Monday, 28 March 2016

Cynical vs Non Cyclical Stocks

Note: By cyclical I’m referring to resource stocks rather than the technical definition which is stocks that rise and fall with the economy, say car stocks for example.

I’ve had this discussion with various buy and hold bloggers and the issue is that investors tend not to distinguish between cynical and non cynical stocks.

Cynical stocks are driven nearly 100% by commodity prices and herd mentality. You get in, take your profits and leave. There is very little a company can do to increase earnings when  commodity prices are depressed.

Non cynical stocks, and this is the part that really matters are more suited to buy and hold investors. Short term you see price volatility due to herd mentality. Sectors fall in and out of favour giving you opportunities to pick up a stock at a better price. Take banks as an example. Prices are (were) quite depressed so bargain hunters started shopping driving prices up but at some point the housing bubble is going scare off investors off leading to a major sell off. Prices will drop but unlike the resource sector dividends and yields will continue to rise and the whole cycle will repeat itself giving the astute investor an opportunity to profit.

But what about Manulife you say?

In this case it has less to do with cynical vs non cynical but rather a poorly run business. The company ran into problems had to cut the dividend and the stock price simply tanked. While they did restructure and eventually return to profitability the stock price has never recovered. I wrote about Manulife here.

Friday, 25 March 2016

Linamar (LNR) moving beyond the safe world of bank stocks

I’m slowly in the process of expanding my investing horizons. Up to this point I’ve always stuck with tried and true solid blue chip dividend stocks with a higher dividend yield.  While I have done quite well I’ve noticed two problems. First the upside is generally limited and secondly in taking profits it be hard to find where to re-invest profits.  On the first point Intact Financial is a great example 2% yield but up 100% in the last 3 years. The second point I only buy stocks that are undervalued and when you investing universe is only 15 stocks it’s hard to find any. What I did was to sign up for several premium newsletters (more on that in a later post).


This stock came up on my radar thanks to Canadian Dividend Growth Investor
over at  Seeking Alpha. Yield under 1% so normally it wouldn’t show up on my stock screeners. To quote his summary. 

Why I like this stock

·       Linamar is priced at a cheap multiple of 8.6 and it just reported double-digit growth in its sales and earnings for Q4 and 2015 overall.
  • Discounted by 35%. Upside potential of 50%.
  • Exceptional business performance expected to continue.
  • Strong balance sheet.
Again let me insert a Fastgraphs chart. This is what I like to call a classic Fastgraphs chart, steady as she goes earnings and then kaboom the earnings take off (ignoring 2008)

 Now if we insert the price you can see that it is clearly undervalued at the moment. BTW if you look a bit and you can see what happens when a stock is overvalued. Sure you get a dividend but a 40% price drop, ouch!

Second chart is earnings growth (which drives the stock price) and normal PE ratio and the price should the stock return to it's historical PE ratio

As you can see the potential 50% price gain more than makes up for the low yield. Now before I go out and put down my hard earned savings I do have a few thoughts/questions.

1. Does earnings drive the stock price?

This is the underlying theory behind Fastgraphs. You find a strong company that for whatever reason the market is ignoring. This could be because the sector is out of favour - this happened during the tech bubble. The company could have had problems and have recovered, Manulife after 2008. It could be just a bear market. Knowing this will help you decide when to buy and how much to buy.

2. Can the stock really go higher?

This was Microsoft back in it’s heyday. It was a hot growth stock I remember one analyst who was following the stock never bought it because it always felt expensive and simply couldn’t go any higher. Needless to say this was a 10 bagger stock. Currently Facebook feels the same way.

3. The lower the price the more the opportunity for it to go up

This is the underlying theory behind Benj Gallander and Contra the Herd. A two dollar stock has a better chance of doubling than a fifty dollar stock

4.  Small dividend

This is probably my biggest concern as a dividend junkie, at 1% it’s peanuts. When I bought Manulife the healthy dividend was a fall back in case I got it wrong. 

Friday, 18 March 2016


Dividend Earner recently did a blog post about Loblaws because of the low yield I normally pay much mind to it but having looked at Intact Financial (IFC) and similar stocks I realized that in what they lack in yield they make up for in capital gains. Intact (IFC) is up nearly 100% since 2010.  Now Dividend Earner did a great job of the Loblaws stock metrics so I won’t repeat it here instead I’ll pull up a fast chart to see what it looks like. Now when buying a stock for capital appreciation it helps to keep in mind Benjamin Graham’s famous quote. "In the short term the stock market is a voting machine, long term it’s a weighing machine" . Basically earnings support the price. If The earnings aren’t there neither will the price. Pulling up Fast Graphs we can see that Loblaws is showing some strong earnings growth.

Add in the stock price (black line) and you can see a clear coloration between earnings and the price.

To Buy or not to Buy

Two issues show up. One specific to fastgraphs the other regarding long term earnings. On fastgraphs if you change the timeline the PE ratio (blue box right) changes and since this is the basis for making a decision it matters.

Second point is concern about growing earnings consistently. Manulife ran into problems around 2006 and the stock still haven’t recovered (down some 80%).

Price Growth:

Understand when buying a stock what you are actually buying is a company’s earnings growth. Too high of a valuation will cause you to earn less than the company's growth warrants, and a low valuation will cause you to earn more than the company's growth warrants. Valuation matters and few give it much thought. See the photo below.

Stocks like this can add substantially to your bottom line so at the moment if feels overvalued so I'll keep an eye on it but probably won't take a position at the moment. 

Tuesday, 8 March 2016

Potash (POT) A classic Value Trap

For any investor a bear market is tough. Nobody likes logging into their trading account and seeing it awash in red. Even worse is a bear market accompanied by a dividend cut.  So when Pot started dropping on fears of a dividend cut I had to make a decision on whether I was going to sell or not. So avoid making an emotional decision I looked at the fundamentals to see if anything had changed and secondly calculated what my ROI would be 2-3 years out.
On both accounts the numbers said screamed sell.

  • Potash is a commodity there is very little management can do to increase earnings until the price recovers.
  • Until that happens earnings along with the stock price and the dividend will stay mostly flat.
  • It will take roughly 13 years to make up for the loss (assuming the yield remains at 5%)

Potash is what you call a  classic value trap. You buy hoping beyond hope that it will one day recover. But as I wrote in my forth coming Canadian MoneySaver article, Hope is not a Strategy. Based on this analysis I sold at 22 a share. And Yes I took a substantial loss. I'll detail the lessons learned here in a later blog post.  

Manulife Undervalued or a Value Trap

Manulife has left a lot of pain on the table for buy and hold investors. 2008 pulled the rug out from under the company, earnings and the dividend along with the share price took a massive hit. It’s taken nearly a decade for the company to find it’s footing again. It was a classic value trap. The good news is management did work out the issues.
Now the question is Manulife a buy?
Short Answer Yes

Management has enough faith in future earnings growth that they started increasing the dividend. Forwards earnings growth is 6% (1% in 2016 and 10% in 2017) The stock has now bottom out and is starting to look good. Yield has crossed the all important physiological barrier of 4%. This from

Still suffering from its financial crisis hangover but that is gradually working its way through the system. 2012 was this company’s return to real profitability.

Looking at Fastgrapshs we see this. Earnings are growing (dark green area) and the blue line is the historical PE ratio. The black line is the current PE ratio. As you can see the stock is massively undervalued. 

Price Projection
Normal PE ratio 15
Current PE ratio 9.5
Price projects if returns to its normal PE ration
2016 $13 or 80% price gain
2017 $16 or 100% price gain
2018 $20 or 120% price gain