Are you willing to invest in oil company stocks if you had the money? A new poll commissioned by Edward Jones revealed only 23% of Canadians would! Whereas Calgarians were most likely to invest in oil at 40%, Quebecers were the least likely group at 10%.

Why?

Why are 77% of Canadians not interested in oil company stocks?

With oil companies dominating the headlines with mostly bad news, I think that by the end of July Canadians were fed up with BP’s oil spill fiasco in the Gulf of Mexico, followed by Enbridge’s ruptured pipeline in the Kalamazoo River in Michigan. Add to that a string of bad publicity aimed at the oil sands of Alberta and you got yourself an answer.

I can understand that while the result represents a reaction to the afore-mentioned events, it by no means justifies ignoring the Canadian oil sector totally for the following reasons:

Growing Demand: The combined populations of India and China represent one-third of the world’s total population but only account for 12% of global oil consumption. In comparison, the U.S. represents 5% of the world population but uses 25% of its oil. As these economies grow, they will be consuming more and more oil as they buy more cars, ships, planes and machinery. Keep in mind that they would like to reach the same standard of living we enjoy over here which will place a lot of pressure on supplies in the future.

International Exposure: Oil is an international commodity that gives you exposure to world markets. Many developing countries are increasingly dependent on oil as a cheap source of energy to fuel their economic growth.

Sector Diversification: A balanced portfolio with sector diversification is recommended having 15% in the energy sector. Holding a mix of Canadian integrated oil and gas companies would improve diversification and enhance returns.  One can pick a set of stocks or simply choose from a number of ETFs trading on the TSX.

Political Stability: By investing in Canada you do not have to worry about political stability unlike investing in far away lands under dictatorship regimes. You will be paying a premium in comparison to companies established overseas but this will be offset by reduced currency risks.

Currency Risk: You don’t have to convert your dollars into another currency in order to invest in this commodity. Moreover, the price of a barrel of oil will move inversely to any devaluation to the currency used for pricing.

Sector Stability: It should be noted that Canada has the second largest reserves of oil after Saudi Arabia and is the top exporter of oil to the USA. As such, the Canadian oil companies won’t be disappearing anytime soon.

Would you consider investing in the Canadian oil sector now?

If you wish to learn more about the case for oil be sure to read The Fundamentals of Investing in Oil. Besides the oil sands, Canada has one of the hottest oil plays in North America: Alberta’s Cardium Formation where several intermediate and senior Canadian companies are operating.

About the author:

Mich is the author behind Beating The Index: a personal finance blog with a focus on energy stocks and precious metals. You can follow his fight with the TSX as he tries to beat the index with a DIY approach.   Please subscribe to his RSS feed here.

This post has been written by Mike from Green Panda Treehouse. He is a financial planner and run several finance blogs within his online company. If you like this post, make sure to stop by Green Panda Treehouse and subscribe to his RSS feed.

When I contacted Mike to write a guest post at Money Smarts Blog, he asked me if I could share my vision on leveraged investing. I thought it would be a great idea to share my experience, as I bought my first house through leveraging and I also implemented the Smith Manoeuvre Strategy with my HELOC.

A few years ago, I was working as a banker in a very special sector; we were granting investment loans. I started in this new department back in 2003 and left at the beginning of 2008 (sounds like I may have known something back then ). During those four years, I had helped structure financing for at least 200M$ in investment loans across Canada. During the last 2 years of work, I was working exclusively on investment loans over  500K.

Making money with the stock market was as easy as picking berries during summer time, the interest rate charged on investment loans was extremely low (prime +0% in most cases) and the only fools were the ones who were getting 5% on their GICs!

Only a few months after I started, I opened a 20K line of credit for myself and started my leveraging strategy. Between 2003 and 2006, I made enough money to put a nice cash down payment on my first house. Fortunately for me, I had stopped while the markets were still high.

2008 – The Year When People Cried when They Learned What a Margin Call was

I left the lending side in 2008 switching to a financial planner career opportunity. I remember the discussions I had with the guy I had trained to be my replacement as senior advisor on the leverage team. All he was doing, day in & day out, was margin calls. What is a margin call anyways? This is the worst call you can get apart from the police calling to tell you that your wife is dead:

“Hello, may I speak to Mr. Leveragedboy?”

“Yeah, it’s me”

“My name is Mr. Bad Ass Banker and I am calling to request the amount of $75,000 to be deposited in our account by the end of the week. If you don’t we will have to sell all your (losing) positions to pay off your investment loan”.

Silence on the phone…

A margin call is basically when the value of your investment goes lower than the level required by the bank. For example, if you have a margin clause at 0.90 and you invested $100,000, you will be required to maintain (at any moment) a minimum of $90,000 in your investment account. What happens when the market loses 10% within a week?…. well this is when you get a margin call!

In fact, this is what had caused a part of the high volatility levels of the market investors suffered during the last months of 2008 as Hedge Funds received margin calls for several millions of dollars.

After the Storm, the Sun Rises Again

Capitalism almost died of a heart attack in 2008, but survived the ride and was reborn sooner than expected in 2009. Now that we are slowly emerging from the fear of seeing the old continent going bankrupt, we can hear the evil words “borrowing to invest” coming back to our ears like an old Beatles song.

Markets are low as investor hesitation is still present and interest rates are still low too. This sounds like the perfect match for another investment loan rally! In any case, I seriously think it is a good time to borrow money to invest.

Why I think it is the Right Time To Leverage?

While people who had borrowed money in 2006 are still paying interest without really understanding why they had done such a “stupid” thing since their investments are still in red, I think it could be the perfect time to start a new investment loan. I agree that this technique is not for beginner investors, but if you know what you are doing, leveraging should be considered.

Here’s why:

1. US companies are showing strong results but investors fear the market so they still undervalued.
2. We have a strong dollar which allows us to invest in both Canadian and US currencies.
3. Interest rates are still low.
4. There are several high paying dividend Canadian stocks on the market. Enough to build a strong investment portfolio where dividends will pay more than interest costs.
5. The level of liquidity (i.e. money sitting in cash accounts or money markets) is still very high. Once the fear is gone, we might see another peak in the markets.
6. You now know what losing money means (if you were in the market in 2008) and have seen what happens if you stay in while people are selling (during 2009). You are now fully prepared to live with the leveraging risks.
7. The most important reason of all: because everybody thinks it’s stupid to leverage! Buy when there is blood on Wall Street… and that’s all I e to say folks

If you like this post, make sure to stop by Green Panda Treehouse and subscribe to the RSS feed.

I’ve previously posted about if passive income really exists.  Whether or not it does, as viewed from the personal finance community at large, there is a rabid interest in it.  I can understand the appeal, some work is done setting things up and result in the creation of a “financial perpetual motion machine” that throws off money every month.  Build enough of these machines and you can retire to sitting on a rocking chair, sipping lemonade and musing about how it’s good to own investments.  Sign me up!

All sorts of MLM or investment schemes get people pumped on the idea of becoming independently wealthy.  Sadly, often part of this is also providing them with flimsy ethical justification to take advantage of people (sometimes including friends or family).

“Rich Dad, Poor Dad“, “The 4-Hour Work Week” and “A Million Bucks By 30” each got people quite excited about their ideas, but also raised some ethical concerns.  Is rushing headlong towards passive investing a reasonable excuse for bad behaviour?

Years ago a buddy of mine got really excited about “The 4-Hour Work Week” and was talking about some of the ideas.  He’s an INTENSELY ethical guy (most of our conversations have been about spiritual and family duties) and I was a little taken aback when he talked about streamlining his job responsibilities to 5 hours a week and doing business development, at the workplace, for himself the rest of the time.  When I asked him if he didn’t feel it was an implicit obligation to do his work efficiently and then use the time for his employer, he got a sly smile on his face and said “if I can get the work done in less time, then don’t I deserve to use the saved time for my own projects?”.

Fast forward a couple of years, and I asked him how his 4-Hour Work Week projects were going and he said he’d abandoned them.  He’d found, in the end, that the approach was driving him to make life choices that he wasn’t comfortable with.  He related some anecdotes about a partner he’d been working with, who he felt was also a very moral, ethical person, who had become obsessed with passive income to the point that it was damaging his life.

I’m certainly not claiming that people after passive income are the only ones who get money hungry or behave unethically, but there seems to be a surprisingly high correlation (in my experience).  Gurus offer some lame justification like “once you’re rich you can start a charitable foundation!” and otherwise sensible people start behaving badly.

When Roosevelt introduced universal retirement pensions as part of the New Deal in the US in the 1930′s, retirement was a pretty radical concept.  My father talks about how his grandparents felt like they’d won the lottery when they got their first pension check (in the 60′s here in Canada).  It seems pretty typical from a modern perspective, but the idea of being given a stipend and turned lose to relax for the rest of your life is a very modern idea.  In the past, family members would each contribute to the degree they were able (including the elderly), and family or savings was what would take care of you if you became too ill to do anything useful (otherwise you’d work).  Early retirement pushes this up even sooner, with young people dreaming of the life of Riley.

At the time of the New Deal, the retirement age was around the life expectancy, so only about half of Americans could reasonably expect to collect a pension (and most who did would die soon afterwards).  With ever climbing life expectancies, we now have retirements that can be expected to last decades (along with the large expenses to the system to provide this luxury).

I’m a pretty open minded guy, and if someone isn’t hurting other people, I take a live and let live attitude.  If sitting around in your undershirt drinking beer all day appeals to someone in their 30′s as what they want to do with the rest of their life, “go for it!” is my gut reaction.  But, will doing so make them as happy as they expect?  There have been research studies that show the typical retirement has negative health impact.  Maybe, as appealing as it sounds, becoming useless isn’t good for us? (to be completely honest, there have been other research studies that didn’t support that retirement was correlated with health issues, but they don’t support my post as well as this paper does ).

A number of people seeking passive income and early retirement would protest at this point that they don’t want to sit around in an undershirt (hopefully they’ll still drink too much beer).  They’ll say they plan to:  volunteer, go back to school, run a non-profit, write a book, etc, etc, etc.  I’m sympathetic to this:  3 years ago I even wrote a post detailing wanting to do some of these very things, for an early retirement!  While discussing this with a friend, she made the astute observation that I didn’t need to retire to go back to school (and here I am today, half way through a PhD program).

Perhaps, rather than trying to get passive income before starting to live our lives, we should instead consider how we could earn enough to survive, while doing what we want to do.

I recently did a review of ShareOwner discount brokerage, which promotes regular dividend stock purchases.  One thing that came out of that review, is that regardless of how cheap the trading costs are – regular purchases of stocks are quite expensive.

In this post, I’m going to discuss some strategies to buy dividend stocks (or any other kind of stocks) in the cheapest manner possible at discount brokerages.

Some low cost strategies for buying stocks

1. Buy one stock at a time.
2. Buy less often.  Save up for your purchases until the commissions are less than 1% of the purchase price.
3. Shop around for lower account administration fees.
4. Pick the appropriate brokerage for trading fees.

1)  Buy one stock at a time

If you want to make regular purchases with your money, then don’t buy more than one stock each time.  For example if you have $500 per month to invest and a portfolio of 5 stocks to add to – just pick one stock each month and buy $500 worth of that stock.  Regardless of your trading costs, doing one trade per month vs five is 80% cheaper.

2)  Save up your money and buy less often

If you can handle keeping some cash in your trading account for a while, then how about saving up your coins for six months and then make some purchases.  If you have been purchasing stocks monthly and then switch to twice a year – your trade costs will be reduced by 83%

3)  Shop around for lower account administration fees and other costs

Annual administrative fees vary quite a bit between financial instituation and between account types.  At Questrade, there are no account fees regardless of the type of account or your balance.  Most of the big banks charge $50/year in fees until your account balance is greater than $25,000.  ShareOwner has no account fee for their unregistered account, but their annual RRSP fee is a whopping $79.  ShareOwner also charges “withdrawal fees” which are applied if you remove money from your account.

4)  Pick a brokerage that fits your trading patterns.

I picked Questrade discount brokerage because they meet my needs and are the cheapest brokerage in Canada.  The trades are $4.95 and there are no annual account fees.  However, it’s important for investors to look at their own situation when deciding on which brokerage to use.

If you like to buy several stocks at a time, then ShareOwner might be the best choice.  They have a maximum fee of $40 per trade batch so you can make a purchase in 40 stocks and it will only cost $40.  Bargain.

Active traders have to look at costs, but they also need to consider the trading platform.  There is no point in saving $4 per trade if the best available trading platform doesn’t allow them to trade the way they want to.  If you like to get more services, such as research reports then you might have to go to a more expensive brokerage.

Converting currencies? Interactive Brokers has the cheapest currency conversion rates by far.  However, don’t even think of opening up an RRSP at IB because they don’t have them.

Any other suggestions on what to look for in a brokerage?

This post is a review of Canadian ShareOwner Investments Discount Brokerage, otherwise known as “Share Owner”.  I’ll be looking at the costs and comparing various scenarios with the cheapest Canadian discount brokerage Questrade.

What is Share Owner?

Canadian ShareOwner Investments is a different type of discount broker.  It is the only broker that allows you to set up regular purchase plans for stocks and allows you to buy fractional shares.  It promotes regular investing on it’s website, which sounds like a good idea, but I’m not so sure that regular contributions and stocks should go together.  ShareOwner started in the 80′s, and at that time were fairly ground-breaking since they were a very cheap option for buying stocks.

ShareOwner has a limited pre-selected list of stocks and ETFs you can buy – they are mostly Canadian and US dividend stocks and some ETFs as well.

One of the big advantages of ShareOwner is the fact that you can automate your purchases.  For example, maybe you would like to buy $250 per month of a certain stock?  With ShareOwner, you can set that up quite easily.

However, when I took a look at the overall fee schedule, I was less than impressed.

Some stuff I didn’t like

The trading costs are $9.95 per trade which is no bargain.  At Questrade, the trade would be $4.95.  There is a limit of $40 per “order” so if you do a purchase of 9 stocks or more then it would be cheaper than Questrade.

Account administration costs were high as well.  The non-registered account doesn’t have an annual fee which is good, but all the other account types have high fees.  $79 for RRSP, $100 for RIF or LIF accounts.  RESPs are not offered.  Questrade on the other hand, has no annual admin fees.

The fee which I thought was most unusual was the “account withdrawal fee“.  This is a fee charged if you want to remove money from the account.  It is $12 for a non-registered account, a whopping $48 for a RRSP account and $100 for a home buyers withdrawal!
I’ve never heard of any other brokerage charging a fee for account withdrawal.  This fee is charged on top of trading fees so if you sell some stock in a non-registered account and want to withdraw the money, the trading fee will be $9.95 and the withdrawal fee will be $12 for a total of $21.95.  The same action would cost $4.95 at Questrade.

Let’s take a look at some scenarios and see which brokerage is better.  Keep in mind that these scenarios assume you want to do monthly purchases in several securities which is not the cheapest way to buy stocks.  A future post will go over some cheaper strategies.

Scenario 1 – buying a few stocks every month

Investor wants to invest $350 each month, spread out into three different stocks.

Questrade total fees for one year would be 3 x $4.95 x 12 = $178.20 which represents 4.2% fees on the purchases.

ShareOwner total fees for one year would be 3 * $9.95 * 12 = $358.20 for an open account which is 8.5% of the purchase price.  For an rrsp account the total charge would be $437.20 which is 10.4% of the total purchase amount.

Winner: Questrade.

Please note that both these percentages are excessive – buying stocks on a regular basis is not a cost-effective strategy, unless you are buying large amounts ie $1,000 per stock per transaction.

Also note that using this method of purchase, you would need to have $17,820 in the Questrade account to get the total fees down to 1% of the assets.  In the open ShareOwner account you would need almost $36,000 in assets to bring the total fee down to 1%.

Scenario 2 – buying a large number of stocks every month

Investor wants to invest $350 each month, spread out into 12 different stocks.

Questrade total fees for one year would be 12 x $4.95 x 12 = $712.80, which represents 17% fees on the purchases.

ShareOwner total fees for one year would be $40 (max) * 12 = $480.00 for an open account, which is 11.4% of the purchase price.  For an rrsp account the total charge would be $559.00 which is 13.34% of the total purchase amount.

Winner: ShareOwner

Clearly, the advantage ShareOwner has is the $40 maximum commission.  If you buy 9 or more stocks at a time, then ShareOwner will be cheaper than Questrade.

Here are some pros and cons of ShareOwner:

Pros of ShareOwner

• Automated transactions which aren’t available anywhere else.
• Can purchase fractional shares.
• Trading costs are reasonable, especially compared to big banks.
• No minimum investment amount.
• “Philosophy of investing” – they do some stock selection for you.

Cons of ShareOwner

• Limited selection of securities.  If you want the big dividend players, however then you should be able to find what you want.
• Dividends must be reinvested.
• RRSP annual administration fee is $79.  Even the big banks charge less than this.  TFSA annual fee is $50 and RIF/LIF annual fee is $100.  This is not competitive at all.
• Account withdrawal fees are $12 for open account, $48 for RSP, $25 for TFSA. Home buyer withdrawal is $100!???
• The purchase automation might be convenient, but I think if you are buying shares in individual companies that you should be more hands on.  If you really want a minimum effort investment plan, then do a couch potato portfolio using TD e-funds.

Summary

ShareOwner is fairly unique broker that comes with it’s own investing philosophy and education if you wish to use it.  The trading fees are ok, but account admin fees and withdrawal fees are excessive.  I really don’t like how they promote regular purchases and then charge $10/purchase.  This is not a good way to invest.  In a future article, I will be covering some much more cost-effective methods for dividend stock investing.

If you are only looking to do the occasional purchase and no withdrawals in a non-registered account, then ShareOwner is not a bad choice.  Otherwise, shop around.

More articles on ShareOwner

The GlobeAdvisor did a pretty good review in 2008 – note that the fees have changed.  Here is a list of updated fees.

An Insider’s look at Canadian ShareOwner at Money Energy who likes the service.

Couch Potato Blog did a two part review of ShareOwner:

ShareOwner: A better way to buy ETFs? Part 1 shows how setting up an ETF portfolio is cost effective for a minimum portfolio of $4,000.

ShareOwner: A better way to buy ETFs? Part 2 concludes that ShareOwner is better suited to stock pickers, rather than couch potato investors.  The high costs are also noted.

One of the complaints often heard about the investment industry is lack of disclosure about compensation.  It is up to clients to ask their financial adviser how they are compensated, and even then it might be difficult to verify if the adviser is telling the truth.  The reality is that compensation has a huge impact on the investment recommendations by advisers.

It would seem that more disclosure is the obvious answer, but according to one study I read, it might not make much of a difference in the actions of clients and might make the advisers even more biased.

My wife is currently reading the book Why We Make Mistakes by Joe Hallinan.  This book is similar to quite a few other books I’ve read that analyze why we make the decisions we do.  Books like Your Money Or Your Brain, Nudge, Sway, Paradox of Choice and many others look at various situations we face and try to figure out why we make consistently irrational decisions and what we can do about it.

She pointed out one section of the book to me that refers to a study done by George Loewenstein from Carnegie Mellon.  He wanted to evaluate the effects of conflict of interests disclosure from advisers, on the decision making of their clients.  The study is call “The Dirt On Coming Clean – Perverse Effects of Disclosing Conflicts of Interest“.

The study

His study used volunteers who played one of two roles – the “Adviser” and the “Estimator“.  Estimators had to estimate how much money was in a glass jar and were rewarded for accuracy.  Advisers were provided with more information than the estimators and were instructed to give advice to the estimator in order to help them estimate more accurately.  Each Adviser provided an estimate to help the Estimators.

The Advisers were divided up into two groups – one set of Advisers were compensated according to how accurate the “client” estimated the amount of money and the second group was compensated according to how high the “client” estimated – accuracy didn’t matter for that second group.

Another test was that the conflict of interest that the second type of Adviser faced was disclosed to some, but not all of the Estimators.

The results

The actual mean jar value was $18.16.

• Advisers who were compensated on estimator accuracy estimated an average of $16.48.
• Advisers who were compensated on high Estimator estimates, but conflict of interest was not disclosed estimated an average of $20.16.
• Advisers who were compensated on high Estimator estimates and disclosed their conflict of interest estimated an average of $24.16.

It’s fairly obvious from the results that compensating the advisers for encouraging a higher estimate influenced their behaviour.  What was more surprising is that disclosing the conflict of interest actually increased the bias even more.

Lowenstein says that “moral licensing” is one of the reasons this happens.  Basically this theory says that an adviser with an undisclosed conflict of interest will feel guilty enough about it that they will try to “do the right thing” to some degree.  By disclosing the conflict of interest, it allows the adviser to do whatever they want since they have admitted the conflict and therefore don’t have to feel guilty about it anymore.

On the Estimator side, Lowenstein showed that although the Estimators did discount the advice from the Adviser when the conflict of interest was disclosed, they underestimated the severity of the conflict and the estimates were less accurate compared to the estimates provided where there was no conflict of interest.

Summary

Lowenstein concludes that conflict of interest disclosures may not have much benefit, and can even backfire and produce more distorted estimates as a result.  He concludes that the best way to deal with a conflict of interest is to remove it.

In Britain, financial advisers are not allowed to receive commissions.  This doesn’t mean they don’t get paid – just that they have to charge their clients directly instead of being paid by a third party, such as a mutual fund company.

What do you think?  Should financial advisers be more open about disclosure or should commissions be banned like in Britain?

As I’ve articulated before, I’m not a big fan of timing the stock market, and everything I’ve read about the efficient market hypothesis (that stocks are rationally priced at all times based on the sum of everyone’s understanding of the market) makes sense.

That being said, there also seems to be a great case against selling when markets fall, or buying when markets are very bullish (going up fast). Following the market sentiment apparently can erode the gains many investors could have made. The average investor supposedly made around 6% annually in the market during the 90′s, when the market as a whole was gaining 16% annually. The explanation for this was that most investors were following the “hot money” and buying things AFTER they’d increased in value.

The general advice seems to be that the best thing to do would be nothing.

Given this, if its a bad idea to sell after the market has dropped like it has recently, wouldn’t it make sense that now is a good time to buy? If people lose money selling in fear after a drop and buying in greed during a bull market, it seems to me that doing the opposite should be a good idea. This is often called a contrarian strategy and while I haven’t read much of an objective critique of it, I imagine the investors I admire would claim that its just another form of market timing.

My strategy is to buy from a pool of stocks that have a long history of uninterupted, increasing dividend payments. I currently own BMO, NA, ROC and RUS (this one was a mistake, I somehow got it in my head that it fit my criteria, and afterwards realized its a cyclical). After a price drop, it seems rationale to try to scape together more money to buy more of this (since if I figured they were worth buying at X, they should definitely be worth 90% of X).

I believe the conventional wisdom though, would be to just keep buying on my regular schedule and not try to buy extra (i.e. time the market).

Yesterday Mike reposted an old blog post from my previous blog.  Commenter Adam correctly pointed out that it was quite muddled, to the point of almost being unreadable.  As a gesture of atonement, and to hopefully prove I’ve learned a thing over two over the last three years, I want to take another shot at what I was trying to get at in that post.  And I won’t use any parenthesis!  If you want to play along at home, read yesterday’s post before you read this one.

There are a massive number of statistics which are tracked for most publicly traded companies.  From price, to revenue, to dividends, to volume.  There are a number of ratios and other derived values which investors have also come to base investing decisions on:  from price-to-earnings, to dividend yield, to moving averages.

Different investing styles place greater, or lesser, weight on each of these values and ratios.  Moving average, for example, is a classic technical trader technique, while price-to-earning is a core component of fundamental analysis.  Each investor who follows one of these metrics has a great story why the indicator they believe in gives greater insight into the true value of a market and leads them to beat it.  Joel Greenblatt’s “The Little Book That Beats The Market” presents an investing strategy built on earnings yield and return on capital, Derek Foster’s first two books were built on the idea of investing based on dividend history, while Phil Town’s “Rule #1” details a slightly schizophrenic blend of technical *AND* fundamental techniques.  The famous Graham number, still in popular use by the likes of Tom Connolly and Warren Buffett, is calculated using earnings per share and book value per share.

All these strategies sound pretty impressive when you read about them for 150 pages or so.  Results are typically given which make the reader confident he’s figured out a back door to making big bucks in the equity market!  Sadly, things often don’t play out that way.  Any strategy can outperform in certain market conditions, but they also can take a beating and under-perform in other market conditions.

Beyond any specific problems with strategies, I’m suspicious about the data they’re based on.  Some metrics and the ratios based on them, such as dividend yield, are known.  Price is a record of the value a stock was assigned in a specific trade and is a known value.  Similarly, dividends are cash that actually show up in investor’s bank account.  These are known, real values.  In contrast, a number of metrics are self-reported by companies, who often have a vested interested in presenting a certain perspective on the company’s financial health to the public.  Beyond the self-reported values, other values are from stock analysts who make predictions on what they THINK the company will report in the future.  Clearly this is a spectrum of real, known values through to silly, fantasy numbers.  Some formulas combine silly numbers, magnifying the inherent margin of error.  The likelihood of  the numbers used in a strategy being correct or not clearly needs to be incorporated in the decision about whether or not to base investing decisions on them!

Between dividend yield and dividend growth, I think a case can be made that yield is the far more reliable of the two metrics.  Yield is based on the annual dividend paid divided by the stock price, while growth is the % increase over some period of time.  The yield isn’t certain moving forward, as there is no guarantee that the company will maintain the dividend.  The growth is definitely going to change.  Companies try to maintain dividend payments whenever possible, but they don’t try to maintain a precise dividend growth rate.  If the dividend growth of a company was a reliable predictor of future dividend payments, I’d agree that investing in stocks with high dividend growth is preferable to investing in stocks with high dividend yield, but I don’t believe that is the case.  Blindly investing in high dividend yield companies would be equally foolish.

As Homer taught Bart in the famous Simpson’s episode “Homer at the Bat“:  “Can’t win, don’t try”.  While this isn’t a great lesson for life, it is a good lesson with the stock market.  Instead of betting on an uncertain strategy based on uncertain statistics, investors can give up on beating the market and instead happily match it.  Passive investing lets other people do all the work of frantically appraising every gyration the markets undergo and simply reap the benefit of long-term gradual increases.

Whew – not a single parenthesis! (it just about killed me)

Recently I made a comment which arose from a discussion about stock dividend yield (which I prefer) and historical dividend growth.

My comment was that given a pool of stocks that have consistently paid an increasing dividend (this last phrase is important, so please re-read it before arguing with me), dividend yield is at the CORE of my purchasing decision. Obviously a high dividend yield because the company is in trouble and hence the price is low isn’t good (like GM), or over focusing on a single sector because it has high yield (like me and Canadian banks) isn’t good either.

Dividend Yield or dividend growth?

Before I go further I’ll define a few terms. By certain I mean very likely (as in, the sun will certainly rise tomorrow – there’s a small chance it won’t, but it’s very, very likely or Walmart will certainly still be in business next year). Let’s say certain is a 99.9% chance of something happening. “Less certain” is a 1-99% chance (or at least significantly lets then certain) that something is true and unlikely is a 0.01% chance of something happening (e.g. you might win on that lottery ticket you just bought, but it’s unlikely).

With stocks there are all sorts of numbers you can use to evaluate them (such as price, earnings, income, dividend, assets, etc, etc). Some of these numbers are reported directly, while others are derived from other numbers (for example, the dividend yield is derived from the dividend and the stock price).

Each of these numbers are certain or less certain. Price is certain (you can put an order in and buy at that price), similarly any numbers derived JUST from Price are certain (such as open price, closing price, high price, low price, average, etc, etc). Dividend is certain, it’s actually cash that was sent to investors (and they all can verify that they got paid). Dividend yield (a certain divided by a certain) is a certain value.

Earnings is a less certain value. Enron and their ilk get creative with their accounting in order to put the best food forward with investors. Since this is the game they’re playing, I’m more skeptical of the reported earning and anything based on them (such as income, EPS, etc). Assets equally are being reported by the accountants who have a vested interest in making them be as high as possible and are therefore “less certain”.

Some people like to buy stocks based on Price/Earnings. This is basically saying I want the company that makes the most money for the cheapest price, which is a good buying philosophy. The reason I’m not totally in love with this approach is it’s taking a certain value (the price) and dividing it by a less certain value (the earnings) gives you a less certain ratio. This makes the P/E ratio less certain than the dividend yield (as a method for evaluating the value of the stock).

With things like the Ghaham number, quite of a few of these less certain values seem to be incorporated into the calculation, which makes the final value very speculative, in my opinion.

Obviously if your feeling is that Enron was an oddity and that most companies are honest in their reporting of financials it would be easy to justify a different approach to buying then what I’m discussing.

Now, information is also presented from the past, present and future. The price of BMO when I bought at different points in the past were:

Date – Shares – Price
05/17/07 – 65 – $68.880
06/06/07 – 71 – $69.740
08/01/07 – 77 – $64.93
08/14/07 – 81 – $60.8

These are certain (I can show you my receipts). Please don’t be silly and argue that the price varied over the day or I’ll have to reach through my monitor and shake you like a British nanny. This is past information, which has some relevance to BMO as a company today (although I’d argue it has LESS relevance than the CURRENT price). We can also get talking about FUTURE prices of BMO, which I’d argue is unlikely to be correct if you name an exact price and less certain to be correct if you gave a range (say $0.50).

We can talk about dividend-yield which is certain, we can talk about dividend growth (based on PAST dividend-yields) which is also certain, and we can talk about FUTURE dividend growth or yield which is LESS CERTAIN because we’re basing it on a less certain future price and a less certain future dividend. When you combine two things that are less certain, the product is even less certain then either value. You can argue that price doesn’t matter after purchase (which I’ll agree with), but there’s still a fair bit of uncertainty).

Obviously if someone could give me a dividend growth value that was certain I would be very willing to purchase high growth stocks instead of high yield stocks (by high yield I’m talking BMO at 4%, not some unknown company at 11% – remember: given a pool of stocks that have consistently paid an increasing dividend). Given that the growth is uncertain, I’m less willing to pay for the “growth” stock, when it might under perform the “yield” stock (as in the example of NA vs SLF in my comment – this wasn’t cherry picking data, I looked these two up expecting SLF to have had a higher dividend growth and just said “huh”).

I’d rather buy a stock that’s cheap because of less certain pessimism then buy a stock that’s expensive because of less certain optimism. I’d also rather pay for a certain yield then a less certain growth.

There are two ways to make money with stocks:

1. Appreciation (the difference between the purchase price and the sale price.
2. Dividends (regular cash payments the company sends you a check for or which get deposited into your brokerage account).

Most investors seem to focus exclusively on speculative gains (the appreciation), going so far as ignoring dividend payments when reporting stock market results over long periods of time.

Dividends (even just considering a Canadian context) is WAY too large a topic for a single blog post, so I’ll apologize in advance for a (necessarily) shallow treatment.

What Dividends Say About a Company

There’s some dispute about whether it’s a good thing or not if a company pays a dividend.  The argument against it is that the company can retain the earnings that would have been paid out to shareholders and grow the company in a more efficient manner.  Say a company pays out $1 million a year in dividends.  They could use this money instead to expand their sales force, increase the production capacity of their factory, acquire a small company in a related industry or increase their advertising (and hopefully future sales).  Advocates of this policy feel, given a good company, reinvesting the earnings is a better investment than anything else they could do with the money.  Berkshire Hathaway, Warren Buffett’s holding company, has never paid a dividend and Microsoft just recently started paying a small dividend (until now they’ve reinvested in explosive growth).

The counter-perspective is that dividends are cold hard cash and a company’s ability to continually pay them provides concrete evidence that the company is performing well.  Accounting malfeasance  (such as Bernie Madoff) is harder, or impossible, if a large transfer of cash is going to shareholders on a regular basis.  Further, dividend investors may feel that THEY are able to better reinvest the earnings then the company that paid them (perhaps in another company they feel is undervalued, or in another investment category like real estate or some commodity).

Examples of Canadian dividend stocks

Each of the big 6 Canadian banks is a Canadian dividend stock, as are many of the Canadian companies you’ve heard the name of (such as Loblaws, Shoppers Drug Mart, or Tim Hortons).  Personally, all stocks I own are dividend payers and in addition to the US companies General Electric and Bank of America, the Canadian dividend stocks I own are:

• Bank of Montreal
• National Bank
• Russel Metals
• Bank of Nova Scotia
• Telus
• Fortis
• Imperial Oil
• Transcanada Corporation
• CIBC

In “The Lazy Investor“, Derek Foster recommends a portfolio made up of:  Scotiabank, Enbridge, Imperial Oil, Fortis, and Riocan REIT.  OperaBob (one of the charming and delightful moderators from the DRiP investing Resource Center – actually, he’s a rude jerk, but he does know quite a bit about Canadian dividend paying stocks) provides opinions on stocks for a variety of small portfolios (this post was from 2005, but it’s still very worth looking at).

If you come across the term DRiP while reading about dividends, it refers to a dividend reinvestment plan (which is a topic for another day).  MoneyEnergy has a VERY, VERY good series of posts on DRiPs (on the right side of her page, halfway down).

An excellent list of dividend paying Canadian companies is maintained at the Canadian DRIP & SPP List.  The Claymore S&P/TSX Canadian Dividend ETF provides a list of strong Canadian dividend stocks.  As an ETF, it’s an low-fee way to invest in a diversified collection of Canadian dividend companies (if that’s your bag, baby).

Tax Treatment

Dividends paid by Canadian  companies get a favourable tax treatment.  This certainly improves their returns for Canadians!

Canadian Dividend Investors

Tom Connolly publishes an great newsletter focused on investing in Canadian dividend companies.  While his newsletter is closed to new subscribers, there is an archive of past issues at the North York Public Library and he maintains some freely available information at his website DividendGrowth.ca.

While he can be a controversial figure in the Canadian investing scene, Derek Foster has published 4 books [non-affiliate link] which I feel are worthwhile reading for a beginner interested in dividend investing.

There are a number of strong personal finance blogs which focus on dividends and are a helpful sources of information, including:  Dividend Growth Investor, Living Off Of Dividends, Dividends4Life, Dividend Money, and  The Dividend Guy.