Personal Finance 101

3 Key Issues That Influence the Stock Market

As we head into the fall and we look forward toward next year, it is important to take a look at the general econimc landscape, assess the data that we have access to, and develop our views on the performance of our investments going forward.

The following are three high-level economic data points that we can use, along with our other tools, to further assist us determining our views on equity market investments.

1.) U.S. Housing

As the root of the credit crisis, healing in the U.S. housing market is a precondition for sustainable recovery. Recent data has confirmed that the worst is behind us and the residential real estate market is stabilizing.

The inventory of unsold houses while still high is heading in the right direction towards clearing and sales of existing homes have recently turned positive on a year-over-year basis. And an index which measures year-over-year price changes of houses in 20 major U.S. cities (the S&P/Case-Shiller Home Price Index) plunged 33.6% from its June 2006 peak to the April 2009 trough, but has now climbed 1.9% over the past two months.

2.) The U.S. Consumer

The resurgence of the U.S. consumer will be key to watch as recovery unfolds since consumption is 70% of the American economy. Despite the ‘hit’ that the housing crisis has exacted on their net worth, American household balance sheets are still in relatively better shape than they’ve been in the past due to the tremendous growth net worth over the last decade.

However, the process of deleveraging (winding down debt) has begun and this will impact spending patterns in the near-term.

3.) The U.S. Manufacturing

The level of manufacturing has historically followed an inverse path to the Fed funds rate but on a 6-month lagged basis – as the fed funds rate drops, six months later, manufacturing activity picks up.

However, in fall 2008, although rates declined to historically low rates, the credit crunch intensified and that typical relationship between low interest rates and increased manufacturing activity did not materialize. More recently, credit channels have opened up and the ISM (gauge of manufacturing activity) has improved, indicating the economy is finally responding to massive stimulus after a long lag.

And further improvement just yesterday with the latest ISM level better than expected at 52.9 – the first reading above 50 since January 2008 and hit the highest level since June 2007. This is further indication that while not yet normal, the economic environment is normalizing.

These are three key areas of the market to watch when assessing the high-level economic situation and it’s relationship to the stock market trends and valuations.

Of course this isn’t the be all and end all of data you should include in your due diligence, but it certainly plays a role as you calculate your risk tolerance moving forward.

Posted in Investment News | 1 Comment »

A Look at the Market’s Big Picture

Just a few days into August and markets seem to have picked up where they left off in July.

Here’s a summary of market action and key developments from last month, including monthly benchmarks.

• Investors saw more data indicating that healing is underway in the global economy. Increased optimism paved the way for a fifth consecutive month of gains across world markets.
• International stocks advanced. The MSCI World Index returned 8.4% (in $US terms). Since March 9th, the MSCI Asia Index has risen about 58% in local currency terms.
• Commodity prices rose. Copper is up more than 80% year-to-date supported by increased demand from China. The S&P/TSX Composite Index benefited, adding 4%. The S&P/TSX has climbed 45% since hitting a five-year low on March 9th.
• In the U.S., stocks made up more ground. The Dow Jones Industrial Average (DJIA) had its best month since 2002, up 8.6% . The S&P 500 Index advanced for the fifth consecutive month (the longest streak since 2007) gaining 7.6% . The S&P 500 is now up more than 40% since March 9th and Monday, it closed above the 1,000 level for the first time since November 2008.
• Volatility continued to be a key theme in currency markets. After falling more than 6% against the U.S. dollar in June, the Canadian dollar appreciated by 7.4% versus its U.S. counterpart in July. This cut into returns on investments denominated in $US. Case in point, the 7.4% gain on the S&P 500 was essentially wiped out when converted back to C$.

With much of the latest economic news continuing to look less bad (over 70% of companies beat expectations last quarter and it appears US housing may have found a bottom), the economy looks to be on the mend.
However, we must realize that the rate of recovery that we are seeing is not normal and likely cannot be maintained long-term. That said, as an investor looking out 5+ years I belive valuations in the equity market are still low and the potential remains for double-digit returns heading forward over a 5+ year horizon.

Posted in Investment News | 2 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 »

3 Reasons You Must Invest In Dividend Stocks

As a dividend growth investor, I am frequently asked why I don’t invest in high growth stocks and, more importantly, why I believe investing for dividends is a more appropriate strategy.

In bear markets there are great buying opportunities for dividend growth stocks that are offering yields above their historical averages.  Opportunities to buy great dividend growth stocks at above average yields is a great way to finance your retirement and increase the compounding effect of your future income from these stocks.

Here are the 3 most essential reasons that I prefer dividend investing: 

1.) Dividends offer investors fantastic flexibility.

Dividends give you tremendous financial flexibility throughout your investing life. While you’ve got an income from working, you can reinvest those payments to speed the process of compounding your wealth. Once you’ve decided to retire, the cash thrown off by dividends spends just as well as any other source of money!

What is even better, a rising dividend payment can help you fight inflation by providing you more cash every single year.

2.) You can’t fake money in your pocket. 

Dividends also have the added bonus of being exceptionally difficult for companies to fake. After all, it’s difficult to convince lenders to loan money to a company if that company is going to turn around and hand it over to its shareholders.

As a result, to sustainably make and increase those dividends, the business needs to generate serious cash on both a regular and repeatable basis.

3.) Dividends are paid from the company’s cash flow. 

Perhaps most important, a company’s dividend payment comes from its operational success and not from the panic, hype, or analyst interpretations that influence its stock price. Throughout these rocky market periods, dividend payments allow us to make money even when the stock price moves lower.

Why Invest In Dividend Paying Stocks?

• Quicker compounding.
• Increased financial flexibility.
• Cash in your pocket without selling.
• A hedge against inflation.
• An check on the company’s accounting.
• Cash Flow in a down market.

With all of the benefits of dividends, it’s obvious why they can be an integral component of one’s portfolio.

Did I miss any benefits of dividends?  If so, let me know in the comments! 

Posted in Investor Education | 3 Comments »

Using Historical Averages Can Make You Money In Stocks

A concept that I’ve explored lately in this recent volatile market is reversion to the mean, which suggests that prices have a tendency of eventually moving back towards their long-term historic averages.

A good example of this could be the price of oil. After rising 47% in the first half 2008 and hitting a record high of $147 per barrel on July 11, the price of oil has dropped more than 20% in less than eight weeks as supply-demand dynamics adjusted (Not including the speculative bounce last week). Albeit $120 oil can still be considered high by historical standards, the point is that dramatic increases over short periods of time represent imbalances that are likely to self-correct.

Using The Reversion Theory In Your Portfolio

Within the context of recent history, many people might associate reversion with a downward movement so the first thing that comes to mind is something that’s overpriced. However, if we turn this concept over in order to highlight value as well. For example, while oil has soared to new heights, at the other end of the spectrum global equities have been punished and U.S. stocks in particular have struggled amid the credit crunch and a deteriorating economic backdrop.

Over the last 12 months, the return on the S&P 500 Index has been about -11%. Consider however that the average annual return on U.S equities over the past 25 years is 11.4%. On this basis, investors (especially those sitting on the sidelines in cash) might want to ask themselves whether they think stock prices in the world’s largest and most diverse economy will stay at current levels indefinitely, or whether it’s more reasonable to think that at some point, they’ll revert to more historically normal levels.

Analysts spend many hours and a boat-load of money determining what they perceive as fair value for equity markets. Their valuation models incorporate long run averages for inflation, interest rates and growth and based on current levels for these factors, U.S. equities appear to be trading below fair value. Another way to interpret the reversion theory essentially is a version of the “stocks on sale” message.

Reverting To Positive Returns

If U.S. equities are trading below where they should be based on historic averages for similar environments, then it follows that at some point, they should move back towards fair value, meaning stock prices should eventually rise.

Now, I am NOT forecasting what the price of oil will be or where U.S. stocks will be trading six months from now or when reversion will happen – I’ll leave that to the “experts” . The message to take from this is that amid 200 point swings in the stock market or $10 spikes in oil prices, it’s prudent to think about where prices are in relation to historic long run averages.

In a volatile market it becomes very difficult to predict which individual stocks are going to be most successful. However, buying a broad index such as the S&P 500 will offer significant exposure to a US equity market that has become oversold and is valued at well below historical averages. Not to mention that the S&P 500 has a dividend growth rate of about 11%. So, buying this index offers you an average of 11% raise each year while we wait for valuations to return to the mean.

Posted in Investor Education | 5 Comments »

Spectra Energy Increases Dividend

Growing Dividend

As a spin-off of the successful Duke Energy, Spectra Energy Corp (NYSE:SE) has had a rather successful first 16 months in business and has recently declared an 8.7 percent increase in its quarterly cash dividend
on its common stock, from $0.23 to $0.25 per share. The dividend is payable September 15, 2008, to shareholders of record at the close of business August 15, 2008.

Spectra has what appears to be a very assertive, yet stable, long term growth plan that is focused on organic growth and project development. This includes a very lucrative joint venture with Conaco Phillips and already transports some 12% of the natural gas consumed in the United States.

With these facts in mind, let’s take a look at what the Chief Financial Officer (Soon to be CEO at the end of 2008) of Spectra Energy, Greg Ebel has to say to investors looking to purchase stock in the company:

I think the key reasons are, first and foremost, a home grown stable of expansion projects that give visibility on earnings growth to the better-than-the-pack earnings growth and opportunities they see. Also, solid dividend growth opportunity, sound financial management and overall a relatively safe harbor in what is a somewhat dodgy financial market situation and economic situation we see out there today.

A Closer Look At Spectra Energy

Spectra Energy is one of North America’s premier natural gas infrastructure companies serving three key links in the natural gas value chain: gathering and processing, transmission and storage, and distribution. With very solid transportation contracts into the foreseeable future, there is little concern for profitability and optimism for increasing shareholder value. However, any lagging demand for natural gas would certainly be a concern for the company moving forward.

Spectra Energy owns and operates critically important pipelines and related infrastructure connecting natural gas supply sources to premium markets. Based in Houston, Texas, the company operates in the United States and Canada approximately 18,000 miles of transmission pipeline, 265 billion cubic feet of storage, natural gas gathering and processing, natural gas liquids operations and local distribution assets.

Spectra Energy Corp also has a 50 percent ownership in DCP Midstream, the largest natural gas gatherer and processor in the United States.

Why Pipeline Stocks?

It has been said before, but pipeline stocks are like railroads for natural gas. Simply put, the demand for natural gas is up and correlates somewhat with oil prices, but the upside with pipelines is that they do not have the competition from other forms of transportation. In order to move and significant volume of natural gas a pipeline must be used.

Pipelines are traditionally managed very conservatively, as is Spectra Energy, and make their money through cost-of-service contracts and other required services. This means that cash flow is relatively stable and predictable when compared to the market as a whole. This can be referenced by viewing the Beta coefficients of pipeline stocks which show significantly less volatility than the broader markets.

I have stated before, and I will state again that pipelines are great recession proof stocks.

On top of preserving and likely growing capital, investors can collect a healthy (and growing) dividend yield.

Spectra’s current yield is 3.28%.

Spectra also boasts Return on Equity and Return on Investment numbers that are markedly abov ethe industry average at 17.1% and 5.76 % respectively.

For those of you looking to preserve capital during these rough market times and collect a solid dividend, I highly recommend pipeline stocks. Along, with Spectra Energy I suggest looking at Trans Canada Pipeline (TRP).

Full Disclosure: The Author does not own shares of Spectra Energy, but does own some Trans Canada Pipeline.

Posted in Dividend Hikes | 2 Comments »

Progressive Introduces A New Dividend Model

Progressive Corporation of Auto Insurance fame has changed the landscape of dividend payment to shareholders.  And they did so in dramatic fashion.  Progressive  introduced a new dividend policy for 2007 and  I have been waiting to see if any other companies  would follow suit.  So far, it looks like everyone is watching how this policy is playing out in a bear market to see if investors “jump ship”.

A Variable Dividend

Progressive introduced the idea of a once-per-year variable dividend that will be based solely on the performance of the company.  This type of dividend will award shareholders for their belief in the company and appears to actually treat shareholders like owners by offering up a piece of the profits in good years and leaving them high and dry in bad years.

Here is what Progressive CEO Glenn Renwick has to say about the dividend policy that he championed:

“If the business has a good year, the owners should share in the profit, and if the business has a bad year, why should the owners get anything?”

An excellent observation–one that’s so obvious, it makes one wonder why everyone’s not thinking that way.

My contention is that investors, including myself, are fickle.  As investors we really have no control over the operations of the company and when our cash flow (dividend) is not paid, the only recourse that a dividend investor has is to sell the stock.

Conversely, when there is a big dividend to be had, I would want as many shares as possible.  One may think that this will lead to erratic cycles in the stock price of Progressive as “yield hunters” trade the stock over the course of time.

How The Variable Dividend Works?

Progressive’s board has opted to pay a variable dividend based on the firm’s after-tax underwriting profit. That means the premiums Progressive takes in, less claims paid out and expenses of running the business. Shareholders will get 40 percent of those profits in a great year, 20 percent in an average year, zero in a bad year.

So, what consitutes a Great Year, Average Year, and Bad Year?

It’s not entirely carved in stone , but It helps, of course, that Progressive is solidly profitable and generates far more capital from its operations than it can profitably deploy in its business. But should things turn bad, which has happened to many once fine companies, Progressive won’t be stuck trying to defend an unaffordable cash dividend that shareholders have come to expect. In these volatile days, locking yourself into a significant fixed dividend can be a bad idea.

Could This Dividend Policy Work For Other Companies?

If other companies could stomach what seems to be the inevitable swings in stock price, then this policy may work for them because they would pay out what dividend they could afford and no more.

While this would produce stronger companies in that sense, investors who are seeking regular income (who, as our population ages are more and more), may steer clear from companies offering an unpredictable payout.  This lack of investor confidence could ultimately result in a lack of capitalization that would ultimately harm the operations of the organization.

Because the strength of a company and the performance of management is ultimately gaged on the price of the company’s stock, this dividend policy seems risky for those managers, investors and companies that are more conservative.

I guess we will have to wait a couple of years to see how this policy plays out for Progressive.  While it seems very good in theory, it certainly bucks the trend of traditional dividend theory.

Posted in Investment News | 2 Comments »

Do You Have The Perfect Financial Plan?

We have all heard people harp on having a financial plan and investing for the future, but what does that mean?  What happens when you develop your asset allocation, purchase your Dividend Growth Stocks and Dividend ETF’s and have  saved for an emergency fund with a high interest online account like ING Direct?

We have also heard all of the “talking heads” on television talk about diversification.  They are more than likely talking about diversifying within the stock market.  Diversifying between stocks, sectors, and industries as well as between fixed income investments like bonds and equity investments like stocks.  This is usually good advice, but what about other types of investments?  Where do they fit in the picture and how can they help you to further grow and protect your wealth?

What Happens Next?

At Blueprint for Financial Prosperity, they ask what is next in your financial plan after you have successfully accomplished the following:

• Paid down all your debt until all you owe on is your mortgage.
• Maintain six months of expenses for your emergency fund in a high yield money market account.
• Fully fund your and/or your spouses 401k, 403b, 457, etc.
• Maximize your and/or your spouses Roth or Traditional IRA up to the allowable limit.
• Invest some money each month in a 529 plan (and possibly even a Coverdell “Education” IRA) for each of your children’s future educations.
• Set aside some additional money each month and at bonus time into a taxable brokerage account for such goals as that long-awaited trip to the Orient, the sunny vacation property on the water, or even retirement.
• All your investments are properly diversified by asset type according to your goals, time frame, and risk level.

The article goes on to mention investments in tangible assets such as gold coins or a stash of gasoline, although the latter is difficult to manage.

Diversify Away From The Stock Market!

I would suggest that diversification away from the stock market take into account a variety of tangible assets such as precious metals, raw land (vacation property is preferred), Real Estate, and valuable collectibles or antiques.

You should be aware that these tangible assets typically have narrow markets and can be very illiquid. However, they can be very valuable in times when the stock markets are out of favor and should comprise a small piece of one’s overall investment portfolio.

It is essential that you do your due diligence with every form of investment. Purchasing these tangible assets can be tricky if you are not well versed in the particular niche market. That said, thorough research could yield tremendous value so get out there and test the waters!

I have little in the way of antiques and coins, but I have had some success with Real Estate and I do own some semi-valuable sporting collectibles.

I am a strong believer in diversifying away from the stock market and I prefer rental Real Estate because I am adamant that cash flow is the engine that drives wealth.  Real Estate is the only avenue where the average person can utilize the power of a mortgage as financial leverage to compound their wealth.

Posted in Investment News | 6 Comments »