Investing in Stock- what I am keeping my eye on

So having shared what I look at, these stocks are on my watch list in no particular order (please note that this is not investment advice nor solicitation to purchase any of the stocks below, please conduct your own research before making any investments):

1. Corby Distilleries Limited (TSX: CDL.A): The 2nd largest spirits maker in Canada (they produce Lamb's Palm Breeze, Beefeater, Kahlua). Alcohol is a regulated industry (you have to have rights to produce booze by country; the largest province in Canada, Ontario, owns most of the distribution channels preventing price competition), is in a recession proof industry, has no long term debt and pays regular dividends as well as a special dividend from all the surplus cash it has; and
   
   
2. Johnson and Johnson (NYSE: JNJ): Producers of many house-hold medicines and consumer staples (Tylenol, Bengay, Acuvue contact lens), increasing dividend payments, many of their products are patent protected (which means there is no price competition until the patent expires), net cash flow from operating activities has increased year over year and the stock is trading below its Jan. 1 price providing a buying opportunity.
   

Investing in Stock- a summary

I hope you noticed a few things about my list of what I look for in stock investing:

1. The non-technical factors outnumber the technical factors- at the end of the day, its all about the KISS principle with me. If a company is doing well on main street (the non-technical analysis), the technical analysis, as a general rule (there's always exceptions), should follow. For example, when was the last time you shopped at the Gap? I have not bought a lot there for years compared to the 1990's and neither have a lot of my friends and family (how many khaki's can a guy have?). Look at Gap's stock price- its really struggling.
   
   
2. My technical factors focus on cash- how much its paying out in dividends, how much free cash it has and how well it makes use of investor's cash. I readily admit that this is influenced by what I do. Businesses with more cash perform better than businesses with less cash (the painfully obvious observation of the day!). Think of your house-hold: the more free cash you have, the greater your options right? Its the same with publicly traded stock-the market rewards companies that knows how to generate and pay out cash.
   
   
3. There is no rocket science involved in my analysis. Anyone can apply these factors. Do not let the investment industry fool you into thinking you cannot do this.
   

Investing in Stock: Technical Analysis #3

Look for company's with high return on equity (ROE) ratios

ROE means how well a company is using your investment- in other words, for every dollar you invest, how much can the company make? The higher the number, the better.

I am not going to attempt to break down how ROE is calculated. It is way beyond my high-school math. Most companies or investment research will publish ROE's so look for it in their public releases or in company research provided by investment banks.

As a rough guide, any non-financial company (so anything other than banks, insurance companies etc.) that can generate ROE over 10% is good. However, if the company has a high ROE and a lot of debt, be careful; like any household, growth based on excessive debt is not a good thing.

If you find a company that is doing both technical analysis #2 and #3 well, what you have is a company that can invest your money well (high ROE) and generates a lot of free cash with your money (increasing net cash provided by operating activities). If there is a lot of free cash, the company is hopefully paying an increasing dividend which, on the balance of probabilities, leads to above market return on investment (see rule #1).

Investing in Stock: Technical Analysis #1

If in doubt, buy a dividend stock, preferably a growing dividend stock.

Proof is in the pudding; dividend stocks beat the market and growing dividend stocks do even better. The following is courtesy of RBC Capital Markets

S&P 500 Total Return: Last 10 Years (to Feb. 15, 2007)

S&P 500 Non-Dividend Payers: 6.3%
S&P 500 Total Return: 8.0%
S&P 500 Dividend Payers: 8.5%
S&P 500 Dividend Growers: 9.1%


TSX Total Return: Last 10 Years (to Feb. 15, 2007)

TSX Non-Dividend Payers: 2.7%
TSX Total Return: 8.5%
TSX Dividend Payers: 14.2%
TSX Dividend Growers: 15.5%

Common Sense Analysis #1- explained much better than me

I found this quote on-line from www.money.com. Fortune Magazine reporter Katie Benner interviwed the managers of Hodges Fund (5 year annualized return of 18.8% according to Moringstar).

In response to a question about investing strategies for a unpredictable 2007 market, the fund manager answers:

"We're a big proponent of pricing power. What allows a company to maintain or even increase its prices is a lack of competition, high barriers to entry and good demand. PC makers can never have pricing power because there's too much competition. Instead, we focus on businesses like railroads and steel, where there used to be a ton of competitors and now there are just three or four."

I note that the examples given, railroads and steel, are in regulated industries (you can't just put a train on the tracks without telling someone and steel is subject to pricing regulations and quotas). Its nice to have someone confirm my common sense analysis.

Investing in Stock: Common Sense Analysis Part 4

Don't invest in anything trendy

As I may have mentioned before, I am in the business of giving advice to other businesses so I see a lot of businesses. The "trendy" businesses I see either do either extremely well or completely flame out in months. There doesn't seem to be a middle ground. If you are in technology, you basically have 2-3 years at the very most to make it or you are done (someone has better technology, the market has moved to another application or the venture capitalists are chasing the new darlings on the street- as a sidenote, yes I dislike most tech companies as investments, can't you tell?). For every trendy business that does well, I see 5 that do not.

Not great odds eh?

In comparison, the businesses that do well tend to be in tried and true industries (real estate, import/export, distribution). For the risk takers, there are small cap stocks in each of these industries so just because you invest in these industries doesn't mean you are in for a boring ride.

Let me relay one war story for you: venture capitalists invest in risky businesses with the hope they become big- in other words, they invest in trendy businesses hoping to capitalize on the trend. Most venture capitalists will tell you that for every 10 businesses they invest in their return on investment is as follows:

1. 1-2 successes
   
2. 3-4 "living dead"- the businesses make enough money to repay the loan and that's it
3. Everything else is a failure

If your portfolio performed like this, you would probably be able to retire at 102.

Investing in Stock: Common Sense Analysis Part 3

Don't buy anything you don't understand

What does this mean in plain English?

"Nortel's portfolio of telephony and converged IP telephony solutions deliver seamless, scalable real-time business communications with unprecedented flexibility in telephony applications deployment to meet our customer's environment, expectations, timetable and budget."

I don't want to pick on Nortel (or its copywriter) but I don't understand what this means. I suspect 95% of investors don't either. Nortel isn't alone (again not picking on Nortel). I don't understand what 90% of technology companies do. Or how most hedge funds work.

Enron was, towards the end, not an energy company but engaged in (illegally it turned out) in securitizations and other sophisticated financial transactions (someone had to explain a securitization to me).

I am a real subscriber in the KISS principle. If the company cannot explain what it does in a couple of sentences, I do not invest in it. Maybe I am a simpleton but investing in simple to explain businesses makes me comfortable (see rule #2).

Investing in Stock: Common Sense Analysis Part 2

Invest in what you are comfortable with

This has more to do with the psychology of investing than my first rule. I never invest in a business where my gut says its not perfect even if the investing community says it is: it is either over-priced, in an industry with a lot of fizzle and not a lot of substance (most of the tech industry in my opinion), in a country/region which isn't what the experts say it is (see my post on China- go to the country before you invest in it), its trendy (income trusts or hedge funds), I don't understand what it does exactly (see Nortel in the 1990's) or its being managed by management with a mediocre track record.

The temptation is to always go with the crowd but if it doesn't feel right, I don't do it (there are no style points in investing).

How the Rich Get Richer

In a week that U.S. Investors are selling shares in New Century Financial Corp. and other subprime mortgage lenders (at a loss) for fear that the housing and subprime mortgage industry is collapsing, the Wall Street Journal reports that Goldman Sachs Group Inc. is looking to go deeper into the subprime mortgage business.

I looked this up- Goldman Sachs made $12.73 BILLION dollars in the last financial quarter. Suffice to say, they know how to make money.

If institutions that have a track record of being profitable are going deeper into a troubled industry while the average investor is fleeing it, what does that say about the average investor?

China

Last week's 400 pt. plus drop on the DOW started with a sell-off on the Shanghai stock market. Now that the dust has cleared somewhat, I wanted to share my experiences with China and why I don't investing in China directly.

I have been to China twice since 2002- once on vacation, once on business. The last time I was in China was August 2005. The last time I was there my business associate and I took a cab into downtown Beijing from the airport. As we drove in, all we saw was construction crane after construction crane putting up new office towers. Here's the catch- all the finished buildings were vacant. One building would be built, be completely empty and another new office tower would be built right beside it. We ended up having drinks with a North American ex-pat and I asked him if office towers were built before anchor tenants are secured in 5 to 10 year leases (like in North America). He said no.

Basically, buildings were being built for the sake of being built. If anyone studied Japanese economic history, a similar patten emerged in the late 80's (and the Japanese banking system went into crisis in the 1990's). At some point in time, the banks can only finance so many office towers with no cash flow before the country's economic system experiences some shocks.

The other thing that worried me was whether economic growth was being fueled by throwing bodies at the problem with concern for efficiency. We took a walk in Shanghai one night and there were at least 20 men at a construction site surrounding construction equipment- one guy operating the machine, one guy supervising and the rest of the guys standing around. Its not like they didn't want to help but you can't put 18 guys at work on a construction site which is 10x10 at the very most. However, statistically speaking, this company employed 20 people.

So I wonder if these economic growth is being made by just employing people for the sake of employing people (whether for economic or political reasons) or there is proper productivity gains being made.

Third observation- while we were there, the news reported that the government was bailing out the 5th largest investment bank in the country since it was in financial trouble. Does this inspire confidence if a supposedly pillar of the financial community is in trouble? Imagine what the American economy would be like if the 5th largest investment house in the United States needed to be bailed out?

These observations really scares me- I wonder how stable the fundamentals of the financial system are if this is what is happening on the street level. Peter Lynch, who is a successful mutual fund manager and author, teaches his readers that you should invest in what you know and what you are comfortable with.

Based on my experience, I am not comfortable with the economic development of China supporting a public traded company I would buy (note I am not down on China, I am down on investing on a Chinese publicly traded company). I do believe the country is growing and becoming an economic super-power but at this point in time, I do not want to invest in any public traded company based in China based on concerns about the underlying economic fundamentals.

An investment advisor once told me that the cheaper way to invest in a trend is to invest in fundamentally solid companies that support the trend. For example, when eBay was at its peak, purchasing stock in UPS or FedEx would have been a good idea (after all who's going to deliver all of these purchases?). If China is growing, and you want to invest, think of shipping companies, warehousing and logistics companies- companies that would benefit from the growth of the country.

What Are You Buying?

Have you ever been asked this question?

I hate this question- for three primary reasons.

1. The cart before the horse: The question presupposes that you have an investment strategy in place. This question should only be asked once you understand your investment style.

2. Context is everything: A 35 year old single person is in a different life situation than a 42 year old married person who is in a different situation than a 58 year old widow. Where you are in life should ideally dictate what you buy. This reason dove-tails with reason #1.

3. Missing the boat: How many people tell you about their investment losses? I suspect very few. But people will tell you about their successes. However, by the time they do so, the investment product will most likely be a lot more expensive than when they bought it. In many respects, the answer to the question will be: a really expensive product.

Because of what I do, I always believe that you should always answer "where do I want to be?" before "how do I get there?" but we sometimes chase the glitter before knowing whether we want it or not.

So before we ask others what they are buying think about a strategy first. In the next post, I'll share my worse investing mistakes- many starting from the fact I asked "what are you buying" before figuring out what I wanted.

Welcome to Thicken My Wallet

As the title of the blog indicates, this blog is about all things that will thicken your wallet (and I don't mean bills and credit card receipts). It deals primarily with money, finances and, most importantly, the mind-set of money.

I guess what I am aiming for is a Po Bronson meets Warren Buffet blog on money. Money is a very rational thing seen from afar (the Buffet part) but very emotional seen up close (the Bronson thing). I am hoping to fuse the two together since you can't talk about money without feeling something- wish me luck, I tend to go off on tangents!

In my other life, I am a professional who provides advice (I am not a financial advisor nor do I work in the financial industry). I see a lot of different people from different walks of life, of different ages, backgrounds and life paths. More often than not, the only thing tying all these people together is a common wish to attain financial security (or put another way, not to stress about money every single day!). So I learn from observation and I learn from experience- thus, this blog is partially about learning from the experiences of myself and others. There are far brighter and more stable people than me who teach me about dealing with money.

My first observation- here's the one thing I have learned from people who have "made it" (insert your definition of "making it"):

1. Its much simpler than you think.
2. Its counter-intuitive from what popular media and the investment industry may teach you.
3. There is no "magic bullet" solution.

I hope to work out these concepts through the blog. I hope you enjoy reading and, more importantly, participating.