous economic viable projects… so many they can’t find the staff to execute the work! And yet the industry is limping on one leg… No! it is crawling on one broken leg with one arm tied behind its back! And still it is making big money!

What if Europe gets through its debt crises… and it will!  What if Europe gets out of recession … and its main economies are not even in recession! What if there is no double dip recession in the U.S. and there won’t be one…. In fact, we are not far from a healthy 3% growth rate in GDP and so what if China 'slows' to 7.5% GDP growth?  After the U.S. elections somehow Keystone will be build, and so does Gateway and Kitimat!

Asian investors are stampeding into our oil patch eager to participate in any project. The Chinese, the Koreans and lately Malays! Oh… yeah this is such a risky investment!

Yes it is risky to trade oil and gas stocks, yes it is risky to hold on to your cash, stuff it under the mattress or worse, lock it in for 5 years at rock bottom interest rates that go negative if you add in inflation and taxes!  But investing in the oil and gas industry; buying a little nibble each time with a time horizon of 5 years or beyond, that is not gambling, that is taking a calculated risk that likely will pay you profits by the spade full!
Nibble, don’t buy at once!.... Oh Yeaaaah!... Nibble, nibble, nibble!” Nibble, don’t buy at once!.... Oh Yeaaaah!... Nibble, nibble, nibble!” ” Nibble, don’t buy at once!.... Oh Yeaaaah!... Nibble, nibble, nibble!”....

Sunday, April 15, 2012

Why ‘trendologists’ are so often wrong

We all have read the brilliant essays about why gold has no choice but to outperform all other investments; why oil prices will peak at $250 per barrel within 18 months; why the economy is going into depression based on demographics and presidential election cycles.  The authors of these works, trendologists I call them, are bright people; specialists in their field of expertise whether that is 'world oil and gas markets' or 'demography'.

So why are those forecasts often so far off the mark? The answer is simple: ‘unforeseen factors’.  That is not entirely true; these unforeseen factors that often create havoc with the most brilliant forecasts would have been obvious to specialists in other fields or a person with a wider view than the trendologist. A good example is Jeff Rubin’s conclusion that high oil prices were the real cause to the 2008-2009 economic slump.  Yes, high oil prices are a bit like interest rates; interest rates influence the availability of credit, a key ingredient for economic growth, and oil prices determine the availability of cheap energy another key ingredient for economic growth. However, the important thing to understand is that there is more than one key ingredient and there are certainly many lesser ingredients that affect the economic stew.
In fact it goes back to a famous quote by a very unpopular politician. It is about the ‘unknown unknowns’ – not necessarily unknown to everyone but likely an ‘unknown’ to the trendologist. Right now, natural gas pricing is defying the logic of many trendologists. On this blog we often quote the rig-count-versus-gas-supply study by Chesapeake to help develop an idea about future gas pricing. But not many trendologists took into account the effect of Natural Gas Liquids pricing, the effects of production hedging, or of Pugh Clauses. Yet, these issues are an intricate part of the oil and gas industry that many trendologists should be aware off.
Not to mention the effects of natural gas being a land locked commodity until pipeline issues such as Keystone, Kitimat and Northern Gateway have been addressed. Issues that are not only governed by economic laws and common sense; they also are governed by politics, in particular by reactionary environmentalists. That latter term may sound inflammatory and the oil and gas industry is not innocent either. In its pursuit of profits this industry does not often accept accountability for its tendency of making shortcuts or for the unintended consequences of its actions that are often affecting social and environmental conditions. But neither are numerous other industrial and economic sectors.

I use this inflammatory language more to point out the aggressive confrontational and often irrational and ideological tendency of the environmental action groups. Some, like the Suzuki Foundation started out with laudatory ideals, but just like the trendologists, they are too focused on a small part of the overall picture. The Suzuki Foundation, in my opinion, evolved from a benevolent organization to an embittered group of reactionary ideologists frustrated at not reaching the narrow objectives they so anxiously cling to.
But I digress…  Oil and gas trendologists failed to recognize along with industry leaders, the importance of being landlocked. Also, the political environment is not very accommodative to break this land-locked situation and this ultimately affects everyone’s economic and general prosperity. The trickledown effect can be especially felt in Alberta, B.C. and Saskatchewan. Strangely enough Quebec also is affected; it almost predictably put the brakes on its shale gas potential.  But this won’t last; sooner or later the land locked dam will burst, the overall economy will grow and with it gas demand, the conversion from coal and oil to cleaner and cheap natural gas will happen and so on and so on. This happens while the economics will prevent the petroleum industry from drilling new gas wells. Oh… and one anomalous warm winter does not spell the end of the heating and cooling seasons in North America with its expanding population base.  So, gas pricing will turn the corner, the question is “When” not “If” – unless there will another ‘unknown unknown’ arise in this tangled story, e.g. a new energy source or a paradigm shift in solar or geothermal energy technology.
We cannot really time when this pricing turn-around will occur. Market timing is a money losing game. We may not be in a position to predict which companies will in the end survive and we may wait a long time before we actually could cash in on an investment in natural gas. But we can start with a small position and gradually, while the picture becomes clearer over time, build a position in this market sector. When all lights are about to turn on green, the buying opportunity has likely passed and everyone plus the kitchen sink will jump in and drive prices up. We want to be ready and fully invested when we reach that point. Investing in natural gas now may make your neighbors declare you ‘insane’ but when the lights turn green one after the other; those same neighbors will jealously declare you lucky!
Trendologists are right, up to a point. Their predictions may point in the right direction but the way you travel may lead you to an entirely different destination that neither the trendologist nor you foresaw. Those who take action will benefit; those who don’t have nothing to benefit from; they just sit on the sideline wondering why they’re not moving ahead.

Sunday, April 8, 2012

Revolution – Alberta Style

The current Alberta Provincial Election promises earth shaking changes. After 40 years, the Tory government and its career cronies are too long in power. Their tentacles are pervading every aspect of provincial life. Strangely enough, rather than the opposition parties it was the Alberta Medical Association (AMA) who really showed Albertans how stale and possibly corrupt the old Tory government has become.  Peter Lougheed was a superb leader who brought the Tories to power; after Lougheed we had the Don Getty Lull (I nearly forgot his name) with as only notable legacy, Alberta’s Family Day which I do enjoy every year in February. The party re-invented itself with the Klein Revolution that changed into a tired one-man dynasty. Another weak leader, Ed Stelmach followed a worn-out Klein government by means of a ‘night of knifes’ and the quirky election rules of the PC party.  ‘Honest Ed’ tried to destroy the AMA which released painful commentary and memos on the dysfunctional state of Alberta’s healthcare system and he centralized the regional health care boards into a lumbering giant under tight control of the government. What happened to the ideas of small government?  The Alberta PC became its own anti-thesis – it resembled more the federal liberals than their national cousins – the Conservative Party of Canada!  The latest Alberta Premier, Mrs. Redford deserves our respect, although she also comes across more as a liberal than a conservative. She definitely showed backbone against the old party establishment yet in the end she caved in on various important issues including the abandonment of an independent inquiry into the dysfunctional healthcare system.

After decades of no viable political alternatives (the provincial NDP and Liberals were even less able to do a realistic ‘royalty review’) finally the Wildrose party came to life. About time! It is not that Albertans are all cut from the same wood, far from it, but decades long no real opposition existed. Over the years, Alberta grew by the influx of hundreds of thousands of immigrants; both from overseas as well as from other provinces – in particular Newfoundland and Ontario. You’d think that the eastern influx would change the political makeup of the province over time, but the Tories kept on being elected. Not only because rural voters have more voting power per person than those living in the cities (as so skilfully rigged and maintained by the Tories) but simply because there was no political alternative. I met Danielle Smith when she was a rookie member of the Calgary School Board that visited our neighbourhood to close down our inner-city elementary school. I never forgave her for being such a puppet and for supporting the closing against common sense and the will of the people in our district. But today she has evolved into an intelligent and witty leader of the opposition. Here is a group of true conservatives (and I don’t mean of the demonized fundamentalist Christian type) that offers a slate of relatively fresh politicians, or at least a group of politicians with the balls to stand up and fight the establishment.
That and the Tory chicaneries favoring Edmonton over Calgary (no wonder the PC is doing better in Edmonton than in Calgary) may explain the rising groundswell of the Wildrose Party visa vie the Provincial Progressive Conservatives. In the meantime, anyone with a bit of common sense knows that the historical opposition losers are still not a viable alternative and their votes will only come from their party core.
I truly hope that a fresh wind will blow through Alberta’s halls of government one that maintains a pro-business climate, improves the provincial healthcare system, and that gets rid of the pork barrelling practices of a PC government that outstayed its usefulness. Whether the Wildrose party will form the next government or will form a strong meaningful opposition, i.e. a government in waiting, remains to be seen. It depends on Wildrose's political skills and maturity as well as on its leader. In my opinion, this election is for Wildrose to win and for the Tories to lose provided no mistakes are made. Knowing Alberta, the province is readying itself for another period of blistering growth – both economically and politically.

The coming real estate summer

All investments are geared to business cycles and so is real estate. A number of authors have tried to divide these cycles into stages. Authors such as Don Campbell of REIN (Canada’s Real Estate Investor Network) compared the phases of the real estate cycle to the seasons of the year: Spring, Summer, Fall and Winter. The intend behind the seasons is obvious: Spring is to recover from winter and seed investment; Summer is to grow the investment; Fall to harvest; and Winter are the tough times during which the real investor has to survive before recovery and resumed growth.

Don and REIN’s research team has created another revealing schematic to forecast the various phases of real estate investing which are based on the economics of the market you’re investing in.
Click on figure to enlarge
This is quintessential REIN; explaining a complex concept in a very simplistic looking diagram such as the one above. It basically states that the basis of all real estate appreciation lies in economic growth. You need GDP growth to create jobs; in the next 12 months or so this will result in population growth (in-migration; natural growth); followed by increased rental demand and decreasing vacancies. This in turn leads to increased rental rates and about 18 months after GDP growth resumed this will ultimately result in increased property purchases and higher real estate prices.

You could have seen the Alberta and Calgary economy starting to recover from the 2008 recession and the now long forgotten ‘Royalty Review’ of Ed Stelmach somewhere in 2009. Since then employment has gradually improved and today it is as low as 4.9% in Calgary. Also, after an actual decrease in population, it is now clearly growing again; the current rate is nearly 25,000 persons per year. We have seen a strengthening of rental demand and last summer companies such as Boardwalk, one of Calgary’s largest landlords, eliminated a lot of rental incentives. In the fall of 2011 rental rates started to increase once again. So can you read in the above diagram what the next thing will be that likely is going to recover after having fallen behind the rest of Canada over the last 5 years or so? 
Right, this is probably the last summer before real estate will heat up again – hopefully at a reasonable pace. Don’t be surprised if you see a return of multiple purchase offers by mid-2013. Right now, we’re nearing the end of Don Campbell’s Spring: rents are on the increase, vacancies are fallen; mortgage rates are at lows not seen in generations. This is your chance to become a real estate tycoon! Well… if you were ever dreaming of becoming a landlord, this is the time to start or expand your real estate empire. As Don says: “Get in front of the wave!”
I like to thank REIN and Don for their superb research and leadership – they take the guessing out of real estate investing and show you the underlying fundamentals like no-one else. If you wish to learn more about REIN and their network of enthusiastic real estate investors – all customised for Canadians – then visit their website: - it literally may change your life.

Sunday, April 1, 2012

Should I fire my full service broker?

From time to time I review my portfolio performance. With software such as Quicken that is easy to do, although I am leery of computer bugs and erroneous/inconsistent data entries. That is not to say that I do sloppy book keeping. No, far from it, every month I diligently reconcile my Quicken accounts with the actual bank and brokerage statements. But the sheer multitude of transactions as well as the categorical assignment of those transactions does lead to an accumulation of errors over time.

Also, it is difficult to assess the performance of my real estate investments since these are long term investments with a 10+ year time horizon and I have acquired a fair bit during this last down cycle that started in 2007-2008. Not to mention keeping track of rental income for which Quicken is entirely unsuitable.

Thus, let’s focus on stock market performance. To be honest, the last 5 years were very frustrating for investors and most gains scraped together during the volatile early half of this decade were wiped out in the big crash. So how are you to measure how you’re doing and how your investment advisors are doing?

When you read the financial headlines there are always the same investor star names such as Warren You-know-who and Sir John. Also Irvin Michael and Francis Chou are often mentioned as star investors. So let’s compare their performance with ours over these last tough years. This is maybe also a good time to bring up my full service stock broker, the closest thing I have to a financial advisor. Over the years he has been my devil’s advocate and kept me from various stupid moves although that is offset with some less than brilliant moves by him. Also, he oversaw a lot of my oil and gas investments while I am more heavily in financial stocks and real estate stocks plus U.S. industrials using my discount accounts.

But you know what? Quicken told me that over the last five years my full service broker only delivered me a measly 1.93% annual return. Fire the guy! I can do a lot better and safe on the commissions! So what did I do by myself? Eh…. Eu… 1.01% Fire yourself! Go to Francis and Michael!  Eh… Eu… well they may be better but they are charging MERs and operating expenses. They delivered -2.1% and -1.56% respectively. A TSX index fund would have done ‘least worst’ at an exciting 2.25%.

So, my broker (combined with my own incredible wise input J) did best apart from the TSX. But then, the TSX has good, poor and not so poor years. Some years the S&P and Dow do a lot better. Sometimes real estate blows you away. It truly is a matter of diversification and before it goes completely to my broker’s head he probably managed the best segments of the market! (Really?)

I guess, I’ll better hang on to my full service broker a bit longer and of course, I am praying for a return to the good old 1990s. Hmmm, have you seen this year’s stock market performance? A repeat performance may not be so far off, after all.

Figure 1. Five Year Performance ending Feb 29, 2012
Oh, before I forget. Five years ago was March, 2007. If you had sat out the crash you would by now have recovered had you done nothing but holding on to your TSX etf.

Was Warren that much better?

This is a follow-up to "Should I fire my full service broker?"  I guess, Warren Buffett deserves a posting by itself. How did Mr. Buffett do over the last five years, including his famous GE and Goldman Sachs deals? I guess we better don’t leave out the Burlington deal either. Well here is the long term chart for Warren:
Impressive but even Warren was hit badly in 2008. So how did he do? The answer is: 2.1% per year. Better than most but even for Warren the last 5 years delivered meagre returns.