Wednesday, April 29, 2009

Currency Risk

This is a factor that many investors fail to account for but that has a huge impact of their investing results. Most people may not be aware of it, and thankfully, I fully grasped the depth of those implications the easy way.

Back in September, as I was adding companies to my portfolio, the Canadian dollar was at par with the US dollar. Which made buying American companies at the then current prices a bargain, and I have luckily been proved to be right! From September 17th, when I made my first trades acquisitions of American stocks, to now, the US dollar went from 1.07 Canadian dollars to 1.29 Canadian dollars. That is a 20% jump, and it was mostly due to the financial meltdown in the last quarter of 2008.

Being an investor living in Canada, and that applies to any investor; it is in my advantage to invest mostly in companies that trade in the local currency because I would be in a very uncomfortable position if currency rates had moved the other way. Since currency exchange rates are influenced by macroeconomic factors, I think it is a thing that value investors tend to minimize by not investing much in foreign countries.

That is in fact the main reason I do want to avoid those particular types of fluctuations. I am aware of my limitations in reading macroeconomic trends, so for someone like me, trading with currencies is a double edged blade. That is a factor that can work for me or against me. As a value investor I guess it is probably better for me to stick with local currencies.

Money to Be Made In Alcoholic Beverages

When attending social events, it came to my attention the amount of alcohol that is often consumed when people gather. So I started doing a bit of investigating and noticed that among the biggest companies that produce spirits tend to have very healthy profit margins and incredibly reasonable returns on equity.

While studying the financial statements of Pernod Ricard, I was wondering if that company had a subsidiary in Canada that was majority owned but had enough shares outstanding to still be publically listed and I hit the jackpot.

The company in question is called Corby Distilleries Limited (TSE: CDL.A, TSE: CDL.B). The company has been around for a while in Canada, since 1859 to be precise. It is a leading Canadian manufacturer and marketer of spirits and imported wines. Corby’s portfolio of owned-brands includes some of the most renowned brands in Canada, including Wiser’s Canadian whiskies, Lamb’s rum, Polar Ice vodka and Seagram Coolers. Through its affiliation with Pernod Ricard S.A., Corby also represents leading international brands such as Chivas Regal, TheGlenlivet and Ballantine’s scotchwhiskies, Jameson Irish whiskey, Beefeater gin, Malibu rum, Kahlúa liqueur, Mumm champagne, and Jacob’s Creek and Wyndham Estate wines. Corby has about a 24 percent share of spirit sales in Canada,representing more than 4,000,000 cases of spirits sold annually. Corby owns or represents 8 of the 25 top-selling spirit brands in Canada, and 16 of the top 50, as measured by case volumes. Additionally, with volume of approximately 900,000 cases, Corby is also a leading importer of wines in the country, and that impresses me since it is not a much known company.

It wasn’t a subsidiary of the French parent company at first, because the company already has it’s own brands of spirits. Where things get interesting is the alliance with Pernod Ricard. The company currently has a net income of about 100 million dollars a year without the use of leverage, awarding the company with a net profit margin of about 40%! So it makes total sense for the company to be profitable even during the current economic conditions.

That partnership also awards the company with an expanded portfolio of product so sell. Recent numbers have shown that the Canadian market for alcoholic beverages has been surging through the first quarter of 2009. That is a reason I like this company a lot, mostly since they are the only authorised distributor of Pernod Ricard products in Canada.

Full disclosure: the author has no position in CDL.A or CDL.B

Monday, April 27, 2009

The Northern Track to Profits

When you look at the news that is being circulated buy the many investment pundits, it is very clear that value companies are rarely what generate the buzz in the financial community. The best example I have in mind is the Canadian National Railway Company.

Canadian National Railway Company (TSE: CNR, NYSE: CNI), incorporated in 1922, is engaged in the rail and related transportation business. CN’s network of approximately 21,000 route miles of track spans Canada and mid-America, connecting three coasts: the Atlantic, the Pacific and the Gulf of Mexico. CN’s freight revenues are derived from the movement of a diversified portfolio of goods, including petroleum and chemicals, grain and fertilizers, coal, metals and minerals, forest products, intermodal, and automotive. They are so diversified that every company in North America large enough to need their services has very probably heard of them!

They also have a long history of profitability and their financial statements for the year 2008 show that there is no end to the earning power of the CN. With 8 billion dollars of revenues and 2 billion dollars of profits for the year, the resulting 22% net profit margin is very attractive since very few companies get to reach such a level.

The most amazing those is the impressive 18% return on equity generated by the firm. Even if it has declined throughout the year 2008, that number is almost twice that of the average company. Keeping such a fast pace for almost a ninety years is a very rare feat considering that the great majority of companies fail in their first years without even showing signs of profit to their owners.

I guess I am not the only investor noticing those attributes since the common stock of the company, dually traded on the New York Stock Exchange and the Toronto Stock Exchange has been recovering a lot faster that the overall economy year to date and is moving closer to the intrinsic value per share of the company. It is a sure sign that bargains never last and that investors have to act fast to avoid the mistakes of omission that are caused by what Warren Buffett calls “Thumb sucking”.

Full disclosure: the author has no position in CN

Underlying Value in Drybulk Shipping

DryShips Inc. (NASDAQ: DRYS) is a Marshall Islands registered company that was formed in September 2003. Their principal executive offices are in Athens, Greece. They are a provider of global marine transportation services for drybulk cargoes, including major bulk commodities such as iron ore, coal, and grain, as well as minor bulk commodities such as alumina, bauxite, fertilizers and cement. They own and operate a young, modern and diversified fleet of drybulk carriers that trade worldwide. DryShips is the largest drybulk company listed on a US Exchange both in terms of fleet size and revenue and one of the top Panamax operators in the world.

What attracted me into that company is their sound management. What we have here is a company with a market capitalization of about a billion dollars that has two employees: George Economou, its very involved Chairman, Chief executive officer and interim Chief financial officer, and his secretary. The company makes almost 500 million dollars in net income and capital expenditures rarely run to more than 20 million dollars. Now that is what I call cost control! The rest of the managing job is mainly contracted to affiliated companies that are also run very lean. That focus to reduce costs makes DryShips a company with very impressive profit margins and a huge return on shareholders’ equity since it has gone public. All those elements make DryShips another very promising position. There are very great prospects for the future of the company since it decided to diversify its operation near the end of the year 2008 into oil exploration.

As I talked about earlier, George Economou holds a 31% beneficial ownership in DryShips at the end of November 2008, and he has aggressively acquired about 2 million shares during the last quarter of the year, that high a stake guarantees that most of his decisions will be favorable to the shareholders. In concordance to the earnings statement of Q3 2008, he announced that one of the subsidiaries of the company will be spun-off and that each shareholder will be granted the proceeds from this transaction. That is almost an investment cinch, probably the closest thing to an arbitrage you can get on the stock market.

The company is currently facing a major debt restructuring and has issued an amount of new shares that has caused a quite an amount of dilution to existing shareholders, but I remain confident that DryShips will generate a lot of money in the coming years for the smart investors who are acquiring the common stock at the attractive prices we have had year to date.

Full disclosure: the author holds a long position in DRYS.

Fisher’s Growth investing

In the investment world, value investing and growth investing seem to be perceived as opposites, but I often wonder why. I recently fell on a book by Philip Arthur Fisher, who is considered by many to be the father of growth investing and has been one of the two persons to have inspired famed investor Warren buffet, the other one being the father of value investing, Benjamin Graham. In the 1950’s he wrote a phenomenal book called Common Stocks and Uncommon Profits. The book was, and still is, a very comprehensive guide to the way he went at discovering companies in the stock market and how an individual investor could do the same. A rational investor will gain a lot by getting acquainted with his investment principles.

From what I understood, Phil Fisher wanted to “buy companies that had disciplined plans for achieving dramatic long-range profit growth and had inherent qualities making it difficult for newcomers to share in that growth”. This might seem pretty fuzzy as a concept but if we take a more precise look at what he meant, it comes clearer that the differences between value investing and growth investing, at their core, are not many.

I first understood where Warren Buffett got his tendency to keep companies that he liked for a long time, it is pure Fisher! There are only three reasons that would have caused Phil fisher to sell the stock of a company.
  1. There has been a fundamental change in its nature (e.g., big management changes),
  2. It has grown to a point where it no longer will be growing faster than the economy as a whole or,
  3. It is trading at a very high P/E ratio because of mass market speculation.

If I am not mistaken, those events usually take a while before happening, a lot more than a couple days, probably years. A good example of his habit not to sell is his position in Motorola; he bought common stock of the company in 1955 and kept it until his death in 2004. In my view, that is the closest to forever.

I also noticed that he was keen to keep his portfolio at no more than 20 companies, which is a lot less than the number of companies in the average mutual fund. I also noted the tint of a prudent contrarian investor in him, since he would never accept blindly whatever may be the dominant current opinion in the financial community. But he also notes that he did not reject the prevailing view just for the sake of being contrary.

His process might seem complicated and unclear, but that is only because his philosophy can’t be summarized on a single page. For those interested in acquiring his book, you will find the necessary details here. In my point of view, what is good for Warren Buffett is very likely good for me too.

Moral Dilemma

Most of the time, people think of investing in a business purely as a way to make money from capital gains if you are lucky enough for the trade to go your way. Some industries tend to be more profitable than others, and the net profit margin ratio tends to give a fair measure of the profitability of the business. So when I am on the hunt on the market, I usually screen my search to include only companies that have a net profit margin of at least 8% (the higher the better). Those companies have a smaller tendency to see their net earnings eroded by price fluctuations in their products or services.

One of the seldom industries to have consistently shown incredible earning power for over a century are the ones involved in the petroleum industry, ranging from integrated oil companies to oil exploration companies. That industry is relatively safe because so much of our modern economy relies on oil and gas as a relatively cheap and reliable source of energy.

The company that impresses me the most is ExxonMobil (NYSE: XOM) and I remain surprised to this day that very few people are aware of its gigantic size. The company is in fact the biggest chunk of the now dismantled Standard Oil empire founded by the late John D. Rockefeller. With revenues of 477 billion dollars and 45 billion dollars in net profits in the year 2008, which would give it a net profit margin of about 9.5%, this company is a champion at creating value for its shareholders. And with return on equity of 39% in a year that critical and a direct witness to the spectacular drop in the price of crude oil, I am dazzled at the way a company with assets of about 200 billion dollars still manages to show figures that impressive. That financial snapshot is consistent with other integrated oil companies, whatever their size.

The loophole for a socially aware investor is when you know that as interesting as that figures of that company are, its activity is, directly and indirectly, very damaging to the environment. So one may wonder if it is possible to make reasonably good acquisitions as an investor and at the same time be in line with our moral values. I am not quite sure of that answer yet but I sure hope it is something possible.

Full disclosure: the author has no position in XOM.

Thursday, April 23, 2009

The Missed Occasion Year to Date

Back in February, I was going through some companies that looked promising. One of them, Petro-Canada (TSE: PCA, NYSE: PCZ) was very attractive. It is on of the main integrated oil and gas company in Canada. Their business is diversified in three different fields: Natural Gas in North America, Oil Sands in Canada, and International Offshore.

Reading through their financial statements it seemed to me, using a long term perspective in the 5 year, that their stock was undervalued compared to the income potential of the company

Their return on equity over the last five years has averaged around 22% and their net profit margin of about 11% seemed to offer some kind of safety to the company if the financial crisis came to be longer than expected.

What I liked the most was their total debt/equity ratio. The advantage of such a low ratio resided in the fact that under a 100% Debt/Equity ratio, managers tend to work with the interest of shareholders on their mind (as well as theirs...), rather than spending time with the lenders to get more flexibility in their operations.

During the week ending the 20th of February, the stock price had ranged between 25.61$ and 28.02$ on the Toronto Stock Exchange. As of today, it is trading at about 37$. This would have ensured a minimum profit of about 30%. Over the same period, their Price/Earnings ratio has fluctuated between 3.8 and 4.6, a total bargain! So what happened?

It came about that I was not the only person appreciating Petro-Canada’s financial statements. Suncor, one of Petro-Canada’s competitors announced that the two companies we about to merge, sending Petro-Canada’s share up 20% in a single day, Petro-Canada being the acquired company.

Going through the process of learning how to invest, missed opportunities seem to be all over the place. But as long as I get a couple good shots, I should have decent results.

Full disclosure: the author has no position in PCZ or PCA.

Wednesday, April 22, 2009

A useful rule of thumb

Recently someone was telling me about his savings that were in a guaranteed investment account, he was wondering how long it would take to double his money. I took him by surprise by giving him an answer after a couple seconds of thinking. Some of you might have guessed it, I do not have an integrated calculator in my brain, I just learned a trick from some specialists of the world of finance and, unfortunately, I do no know who the author is.

Usually, if you want to know how long it will take for your money to double, you need to use a pretty complicated formula, in a particular example, if one would ask how long it would take to double 1000$ et would use n = ln(2000/1000)/ln(1+i). Here n is the number of years necessary to double your money, the time frame we are looking for. R is the interest rate the money is invested at. The expression ln(2000/1000) is the application of the natural logarithm. Using that formula on a financial calculator and using an hypothetical rate of 4%, this formula would give us 17.7 years. At 6%, it would give 11.9 years.

Now let me reassure you, i did not make that calculation to give an answer to that friend. That formula should be used if you want to get a very accurate answer. In the everyday life, we can use a shortcut. I did what very few people know about; it’s called the rule of 72. That simple rule has the following form: n = 72/r. That easier expression says that by dividing 72 in to r, that will give you the approximate number of years necessary to double the money. Coming back to the earlier example, 72 divided by 4% will give us 18 years. It is close enough to the earlier estimate of 17.7. With 6%, you get 12 years. It is still quite precise for everyday calculations.

So next time someone you know asks you how long it will take to double their capital, you will be able to surprise them by answering them in a couple of seconds, or almost, just by asking them their interest rate.

Yearly Returns of The Caisse de Dépot et Placements du Québec

Year Total Return
1966 6.4%
1967 -1.2%
1968 4.4%
1969 -4.4%
1970 12.8%
1971 14.1%
1972 10.8%
1973 3.4%
1974 -5.6%
1975 12.5%
1976 18.3%
1977 10.9%
1978 9.9%
1979 7.2%
1980 9.9%
1981 -1.9%
1982 32.8%
1983 17.0%
1984 10.1%
1985 24.0%
1986 13.5%
1987 4.7%
1988 10.5%
1989 16.9%
1990 5.0%
1991 17.2%
1992 4.5%
1993 19.4%
1994 -2.1%
1995 18.2%
1996 15.6%
1997 13.0%
1998 10.2%
1999 16.5%
2000 6.2%
2001 -5.0%
2002 -9.6%
2003 15.2%
2004 12.2%
2005 14.7%
2006 14.6%
2007 5.6%
2008 -25.0%

Quebec’s “bas de laine”

The 2008 results of the Caisse de depot et de Placement du Québec have been the worst in its whole history. Contrary to the general upheaval that has taken place in the public opinion, it remains important to take one step back to get a broader sense of the role of the Caisse and the utmost important role it has been playing in the economic landscape of the province to create more wealth for its inhabitants.

First, it is important to clarify that the Caisse one of about 25 sovereign wealth funds in all the countries on earth, meaning it is an entity that put public money to work for the good of the nation’s population. Measure its size by assets, the Caisse de depot et Placements du Québec, comes 6th, even after accounting for the catastrophic results of 2008.

Assets under management amount for a staggering 220,5 billion dollars as of December 31st, 2008. That represents about 28000$ Canadian Dollars for each resident of the province. In Canada, only Alberta has a fund of similar purpose, but it is still a lot smaller and younger. If you count the Alaska Permanent Fund, it becomes pretty clear that there are only three funds of that type in North America.

Looking a little further into the future, Quebec has to be on a smart path to create collective wealth, if we think of the magnitude of the Abu Dhabi Investment Authority. That entity of gigantic proportions manages assets of about 875 billion US dollars... yes billions with a B. Dividing by the number of residents of that kingdom, you get a collective wealth of about 2 million US dollars per person!

That funds managed by the Caisse do not come from a source as lucrative as oil, but with the deposits made to it by numerous provincial pension funds, the Caisse will be a very valuable instrument for the creation of wealth in Quebec. It was a bold proposition from, then Prime Minister Jean Lesage, but it seems that very few people appreciate it and are fast to get angry when things get sour...

Tuesday, April 21, 2009

iStar Financial: The Yield Play

iStar Financial Inc. (NYSE: SFI) is a publicly traded real estate investment trust (REIT) focused on the commercial real estate industry.

The only reason I got involved with this company is certainly the fact that it is a great income source, but I later came to notice that it did not come at such a cheap price. Basically iStar, as Ben Graham most notorious student Warren Buffett would put it, is a cigar-butt type of investment; let me explain with a simple analogy. You are walking down the street and, all of a sudden, you find a cigar-butt on the floor. It is repulsive but there’s one or two puffs left on it. It is still ugly but since you are looking for a free puff, you smoke it. That is the definition of a cigar-butt investment; it is free (or almost) but there are a couple of earnings left on it. The shaky nature of the company still makes it attractive for me.
They suspended their dividend in the fourth quarter of 2008. I am holding my position for the simple reason that as soon as the dividend is reinstated, the yield on the my shares will be incredible! Assuming the reinstate the dividend at 20 cents per quarter, less than 75% of the original dividend. At today's closing price of 3.72$ a share, I still get a 21% yield.

So why, if the opportunity is great enough not to be missed by a beginner, doesn't everybody jump on it? It is actually quite simple, people do not know when the dividend will be reinstated and uncertainty is very bad for the price of a stock. Fortunately enough, I am patient and i will wait for as long as it will be necessary because my average purchasing price is way lower than today's closing price.

Comprehensive financial information can be found on their website at:
Interestingly enough, they put a lot of money for the quality of their website and annual reports and kept doing it for their 2008 annual report, even after a terrible performance.

Full disclosure: the author holds a long position in SFI

FairFax Financial: The most interesting company to date

Fairfax Financial Holdings Limited (TSE: FFH. NYSE: FFH) is a financial services holding company. It also is the biggest Canadian reinsurance company. A close look at their financial statements allowed me to conclude that the company had had an excellent return on equity since it went public in 1985: a consistent 20% every year. Talking about the business, the company’s stock is selling under book value and intrinsic value, which is one of the main reasons I decided to get involved with that company. The only reason why people might have missed on that company is that their stock is also selling at a psychologically high level for a trader. Most people would be intimidated by a company with a stock price in the hundreds of dollars, but the intelligent investor looks further than just the price tag. In fact, the price of a stock will be the last element we will take into account in our analysis before making an acquisition.

The ultimate reason I have a very important part of our portfolio in Fairfax is the chairman and CEO: Vivan Prem Wasta. His letters to the shareholders of the company are a masterpiece of financial knowledge and literacy of the insurance industry in Canada. I was far from surprised since he is a proud member and advocate of the value investing philosophy. He adheres to making much reflected acquisitions and keeping the company in a strong financial position; that focus is reflected in their very healthy balance sheet. Since he is a big individual shareholder of Fairfax, his attitude is very much reflected in how he leads the company. He is exactly the king of managers I look for.

Fairfax is probably one of my most promising positions and it has proved its performance by showing record profits in a year gloomed by a bear market. Acquiring parts of that company at such a low price is the closest thing to a robbery and I am pretty sure that I will be even more surprised when the company gets to be fairly valued by the market.

More on their website at:

Full disclosure: Long FFH.TO