Dividends

A Non-Traditional View
My viewpoint on dividends is not the traditional one.  While there are many reasons given for buying dividend paying stocks, few look at the opposing point of view.  Mine is not the popular viewpoint, so at the risk of sounding like I don't know what I am talking about, I ask you to consider what I am about to say.

Getting Paid To Wait
The classic reason for buying dividend paying stocks is because you get paid to wait.  For a less than apples to apples comparison, I suggest we look to the rental income market.  Should we insist on keeping renters who are paying the rent, but who destroy the premises in the mean time?  I think most landlords would not want to continue their relationship with renters who are costing them money.  Yet,  when it comes to investing, we are expected to waste capital in the event the stock price goes lower in order to gain income.

Dividend Support
No worries, they say, "Dividend paying stocks lose less than other types of stocks in a downturn!"  Our single largest advantage over the pro's is our ability to move quickly.  Why would I want to hold any stock that is losing money?  In selling, the worst case is we buy it back later at the price we sold it, but normally we can buy it again at a lower price which would more than make up for any dividend.  As for losing less, dividend paying stocks also make us less, because they have to pay the dividend.  It is like a tax on our profits.

Return of Capital
Speaking of tax, I know there are many, many people who delight in receiving a tax refund.  While it feels good, all it really means is we paid too much in the first place!  Meanwhile, the government has been using our money until we later prove to them it actually belongs to us.  I look at dividends as a return of capital - money we paid to get the stock in the first place.  Why is it we are happy to get our own money back?  If
we hadn't "overpaid" for the stock to get the dividend in the first place, we could have purchased more stock!

Outperformance
Of course, dividend paying stocks outperform in the long run, but only in a buy and hold portfolio!  As I have said before, nothing says we need to hold stocks that cost us money, or under perform other stocks.  My preference is to buy stocks at a low price and sell them at a higher price.  The fact that dividend paying stocks don`t drop as much as others means it is more difficult to buy them at a low price relative to other stocks.  When the market corrects, I want stocks to drop as low as they will go, so I can buy them at a real discount!

Over-hyped?
I`m not just poking fun, here, either.  I no more consider the dividend yield of a stock I am buying than I count the number of members on the board of directors.  I neither buy a stock because it pays a dividend, nor discount the ones that don`t.  That doesn`t mean that others shouldn`t consider dividend yields, but I am not in favour of the buy and hold approach. 

I`m curious about other people`s approach regarding dividend paying stocks.  What do you do?  

Following An Investing Strategy

Playing The Odds

Would you buy a ticket in a draw that offered you one chance in twenty of winning?  As draws go, those would be fairly good odds.  If the draw was for a worthy cause, we would likely be even more inclined to buy a ticket, provided it was not incredibly expensive.  Would you still buy that same ticket if I told you I owned all of the other 19 tickets?  Most of us would not, no matter what the price.

The odds can be in our favour, or not, but that is not going to be the only thing that determines what choice we make.  Our decision is based more on our perception of the chances of winning.  This is one of the reasons it has been said that the markets can remain irrational longer than most people can remain solvent.  What does this mean to investors like you and I?

The Need For A Strategy
The first thing is we need to admit to ourselves that we are human, which means sometimes our decision making process is flawed.  Knowing that, we need to find a strategy that takes a certain amount of the emotion out of our buying and selling decisions.  This strategy needs to be one with which we are comfortable, and one that works over a longer period of time.  Not having a strategy, or not having a valid strategy (no, using horoscopes to pick stocks is not a good idea) is one of the single largest reasons people fail to do well in the stock markets.  For that matter, it is one of the single largest reasons people fail to be successful in life, itself!

Notice I described it as a plan that works for you.  There are almost as many strategies out there as there are people.  Look for a strategy that meets your personal objectives.  If you have enough money, and interest returns are sufficient, a fixed income strategy could be best.  However, few of us are that financially well off. 

Risk

Also, the level of risk associated with any strategy needs to be taken into account.  Measuring risk can get a little tricky.  For one thing, the better we understand the cause of the risk involved, the more tolerant we can become of that risk.  Risk exists in any portfolio.  Risk that we have some control over can, at least, be partially mitigated.

Let's face it.  There is risk associated with driving a car on the highway.  Mile for mile, it is much more risky than flying the same number of miles.  Yet, we still accept the risks and drive on the highway anyway, even though there may be a plane that would get us to our destination.

Using A Strategy

We need to develop a strategy that keeps the risk within our tolerance level, and helps keep us successfully on track.  Then, we need to test it.  If we develop the discipline to follow our winning strategy, we will be ahead of at least eighty percent of all other retail investors.

Do you currently have and follow a particular investment strategy?

Fundamental AND Technical Analysis

Tools of The Trade
Orienteering is a sport that requires competitors to find flags hidden outdoors by using a map and a compass to navigate a course. The map shows the contours of the terrain, and uses different colours to illustrate the type of ground cover - trees, clearings, water.  The compass is used to orient the map and to guide the competitor in a particular direction. Close to the flag, the use of the map is crucial in pinpointing its whereabouts. The course could be navigated with only the map or the compass, but it would usually take longer because it is much easier to make navigational errors when not using both.

Fundamentals or Technicals?
When I hear advisors who say they rely on the fundamentals and others who say they rely on the technicals, I often think of orienteering. Why would they want to rely on only one, or the other, when both are available to them? I suppose we have all heard the expression, "Jack of all trades; master of none," but we don't need university degrees in either area to use them effectively. We don't need to know every last detail. I think we can all agree that knowing how many pennies the CEO has in her purse, is detailed, but useless information. Likewise, knowing the number of years in a row a stock has made an uptrend in the month of September is, for the most part, of little value.

Done properly, fundamental analysis tells us what we can reasonably expect to pay for a share in any company. Likewise, technical analysis can tell us whether we are close to the beginning, or the end, of any trend in the price. Armed with that information, alone, we can make intelligent decisions about what to buy and when to buy it.

Why Not Both?
I continue to hear the talking heads proclaim they are a fundamental, or a technical sort of person - and proud of it. I understand the two types of analysis represent a different approach and mindset. They are two different ways of looking at companies. That is the strength of using both types of analysis. If they both confirm a buy decision, then great. If not, then why risk it? Would you recommend a dentist who only uses half of their tools? Imagine your dentist saying, "I don't do x-rays because I don't find them very helpful!"

The problem is the two approaches are seen as either/or instead of both/and. The fundamentalists cast dispersions on the techies claiming how much more thorough their analysis is. The technical analysts claim the fundies are not even necessary. Yet, it is not the type of analysis, which is important, but the information that each yields about any potential investment. Unless, of course, we assume there is no use trying to buy at a low price because we are almost never going to sell, anyway.

The Bottom Line
So there is the rub. Why give credence to any tool that flies in the face of the sacrosanct buy-and-hold marketing strategy? Funny thing is, I'm willing to bet that most fund managers actually pay attention to moving averages and other technical signals. It would likely have a negative affect on returns if they didn't. Doesn't it go to follow, then, that the very existence of technical analysis would dispute the notion that it is impossible to time the markets? Unless, of course, technical analysis is just a lot of creative imagination.

What do you think? Which is for real, technical analysis, or buy-and-hold? 

Money

Is there an inherent conflict between living a spiritual life and the act of making money in the stock markets?  There appears to be in the minds of some people I have met.  During my participation in one particular career workshop, people thought it was a bit strange that I would, on the one hand, talk about my spiritual values, and on the other, discuss my interest in creating strategies for making money in the stock markets.

Personally, I don't see the issue.  Mother Teresa, for example, worked with donations which were estimated to be in the millions of dollars, although nobody knows the exact amount.  You might argue that the money wasn't hers.  Funny, that is exactly how I feel about money.  It does not belong to me, I simply have the use of it.  The point I am trying to make is the difference between making money, and having money.

I want to help people to make money, rather than help them to have money, if that makes any sense.  Think of a person who is so self-actuated, so loving, so confident, so together, that they feel completely secure in giving their time and wealth to others because they feel totally assured that there is so much more waiting for them, even if they don't possess it in that moment.  This type of outlook is aptly labelled an attitude of abundance.

The one belief at my very core says every person in this world has been granted unique gifts and abilities, even if it is nothing more than an ability to inspire even one other individual person.  These gifts and abilities serve us, but I believe they are much better used to serve a multitude of other people.  I think it was Zig Ziggler who used to say, "You can have everything you want in life, if you help enough other people get what they want!"  Those gifts and abilities are less about being for us and more about being for others, through us.  If I am blessed, then I can bless others in the use of my gifts to help others.

In the "Seven Habits of Highly Effective People", Stephen Covey tells a story about the seventh habit which he calls Sharpening the Saw.  He talks about the person who is so worn out from sawing that they feel they don't even have time to conserve energy by stopping just long enough to sharpen the saw!  In the investing world, I am constantly surprised by the number of people who feel they can't afford the time to learn new strategies to make greater returns because they are too busy trying to pay their bills.

My gift to the people who ask for my help is, in the end, more money for them to do what it is they do, and perhaps, a sharper saw.  Yes, we should put away ten percent of what we make, but it is really about how to make the money we need, not about how much money we have in our possession.  When spent, our money, like our talents, has a multiplier affect around us.  If we spend our money, our time, and our talents on those who are most in need of them around us, could it be they might ensure that we will have our needs taken care of, in return?

I understand how hoarding money is not seen as appropriate behaviour.  Yet, having the ability to donate money, when we don't even have the time to give, is the best way we can help others to live in a more abundant world.  I don't see money as the real issue, but instead, what we choose to do with our money.  In saying that, I also don't believe the end justifies any means.  That is a whole other blog post!

We Can't Time The Stock Market: Urban Myth

The big debate for baby-boomers these days is how large their "number" needs to be.    How much do they need to save to earn a passive income which would allow them to "retire"?  It seems once we get past a certain age we are supposed to stop investing in the stock markets, and live off the interest from what we have saved.  That would make sense if we are simply passive investors, but what if we are actively managing our own portfolio?

The real question is how much can we earn, not how much do we need to have?  I don't know all that many people who expect to hang up the gloves and invest in a rocking chair for thirty, or forty years!  Besides, the quickest way to end one's retirement is to sit around and do nothing!  Sure our retirement is likely to lead to more leisure time, but I don't buy the financial services version of it being an event which happens to us one day, after which we make no attempt to earn anything but interest on our savings.

Sure, they would love for every one of the baby boomers to have close to a million dollars salted away, earning service charges, fees, and investment income of their own.  The truth is, only a small percentage will have that luxury.  Most are going to have to make the most of what they have and, health permitting, continue to work as long as they can.

Having said all that, I never cease to be amazed by how few people want to take responsibility for their own investment portfolio.  I get the fact they don't understand the issues, and don't have any interest in becoming an expert in financial markets.  What I don't get is why they don't become more involved, and more educated.  Why is it we can spend 80 hours a week at jobs we hate, but not be able to dedicate a few of those hours to improving our return on investment?

Maybe we can thank the financial services industry and all of those advertising dollars.  I'm still having a tough time convincing many people the best returns come from timing the market - something the "experts" and sales people keep saying is impossible!  Still, I'm going to keep telling people.  We can improve our returns and even beat the market by spending only a few hours a week.  In my mind, "you can't time the market" is the single largest urban myth robbing people of retirement savings.  It is a myth perpetrated and perpetuated by the financial services industry, for their benefit.  The sooner this myth is debunked, the better for anyone not in financial services.

Do you think there could be such a thing as timing the stock markets?  If not, what would it take for you to change your beliefs?

   

Investing Seasonality

Nasdaq Composite

I am not one to make my investment decisions purely on the basis of seasonality.  I do watch for seasonal trends.  One of the best ways of monitoring what's in season, and what isn't is to check http://www.equityclock.com/.  From the main page click on the Seasonality tab at the top.
We can see from the list of Primary Sectors that the Information Technology sector is normally strong from October 9 to January 17.  If we look at the chart for the Nasdaq Composite we can see the momentum has carried right into the end of February.  Missed it, right?

No, since I believe the markets are due for a correction anyway, what better way to play the decline than to choose the sector which has just recently peaked?  More bang for the buck, so to speak.  The easiest way to do so is with the Horizons' Nasdaq 100 Bear ETF.  The ticker symbol on the TSX is HQD.  Although I like to use these ETF's, I have to warn others who might want to that they use leverage.  In this case, for every single percent the Nasdaq 100 falls, this particular ETF will gain around 2 percent.  I say around 2 percent, because this type of ETF does not always track the underlying index perfectly.

In a very exaggerated example, think what would happen if the market rose by 25 percent in one day.  This would mean the ETF should drop 50 percent (2 times).  The next day, if the market dropped by 25 percent, the market would be around 94 percent of where it started.  The ETF, on the other hand, would lose 50 percent, then gain 25 percent (50 percent of 50 percent) and only be at the 75 percent level of where it started.

This is one trade where timing is everything.  Success will depend entirely on getting in and getting out at the right time.  With the help of seasonality, and technical analysis, it can be a very lucrative trade.  Still, if it goes wrong, the key is to recognize that fact, and just unwind the trade.  Any time a trade is costing me capital, I have to be doing it wrong!

Paying attention to market seasonality is one way we can identify setups for profitable trades.

If you had to choose one thing which, to you, is the most important advantage the retail investor has over the larger institutional investors, what would you choose?  I hear lots of talk about the advantages the institutional investors have over us - research, resources, time, money, and education, to name a few.  What would you say is our largest advantage? 

Certainly, the lack of politics and red tape would be one.  If you have ever worked for a large company, let alone a large financial services company, you know how politically charged the atmosphere is.  I don't mean politics in the sense of government, either, although regulation would count as a major drag on productivity that the retail investor doesn't have to face.  Some might argue there has been a lack of proper regulations put in place, but I would say they are there.  It's just that they have not been enforced.

Not being tied to a particular mandate is another advantage for the retail investor.  Sector and index fund managers are limited as to what they can invest in.  Some might say the problem for retail investors is they can be all over the map and lose capital by churning their investments.  They hold one product just long enough to lose more money before switching to the next.  As I see it, though, one of the biggest disadvantages for fund managers is the limited amount of cash they can normally hold, even at the worst of times.

The retail investor also has the advantage of not having to chase returns.  Fund managers aren't going to receive any bonuses if they don't finish at the top amongst their peers.  They have their tricks they can use to put the best light on their results, and to catch up to the herd, but playing catch-up can also force them to make mistakes.

There is no doubt in my mind the single largest advantage retail investors have is size.  Institutional managers can take weeks to move into, or out of, a position.  It usually takes me a day - two or three at the most.  It can take fund managers weeks to buy enough stock.  The size and duration of their trades make what they are doing fairly easy to see.  Nobody needs a microscope to spot an elephant.  Using the charts, it is easy to see where the big money is headed.

Even though I feel the speed with which we can run circles around the big managers is our single largest advantage, most people don't even try to profit from it.  I'm not necessarily talking about day trading, either.  In fact I think day trading has become a whole lot harder because of high frequency traders and program trading.  Still, buy what the fund managers are buying, and sell when they are selling.  You and I can't generate the volume required to show up on the charts, but they always do.  That doesn't mean we have to be in and out every day.  It means we need to tune out the incessant chatter, a little, and watch for the underlying trends.

Tim Horton's Timbits hockey has a different purpose and has different objectives than the NHL games.  Believe it or not, retail investors have a different objective than the professionals do - to make us money.  Don't get me wrong, financial firms like it when we make money, it just isn't their top priority!  I, for one, believe that when it comes to exploiting our advantage, size does matter.

Do you feel we have any advantage over the pros?

Analyst Ratings

Analyst ratings are not useful in helping us determine if we should buy a stock.  A buy rating by itself means nothing.  How and when an analyst changes their rating can be informative, but I never go by ratings.

Analysts are real people too.  They only have so much time in the day, just like you and I.  There is no possible way an analyst can provide ratings for hundreds and hundreds of stocks.  Jim Cramer on CNBC's Mad Money recommends we spend at least an hour a week on each stock we invest in.  The point is even an analyst can only rate a limited number of companies.

Buy-side analysts research companies for fund managers.  The purpose of a sell-side analyst is to provide a compelling case for owning particular stocks.  If there is only so much time in the day, then some of that time can be used to rule out some of the candidates, but the remainder of the time has to be spent building a case for buying others.  In a finite universe of companies, some will always be sells, some holds, and others buys.  In other words, it is less about absolute performance, and more about relative performance - how one company will perform compared to another.  If we are in the middle of a bear market and the prices of stocks are plummeting, it is cold comfort to know that my stock has crashed to a lesser degree than a competing stock.

Yet, the analyst always has to have a buy recommendation.  That is their job!  In addition, analysts work for firms that have business relations with companies that want to go public, or issue new shares, or raise money using their services.  When an investment firm provides money to a company for an initial public offering (IPO), the investment firm needs to find buyers for the stock.  Have you ever received one of those calls where some advisor you have never met before wants you to buy the hottest stock since, well, ever?

Analyst ratings affect the price.  Watch for times when an analyst has it wrong and continues to raise their target price despite not liking the stock.  At some point that same stock could get so strong relative to their other ratings, they have to change from a sell, or a hold, to a buy.  When that happens, it will normally be good for the price of the stock.  Watch for any change in earnings estimates.  That is a good time to reevaluate our own target price and how many shares of a stock we might want to own, if any.

I aggregate the earnings estimates to determine a fair price for a company's stock.  If there is a herd instinct among buyers, it can also be said for analysts.  When everyone is saying the same thing, I check for alternative scenarios.  I would never buy on somebody else's say-so, and especially not on an analyst's buy rating.

Do you use analyst ratings?

Price Earnings Ratio

Price = earnings times average p/e ratio

Personally, I would never consider buying stocks in a company simply based on the recommendation of someone else.  Still, I get questions from friends about buying this stock, or that, based on a phone call they received from some "well-intentioned advisor".  Usually the story is pretty compelling, and there is always a sense of urgency to get in before it is too late.

While I struggle to comprehend the value provided by sell-side analysts, I suppose their value is not lost on firms trying to engineer the case for buying the next hot stock.

There is one piece of information those analysts provide which I do use.  It is the annual earnings number.  These people know and follow their companies better than I ever could.  They crunch the numbers and come up with an estimate for company earnings for the end of the next year.  I don't rely on any one estimate, but I do look at the average of all of the estimates for a company.

For that reason alone, if a company does not have an analyst following it, I won't buy it.  I am only interested in owning companies with a long enough track record and sufficient size to have analyst coverage.  How else can we put any probability on what the company is going to do in the future?  How many times have I seen people lose money in the stock of companies that never made a single cent?  Never mind the hype and the hyperbole, show me the money!

Did you pay full price for the vehicle you are currently driving?  If so, why?  They want our business, and will make concessions to get it.  Do you buy groceries and pay full price when you know there is a sale coming up for the same items, or a coupon which is good at a future date?  Why should we purchase any stock unless it is on sale?

Any company I would be interested in, has to have a track record, have a couple of analysts covering it, and it has to have made money for, at least, a few years.  I have no desire to own penny stocks, or hopeful wannabe's.  The companies I want to own have a great, if not the best track record in their market.  Since I know the future earnings numbers and I also have historical price to earnings ratios, I can calculate what the price of a single stock is worth.  Earnings per share multiplied by the historical average for the price/earnings ratio equals what the stock is worth.  If that is the current price, why would I buy it?  The lower the current price is below the result of my little calculation, the more interested I become.

Don't take the recommendations of other people, especially those trying to sell something.  We need to do our own homework, and calculate what the stock is worth.  Myself, I still wouldn't run to the computer and buy it without, first, doing some technical analysis to figure out a good point in time to buy.  Regardless, unless it is on sale, I won't even consider it.       

Producing Ethanol

It can be interesting how, once information makes its way onto the internet, it can be perpetuated long after new information contradicts it.  I recently read how forty percent of the corn crop grown in the U.S. is being used in the production of ethanol (google: "40 percent of corn used in ethanol").  As a result, there is concern about corn prices, and even wheat prices being forced higher.

When I researched further, I found it interesting to find how little of what I had been led to believe in the past was true.

Myth Number 1:  The use of corn to make ethanol is driving up the price of grains.
Prices may be up, but it isn't necessarily because corn is being used to make ethanol instead of being used as feed.  Corn is mostly used as animal feed, and the corn that is used to make ethanol can still be added to feed.

Myth Number 2:  It takes more energy to make ethanol than ethanol produces.
According to calculations using modern farming procedures and modern production techniques, it is currently estimated that ethanol contains at least 30 percent more energy than it takes to make it.

Myth Number 3:  Using all of the farmland in the U.S. to produce corn for ethanol would only meet 4 percent of the energy needs of that country.
Ethanol burns cleaner and is therefore better for the environment.  The carbon dioxide that is given off in the fermentation process can be captured and used, or stored instead of being released into the atmosphere as when burning hydrocarbons.  Any reduction in green house gases should be seen as good.  We spend money on wind and solar.  They will never meet the total energy needs of the U.S..  Does that mean we shouldn't bother?

Myth Number 4:  Corn grown to produce ethanol is ruining the farm land and wasting water.
That is like blaming nuclear power plants for nuclear bombs.  The real problem lies in proper farming practices, not in the type of crop being grown.  It is okay to grow corn for feed, but it is not okay to grow corn to produce ethanol and then use the corn for feed.  Why?

Myth Number 5:  The high price of corn (because of ethanol) is driving up the price of meat.
As stated before, the more corn that is grown for ethanol production, the more of it is available for feed.  How does that increase food costs?

Myth Number 6:  Ethanol production is only viable because it is subsidised.
With corn at $3.00 a bushel, it is believed to be competitive when oil is at $70.00, or more, a barrel.  The price of corn has risen to twice that recently.  How much should we expect to pay for a barrel of oil in another year?  Two years?

All in all, I am sure the production of ethanol is having some affect on corn prices, but to say the current price of food is because of ethanol is, in my opinion, irresponsible.  Then there is the question of whether it is a good idea to subsidise the production of crops for energy.  We subsidise other forms of alternative energy, why is this example such a particularly bad one?  If we really want to be efficient in our land use, we should stop growing corn for feed, eat less meat, and grow more human food.  Why don't we do that?

Rather than debate the real facts, we end up with a whole lot of misinformation for, and against.  This is exactly what I warn against when trying to decide where to put your money in the stock market.  Identify the relevant data, verify it, check for hidden agendas, and don't listen to all of the unsubstantiated double talk.  By knowing what to look for we can avoid a huge amount of irrelevant, and misleading "noise" and focus, instead, on the important facts that can give us a real return on our money.

Was it only me?  Had you heard of any of these myths about ethanol?

February Portfolio Update

Year To Date Returns

Despite having taken my gains from the decline in gold stocks, I gave up those gains by being ahead of the pending market correction.  I have put money into inverse ETF's (they make money when the underlying index goes lower) since everything I have learned about these markets tells me we will end up lower than we are now.  Nobody can call the exact top for the markets.  In this case, it turns out I was too early. 

Even though the saying is that the market can stay irrational longer than one can stay solvent, I still expect to make up the difference, and then some, in the longer run.

The Basic Timing Model is doing slightly better than the TSX index as money makes its way into the stocks for larger companies - many of which make up the XIU ETF.
 
Two month return for TSX @ Feb. 28, 2011 = 5.37 percent
Two month return for Basic Timing Model using XIU = 5.4 percent
Two month return for Advanced Timing Model (my returns) = -2.7 percent
Money for charity = $411.27