Personal Finance 101

Fighting The Herd Mentality

We’ve recently come to recognize the herd mentality that’s been corralling the minds of retail investors and how this has led to a ‘bubble’ in U.S. Treasuries. This phenomenon reflects the extreme risk aversion that’s moving the markets these days and how people are more focused on return of investment than return on investment.

Even though the yield on Treasuries is at historically low levels, investors are willing to sacrifice the returns they need for the sense of security they want. Unfortunately, this fixation with ‘safe’ assets doesn’t make much sense within the context of long-term goals.

Let us now look at the other side of the Treasuries phenomenon. In their quest for certainty, many investors may be unwittingly ignoring dividend yields on stocks, which have become more compelling as a result of the downturn in global markets.

The Dividend Yield

As dividend investors, we have recently noticed that the dividend yield on the S&P 500 Index is greater than the yield on U.S. Treasury bonds for the first time in 50 years!

Case in point, the dividend yield on the S&P 500 as of the end of November was about 3% versus the yield on the 10-year Treasury which today, is about 2% (the 2-year Treasury is yielding about 0.70%). What’s more, this isn’t just a U.S. phenomenon. In Europe, the yield on stocks also currently exceeds the yield on government bonds.

Of course, dividends are a key part of total returns (price appreciation plus investment income, including dividends).  The fact that dividend yields are high relative to Treasury yields right now makes the case for dividend-paying companies that much more compelling.  

If we look back to the period between 1974 and 1982, the performance of the S&P 500 was sluggish on a price return basis.  But if you look at what happened as markets began to recover, including dividends in the returns that investors earned as they emerged from a period of economic uncertainty and capital market weakness (i.e. looking at total return) made a significant difference.

Herding To Safety

Today, the desire for safety runs the risk of driving ‘the herd’ off the edge of the proverbial cliff as people abandon their long-term goals in favor of short-term stability. But despite what the headlines might suggest, the world isn’t two- dimensional.

That is to say it’s not just risky assets or safe assets. To see the total picture, including why dividends need to be a key consideration in the investment process, is a starting point to having better, more robust conversations in today’s uncertain environment.

Posted in Stock Studies | 4 Comments »

Why Don’t We Buy Stocks When They Are On Sale?

As I came into the office today, I was reminded of what time of year it is. Every year a very large tree is set up and decorated in the lobby of the building. Years ago it was a Christmas tree but as times changed it became known as a holiday tree. This year, in order to spare the slaughter of an innocent tree, it’s a 10 foot steel cone covered in green, prickly plastic. So, as I walked past the holiday cone I was reminded about what’s coming later this week in the U.S. – Black Friday.  

Black Friday

Black Friday is so named because it’s the day that retailers finally move into “the black” for the year and it’s the day that marks the unofficial beginning of Holiday shopping. It’s also the busiest day of the year for most retailers in the U.S. and a day that many items go on sale as businesses compete for those gift shopping dollars. Seasoned shoppers will do their research by scouring through local papers then line-up early in order to get the best deals – after all, if you can get the same item at a lower price, why wouldn’t you?

Strangely, when it comes to investing it seems that people want to pay more. Mutual fund sales show this time and time again. When markets are close to their peaks, mutual fund sales are strong, but when markets are close to their bottoms, mutual fund sales are weak. But who can blame investors? If we look at markets in the U.S., the S&P 500 Index is currently at levels similar to 10 years ago and while Canadian markets have faired somewhat better, it’s still been an ugly 10 years.

A Lesson In History

In 1974 the S&P 500 Index dropped from a closing value of 99.74 on March 13 down to a closing value of 62.28 on October 3 losing over 37% of its value (note that the index is based on price only and does not include dividends). And much like today, there were several events that were weighing on the minds of investors, such as:

1. The energy crisis following the OPEC oil embargo
2. The resignation of President Richard Nixon following the Watergate scandal
3. The loss of Vietnam war
4. An economy in recession

What investor would want to be in the market at a time like that?

Well, as it turns out, a very astute one. The table below shows the returns of the S&P 500 Index following October 1, 1974.

S&P 500 Index

The most important thing an investor can do right now is to learn from history. Although there are some differences between any two periods of time, there are examples of times in the past with many similarities to what we are seeing today.

Those past times represented outstanding investment opportunities in equity markets. No one knows exactly when the market will be at its bottom, but if you’re buying right now, you know for fact that it’s not at its peak. And, like many consumer goods, the market is on sale.

Posted in Stock Studies | 7 Comments »

How Interest Rates Impact Your Investments!

This is a question that I asked myself a few years ago and since the topic came up the other day, I thought it best to answer it here at Dividend Money.

Inflation Control

The central bank fights inflation by attempting to control the rate of growth of the money supply. When inflation is rampant, interest rates will rise, as the central bank attempts to cool down the economy. The bank will attempt to decrease the supply of money available in the banking system, thereby causing demand in the economy to contract.

If this is done, the result will be a decline in the rate of inflation and a relative decline in the demand for money. If the economy shows signs of recession, the central bank will supply more money to the banking system and expansion will usually follow. Interest rates will decline for the short term even though the injection of more money into the economy is inflationary in the long run. A catch 22.

Use The Fed To Buy Fixed Income

Since fixed-income security prices move contrary to interest rates, the best time to invest in fixed-income securities is at the peak of an inflation cycle, when interest rates are high and fixed-income securities trade at low prices.

Such opportunities are likely to occur periodically every few years, due to the inability of federal governments to fight inflation with only fiscal policy and the limitations that the central banks face when trying to curb inflation with tight monetary policy.

That said, just how an investor determines when the peak in the cycle occurs is a question that is not easy to answer.

How Are Common Stocks Affected?

The reaction of common stock yields to fluctuations in interest rates, both nominal and real, is very similar to that of fixed-income security prices, and that similarity is quite natural. Regardless of whether an investment is made in common stocks or fixed income securities, the expected result is a satisfactory rate of return.

The typical measurement for common stock returns is the return available from short-term bonds or the risk free rate. When returns from fixed-income securities are low, the stock market becomes more attractive, since even common stocks with relatively low dividend yields provide a competitive alternative to fixed income securities.

On the other hand, at the peak of an inflation cycle, stock prices are very high. Their returns and yields compare unfavorably with the high yields available from fixed-income securities and there is less risk of loss of principal from fixed-income securities.

What Happens When It All Hits The Fan?

Sensitivity of the stock market to fluctuations in interest rates has been particularly pronounced in the last couple of decades – however, in the recent crisis this correlation has been all but thrown out the window!

Knowing this, where do we stand in this cycle today?

What does this mean for stock prices in the near term?  The long term?

Posted in Investment News, Stock Studies | No Comments »

Selecting Great Dividend Growth Stocks

Where To Start Your Research

When starting your research for dividend growth stocks, much of the work has already been done for us.  We just need to know where to find it!

Start out by reviewing the Dividend Aristocrats or Dividend Achievers lists to identify a broad category of stocks that have consistent dividend growth.

Once you have identified a list of stocks using the dividend achievers list, it is time to narrow it down to a few of the best dividend growth stocks.

Sector Selection

A general rule of thumb for dividend growth investors is to select one or two stocks in different sectors, such as insurance, utilities, financials, telecom, etc., with the higher than average dividend yield and a recent dividend increase.

Many dividend growth investors will require that the dividend increase be within the past year, the more recent the better. Dividend growth investors are of the philosophy that an increase in a company’s dividend means that the company is healthy and its future prospects are solid. Therefore, the amount that the dividend is increased should also be taken into consideration.

Dividend Growth Rate

The amount that a dividend is increased on a year to year basis is called the dividend growth rate. The philosophy of dividend investors is that the higher the dividend growth rate, the higher the prospect for the stock to increase in value.

For instance, Sun Life Financial (SLF) has a dividend growth rate of approximately 20% over the past 5 years. Over that same time, the stock has doubled in value from $20.00 per share to over $40.00 per share. If you had purchased Sun Life Financial 5 years ago at $20.00 per share, with the current dividend rate of $1.07, your yield on the purchase price would be 5.4%.

Not only would one be receiving these healthy dividends this year, but one could reasonably expect to get a 20% raise next year!

This is the basis of dividend growth investing; to produce consistent and inflation hedged income.

Due to the fact that the dividend growth rate can play such a significant factor in the future value and income potential of the stock, it is suggested that the investor find a middle ground when choosing stocks for a dividend growth portfolio.

The middle ground should consist of:
1.) A reasonable current yield, compared to its peers and itself historically.
2.) A recent dividend increase combined with increased earnings
3.) A high dividend growth rate compared to the industry.

Stocks selected from Mergent’s Dividend Achievers that display these factors should provide a great starting point to a dividend growth portfolio.

With the recent turmoil in the markets, now is an especially great time to search for financial services companies and banks that have strong balance sheets and are well capitalized.  Consumer staples and health care stocks are also viewed as potential safe havens and opportunity stocks in this type of market.

I’d be happy to hear any comments or questions regarding this strategy and I hope to have more detailed information up here in the near future.

Posted in Stock Studies | 21 Comments »

A Select List Of Dividend ETF’s

Welcome to readers from The Street.com and the Kirk Report.  Please take a moment to visit our About Page to see why we love dividend stocks and subscribe to our blog using the Subscribe Form on the right side of the page.

I am a huge proponent of buying the best dividend paying stocks when they are value priced. However, if you aren’t sure about picking an individual stock and you still want to reap the rewards of Dividends, check out this list of some different Dividend Exchange Traded Funds (ETF’s).

The Vanguard Dividend Appreciation Fund (AMEX: VIG) is a one of the cheapest dividend ETFs, with an expense ratio of 0.26%. Some rivals charge as much as 0.60%. But fees aren’t everything here. VIG’s current yield — slightly less than 1.77% — is on the low side, as is its total return of roughly 7% since its inception in late April 2006.

VIG is benchmarked to the Mergent Dividend Achievers Select Index, a subset of the Mergent Dividend Achievers Index — a market-cap-weighted index of stocks with a consistent history of increasing dividends. Its holdings are highly concentrated in three sectors: consumer staples at 23%, financials at 20%, and industrials at 17% of assets. The top five stock holdings include Johnson & Johnson, GE, ExxonMobil, AIG, and IBM, each representing roughly 4% of assets.

Among other ETFs focusing on high-yielding equities, the iShares Dow Jones Select Dividend (NYSE: DVY), the first dividend ETF, has gathered more than $7 billion in assets. It invests in 100 of the highest dividend-yielding securities (excluding real estate investment trusts) in the Dow Jones U.S. Total Market Index.

First Trust Morningstar Dividend Leaders (AMEX: FDL) invests in the top 100 stocks of the Morningstar Dividend Leaders Index. These are the index’s highest-yielding stocks, ranked by the consistency with which they pay dividends and the ability to sustain those dividends going forward. Three securities — Citigroup, Bank of America, and Altria — together make up more than one-fourth of the fund.

State Street SPDR Dividend (AMEX: SDY) invests in the 50 highest dividend-yielding S&P Composite 1500 constituents. This index tracks equities that have consistently increased dividends every year for at least 25 years. Investing in these long-term dividend-paying stocks reduces the risk that the fund’s holdings will cut their dividends.

For Dividend Daredevils
More adventurous investors might consider the Claymore/Zacks Yield Hog ETF (AMEX: CVY), which aims to double the yield of other dividend-paying ETFs. The fund invests in high-yield securities such as preferred shares, master limited partnerships, closed-end funds, American Depository Receipts, and Real Estate Investment Trusts. It’s a riskier play, since the holdings don’t all have a long history of regular, stable dividends.

Paying the piper
Tax law changes in 2003 lowered the tax on most dividends to 15%, making dividend-paying stocks more appealing. This law is set to expire at the end of 2008, and if it does, dividend-paying stocks may become less desirable.

Courtesy of Motley Fool

Posted in Investor Education, Stock Studies | 2 Comments »

Why I Like Capstone Mining – CS.TO

Once in while a non-dividend paying stock crosses my radar and I just can’t ignore it. Such is the case with this week’s analysis of Capstone Mining (CS.TO).

Capstone Mining is a well run company that reopened and operates a single copper (with zinc, lead and silver) mine in Mexico which has recently more than doubled its production. The results of this production increase were starting to be evidenced in the financial statements last fall, but this spring and summer should produce even higher numbers because of the increased price of copper.

The Major Highlights of Capstone Mining

• Capstone continued its share buyback plan and purchased an additional 219,900 common shares on the open market at an average price of CDN$2.78.
  The shares have been returned to treasury and canceled under its normal course issuer bid.
• At March 31, 2008, Capstone had working capital of $56 million and no bank debt. In addition, the fair market value of Capstone’s share ownership of Silverstone Resources Corp. is approximately $65 million, which is not included in working capital.
• Copper production during the quarter was 6.0 million lbs compared with 2.8 million lbs for the three months ended February 28, 2007.
• Record operating profit of $15.9 million or $0.20 per share.

As you will see further on in this analysis, Capstone’s management have pulled out all of the stops in making this a very profitable long-term investment for shareholders. Certainly, nobody knows what the future holds for copper prices and while the immediate future looks bright, Capstone’s management is focused on keeping the mine profitable for many years to come. So, how do they make sure that their shareholders are rewarded…they tackle the future right now!

Capstone Has Hedged Their Bets

CS hedges 20% of their copper production with forward contracts … in simple language, for each year until 2011, they have already sold 20% of their copper at an average price of $3.18. They do this to cover the majority of their production costs.

This is critical to mines because it means that if copper prices dive, they will be guaranteed to generate enough cash flow to stay open. It is really just an insurance policy for shareholders.

Capstone is obligated to report the difference in value of these future contracts to the current market price (called a mark to market calculation) in their income statement as a non-cash item. So here’s how that works.

For 2008, they have forward contracts to sell 7 million pounds of copper at an average price of $3.38/lb. The math for the contract reads … 7,000,000 lbs x $3.38/lb = $23.7 mil. Now, at the end of the last quarter, on March 31/08 the price for copper that day was $3.84/lb. The value of that 7 mil pounds of copper at that price would be 7,000,000 lbs. x $3.84/lb = $26.9 mil.

Soooooo…for this year’s forward contracts alone the loss on paper is $26.9 mil – $23.7 mil = $3.2 mil. Add to that by the other 3 years that they have forward contracts for and you end up with about $12 million in recorded NON-CASH losses that they have to record in this quarter.

What We Must Understand

Capstone did not actually “lose” any of that money. They simply lost the $12 million worth of additional profit that they could have made over the next 4 years if they had not pre-sold 7 million pounds for each of the next 4 years. What the report tells us is that for those future sales, they could have made an extra $12 million over the next 4 years If, and this is big “if” Copper prices remain at or above $3.84/lb.
We must also remember that those forward contracts only represent 20% of their production … so the other 80% will be sold at market price.

You Still With me?

OK, so for those of you who are real keeners here’s how the future is calculated.

Contracts have already been brought into the income report at a value of $3.84/lb. Therefore, any future variation in price will work off of that price. So, even though the real price of the contracts average $3.18/lb, the next report will calculate a gain/loss based on the already calculated price of $3.84/lb.

Therefore, if Capstone just keeps the contracts that they already have, which on paper now reads as a value of 28 mil lbs (4 yrs x 7 mil lbs/yr) valued at $3.84/lb, and copper goes down $.10/lb by the end of next quarter on June 30. In this case, their income report would show a profit of 28,000,000 x $.10/lb = $2.8 mil. Basically, they will have gained back some of their “non-cash” loss from this quarter. If copper continues to rise, they will report another loss of potential.

So you see, the loss they have to report this quarter is not a real loss. It’s a loss of potential assuming that the price of copper is $3.84 when they actually sell those 7 million pounds each year to fulfill those contracts.

Bottom line … the real Operating Profit (which does not account for the forward contracts or future possible income tax) … is $15.9 mil … or $.20/share for the first quarter of this year.

Now for the real keener keeners…

Let’s assume for a bit, that copper prices drop in the next 3 quarters. CS sells 80% of their copper at market price so they will be generating less revenue. However, as we’ve seen from the calculations above, when the price of copper drops, those forward contracts report an increase in value from one quarter to the next. So these gains will help offset the drop in production copper sales. This is how hedging smooths the fluctuation in commodity prices for the producer.

At a quarterly profit of $.20/share, the annual earnings could easily be $.60-.80/share. That’s an EPS of 4x-6x.

Generating Their Own Cash Flow

Capstone has also made certain that they are getting the most bang for their buck with regard to their silver production. This may be the smartest move that a mining company has ever pulled off in terms of generating cash flow. You see they spun off a silver producing company, of which they still own 20% of and are selling their silver production to them. Here is an excerpt from another article that explains the situation rather well.

Silver mining companies receive much higher multiples (e.g. P/E ratios) than base metal mining companies (e.g. 20 to 1 vs 5 to 1). Capstone has leveraged this by selling its silver production to Silverstone Resources (SST.V). SST.V is a company which Capstone spun-off and IPOed and which should ultimately receive the ratios of a silver producer. Capstone has 23 million shares of SST.V. SST.V is reputed to be undervalued relative to comparable companies and to have a considerable growth coming.

A huge consideration is that cold hard cash and shares in Silverstone (SST), another undervalued company, make up 45% of their market share price!

Other Considerations

Besides their solid production, cash, profitability, and their ownership of 20% of SST, CS will benefit from higher copper prices which showed a surge testing the $4.00 level. Remember, CS has already presold 20-25% off their next four years’ production at $3.18, but the other 75-80% is going to benefit from market surges. Plus, from the volume action of late, it looks like CS is still utilizing that massive mound of cash by buying their own stocks back to further strengthen their share value.

You know you are on to something when management says this during their conference call:

[With regard to cash on hand]…”We would love to purchase another mine if we could find one as profitable as our own”.

I would venture to guess that this means they will continue to buy back their own shares until they find a profitable investment elsewhere. This is certainly not a bad decision for a mining company.

Honestly, I have not seen a company managed so intently with shareholders in mind for a long time. Capstone could have easily gone out and bought another mine that was not as lucrative because they have too much cash, but they didn’t. This is prudent management and it is refreshing to see.

Full Disclosure: The author does have a position in Capstone Mining (CS.TO).

Posted in Investment News, Stock Studies | 4 Comments »

Start Buying Dividend Stocks Now!

Here is why you must start buying dividend paying stocks now!

It has long been a strategy of mine to invest in high quality Dividend Growth Stocks as a  for retirement and I’m about to show you why you should do the same!

The beauty about this strategy is that it is not rocket science and that everyone can understand the basic principles behind it. I’m not promoting trickery or complex technical mumbo jumbo, just good old fashioned common sense with a side of logic.

The Stock Market Crash Scare Tactic

I’m sure that we have all heard that the baby boomer generation is aging and entering into retirement. We have also been told that all of these individuals are going to make a mass exit out of the stock market, causing the greatest stock market crash that we have ever known.

Some so called “Gurus” have suggested that the aging demographic is going to cause havoc with the markets by selling all of their stocks to fund their retirement.

Is This Possible?

In theory, the outlined scenario could be possible if all of the baby boomer’s withdrew their money from the stock market at the same time. But, as we know, the boomer generation lasts for a couple of decades…they were not all born in the same year! And even if they were, not everyone can or will remove their equity from the markets at the same time.
Therefore, we can clearly see that this scenario is highly unlikely.

But Aren’t All of The Baby Boomers Going to Buy Bonds?

While conventional wisdom dictates that fixed income (bonds) should comprise a larger portion of ones portfolio as they near retirement, it might not be as simple as black and white these days.

For instance, as time goes by the life expectancy of retirees becomes longer and longer. This means that a retiree will need to make their nest egg last for several more years than they my have previously thought.

Therefore, the retiree will need to take on additional risk in order receive higher returns in order to ensure that they do not deplete their principal prior to death. Taking on more risk means investing in more equities (stocks) gaining capital growth in their portfolio to fund a longer retirement.

So Why Should I Buy Dividend Paying Stocks?

The reason we must invest in dividend paying stocks now is because they will be the investment of choice to fund the retirement of Baby Boomers.

You see, dividend paying stocks have the potential for both capital gain and income production. Not only that, these investors will be looking for stocks that have a track record of increasing dividends…giving them yet another hedge against inflation. This combination, as explained earlier, will be necessary to fund the lengthening retirement that comes with a greater life expectancy.

If we combine this factor with today’s low interest rate environment, we can see that fixed income instruments (with the exception of TIPS) such as bonds and CD’s provide little, if any, protection against inflation.

Factor that in with the fact that historically, dividend paying stocks have outperformed non-dividend paying stocks.

So what do I do now?

In order to provide potential capital growth, income, and protection against the erosion of purchasing power, we must buy the best dividend growth stocks and hold them for a very long time. Read How To Choose Dividend Growth Stocks.

Even if you are young, the generation of retirees that are looking for this 3-part combination of shareholder yield to fund their retirement will start to accumulate shares in high quality, dividend growing, blue chip companies in order to fund a long retirement and help to hedge against inflation.

The accumulation of these stocks will, of course, drive up the share price which means big profits for you!

The Closing

You see, it doesn’t take rocket science to see what is going on. I’m certainly not leading the charge with this idea.

Get out there and search for some great companies that grow their dividends year after year. You won’t get rich overnight, but the strategy works.

Remember to always do your due diligence and as Charles Kirk reminded me, don’t buy a stock just for the dividend!

Posted in Stock Studies | 16 Comments »

Shoppers Drug Mart Impresses

One of my favorite Canadian companies that isn’t involved in the financial sector is Shoppers Drug Mart (SC.TO).

Shoppers recently announced that 4th Quarter profit jumped 16% over last year and followed that up with a dividend increase of 34.4% to boot.

Recent Reports

While some thought that a mild cold and flue season this past fall would hurt sales, the numbers proved otherwise and Shoppers bounced off a 52-week low in the morning session to finish up over 4% on the day.

I recently talked about trying to recession proof a portfolio and that is something that is typically an issue with retail stocks. That said, I wondered how Shoppers was positioned to battle a recession from the United States, should th effects leak into Canada. This is what Shoppers’ CEO, Jurgen Schreiber, said on the issue:

“We have a significant amount of categories which are relatively independent from recessions,” he said, naming the pharmacy and over-the-counter medications, as well as cosmetics.

Shoppers Drug Mart will hold its own as defensive stock with a Beta of 0.54, making it about half as volatile as the market. And as one Analyst reported, they are sticking to what they know they can do well.

“They are in a business that is fairly resistant to any economic troubles,” said Aman Budhwar, senior investment analyst at AIC, whose fund holds more than 1 per cent of Shoppers’ outstanding shares. “The economic picture hasn’t impacted them as much as some other retailers. The company continues to do what they’ve done well in the past – they’re not trying anything fancy.”

The company also provides a dividend yield that is double the industry standard, while maintaining a relatively low payout ratio of ~27%. A higher than average dividend yield, coupled with a relatively low payout ratio should enable Shoppers to consistently create shareholder value while continuing to expand the company.

The Chart

The technical picture for Shoppers Drug Mart isn’t exactly pretty. However, if you were waiting for a good chance to purchase an initial position in this stock then now might be as good a time as any.

There appears to be some long-term support at around $48.00; a price that held up with some strong volume support as shown in the chart below.

Long term buy and hold investors may see some upside resistance between $51.00 and $53.00, but most analysts are showing a target price well above that range given the recent performance of the company and the hefty plans for expansion.

I mentioned a few weeks ago about going shopping on the 52-week low list and these are the types of deals that you should be looking for. Assuming you require this type of stock to balance out your portfolio allocation.

What’s on your shopping list?

Posted in Stock Studies | 1 Comment »