Sunday, May 12, 2013

Buy and hold is not the whole story


This year we have focused on building 4 stock portfolios. The first portfolio is a simple ETF portfolio with Canadian (40%), U.S. (40%) and European (20%) Market Index ETFs. The second portfolio is a Low P/E and moderate dividend portfolio which is updated once per year. Then we have a dividend portfolio, which is a true buy and hold portfolio and we have discussed how to select/value investments for this portfolio in our ‘intrinsic value’ posts. We also discussed that with debt free companies such as Microsoft in this last portfolio, we may use prudently borrowed money (LTV 50%) to enhance the performance of this portfolio.  The fourth and last stock portfolio is aimed at theme and cyclical investing.
Examples are investing in undervalued biotech companies who right now are in ’bull market’ mode. Investing in pipeline companies that are benefitting from a lack of oil and gas transport capacity. Or investing in natural gas producers in anticipation of a return of higher gas prices. The same for investments in light or heavy crude producers or uranium, gold, etc. Investing in such companies can be extremely profitable. But…. they also are boom and bust! Once you have made your money, it does not pay to hold on to them as such companies themselves become disrespectful of all the money investors throw at them during booms or due to the risk of oversupply and subsequent falling prices and… consequently falling profits.

Canada’s stock market is loaded with such thematic stocks, Potash, Canadian Natural Resources, Silver Wheaton, to name just a few. Looking back over my investment life, I have made my largest profits and losses with these stocks. My biggest mistake was trying to hold on to them as buy & hold companies.  Unfortunately, the hardest thing to do is to decide when to sell these, often volatile, investments.
Well, right now, we’re again in a down cycle for many commodity based companies. About a year  or two ago, I recommended to start nibbling at the natural gas producers. Although the natural gas prices have roughly doubled from the lows of last year, this has not yet been reflected in the share prices of many of the producers. My guess is, that over the coming two years natural gas prices will stabilize around $6 to $8 dollars per mcf or per 1 million BTU. This reflects current finding and production costs plus a modest profit margin. Other than in upcoming producers such as Peyto, this is just barely reflected in the stock prices of many natural gas producers so there is still plenty of opportunity to nibble.
Oil producers and their value are more difficult to gauge. In spite of the explosion in light crude production from low permeable resource plays and the lack of pipeline capacity, oil prices have been remarkably stable hovering now for the last number of years around $80 to $90 per barrel (WTI). This is a very good price for cheap conventional oil, but the new technologies are expensive and the oil industry is still dieting off the fat from the big resource boom of 2000-2008. Apart from being segmented into natural gas and oil producers, we’re now have also conventional oil, resource oil and heavy oil producers. Only the most diversified companies such as Canadian Natural Resources are sailing relatively unscathed through all the upheaval although that is not clearly reflected in its share price. The specialized companies are much more volatile and are difficult to assess.
Yet, with the new pipeline projects inching towards approval and the potential opening of export markets outside North America, things start to become somewhat clearer. I am not sure whether China will resume its astounding rate of economic growth; but even at 7% real GDP growth, Chinese and other large emerging markets combined with improving western economies should sooner or later result in additional demand for hydrocarbons. Thus, over the long term I am bullish on the petroleum industry and suggest to invest a-la ‘nibble-nibble’ in moderate dividend paying oil producers with solid balance sheets.
In the meantime, we should keep our focus on building up our dividend portfolio as long as we can find reasonably priced companies such as Cisco, Microsoft, Wells Fargo, Proctor and Gamble, Power Corp, Brookfield, etc.

Buy and Hold works for Warren Buffett stocks but not necessarily for many Canadian Stocks.

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