Blessed by the Potato

So, despite the fact that I don’t particularly care for the word “blog” (as a bastardized contraction of the no better “web log”), and generally refer to my blog as a “site” — how very Web 1.x — I really like blogs as a thing. There are a number that I check at least weekly, from humour to personal finance, through personal diaries, to other ones that defy categorization like Whatever. And most blogs have comments (ok, this one doesn’t because my readers are non-involved zombies, or I’m not nearly as controversial as I think, but the software does allow for it). A lot of the time, I do read the comments, especially when the comments number less than about 20 and are relatively intelligent. It’s this kind of “discussion/interaction everywhere” that I like about “Web 2.0”. It’s especially nice for fact-checking, particularly when you start talking numbers in the personal finance world. I’ve taken FT at MDJ to task before for missing something in an analysis, and it looks like another silly mistake has crept in in his recent post on whether it’s better to sell stock to pay down debt. His conclusion: if your marginal tax rate is 40%, it’s better to slowly pay down credit card debt at 18.5% than to sell your investments making 5% to pay it off right away.

Wait… what?!

I think almost anyone with some personal finance common sense would immediately say that of course you sell your investments to pay off credit card debt. No way are you going to make 18.5% on your money in the stock market to make it worth it (you might get lucky, but you can’t really expect to earn that much). But FT@MDJ had a spreadsheet, so how could he have gone wrong? This is a case where making sense is more important than making numbers. It was pointed out pretty quickly in the comments that he wasn’t taking the opportunity cost into consideration. Basically, the ~$600/mo to make the minimum payments on his hypothetical $20k credit card bill were just sort of materializing to pay that debt down if the stock investments were kept, but if the stocks were sold to pay the debt off immediately, the ~$600/mo was not being used to buy more to rebuild the stock account. Once that opportunity cost was factored in again, we got back to the common sense solution that of course it made sense to pay that kind of debt off quickly, even if if means you have to pay some capital gains taxes. So it was kind of neat to see proof of that old adage “the fastest way to get information on the internet is to post something wrong and wait for corrections.” It kind of justified reading comments on blogs, though usually the discussion is worthwhile on its own, and not just for corrections.

More interestingly, is that this also serves as a special case to the conventional wisdom. There are people out there, terrible as it sounds, who can’t save. I don’t know if they spent too much time in government offices where any budget funds not spent at the end of the year would not be offered again, or what. But for them that rolling of the opportunity cost, the money that would have gone to the credit card bill, back into the investment account that was liquidated to pay the debt off wouldn’t happen. For them, if they had $600/mo that wasn’t going to their credit card, they would just spend more until it was gone. They wouldn’t save it up, and in that case FT@MDJ’s calculation shows that it might be better to just hold on to the investment account and slowly, painfully pay off the credit card than to pay it off quickly and give up what savings they have managed to acquire. Heck, for those sorts of people the fact that their credit card is maxed out is probably the only thing that keeps them from putting more on it. Likewise, all those rent vs. buy calculations that I like to pull out to show it’s better to keep renting at the moment than to buy all depend on the hypothetical person saving (and investing at some mid-to-high single-digit % return) the difference between what it costs to rent over the costs to buy. If you are not one of those people (and Wayfare and I actually know some), then buying a house is a good thing to do because it’s a forced savings plan. It is, as I’ve said before, one of the worst ways to save, but if you’re to the point where it takes the threat of getting kicked out on your arse in the dead of winter to not spend money on hookers and blow (or cars and clothes, or wine and vacations, or whatever your vice might be), then at least it’s a method of saving. Kind of like universal life.

On another note, I’ve got something like 5 or 6 posts in draft status, which is pretty typical for me; when I go a few days without a new post idea, I tend to brush one off and post that up so that I keep up my posting frequency of 1-5 (aim for ~3) posts per week. Well, now most of my backlog is somewhat topical with the election on, and I’m also going to take some time off from posting for the next two weeks. So, apologies in advance, but there’s going to be a rash of nasty political posts over the next few days, and then, apologies again, a dearth of posting. Please try to remember that I haven’t died and haven’t lost interest in blogging, and will be back in mid-October, and hope you will be too; in the meantime try to make the next few last. I might suggest only reading one every third day, even if more than one come up per day coming up :) I could go find some posting scheduling add-ons so that my pre-written posts show up spread out at some more reasonable frequency, but that sounds too much like work for the one time in 3 years it’s actually been necessary.

The day’s not over yet, but it’s looking like a real killer on the market again. I had expected when news about Lehman Brothers came out on Monday that the Canadian banks would also get hit hard, as would BCE… and while BCE hass been hit hard because of new doubts about whether its takeover will go through, the banks weren’t really hit that hard until today. In fact today the market indicies are down more than on Monday, breaking through to new lows, so who really knows where the bottom is now. It makes me wish I still had some dry powder to go off and do some buying — it seems that I panic more when I can’t bargain shop. I’ve got a list of stocks I’d like to buy today as long as my arm… and while leverage is an option (I haven’t tapped my LoC for the wedding yet), I don’t want to go there with so much uncertainty and falling knives and what-not.

Oh, and this rather weak post is my 500th. Yay?

I’ve had a number of only vaguely related thoughts on real estate lately, so let’s see if I can string them together into a coherent post:

A report recently came out from UBC asking the question “Are Canadian Housing Markets Over-priced?” The answer was not quite what I expected: the paper figured that Toronto was at equilibrium, Vancouver was 11% overpriced, and Ottawa 25% overpriced. If I were to rearranged those numbers based on my current understanding of the housing market, I would say that Toronto was 11% over, Vancouver 25% over, and Ottawa at equilibrium.

Some people have, naturally, been tearing the paper apart, especially since they rely on ads on Craigslist and in the newspaper to determine the market rent. While this will tend to give a higher rent than might perhaps be the true market rent (since those are the asks and not the actual agreed-upon market rent), I’m ok with using that as a tool to get an estimate. Others complained about how they figured the average (SFH, detached) home price.

My big issue with the paper is how they get to their equilibrium. It understates what the equilibrium yield should be. They include the cost of the capital (mortgage costs), maintenance, taxes, insurance, and then takes out the anticipated capital gains. They say that the market would be in equilibrium when the rental rates equal that net cost of owning. However, that leaves zero profit for taking on the risk and effort of owning/landlording. IMHO, there can’t really be an equilibrium until there’s at least some kind of profit/risk premium margin. If we were to put in even a 2% premium to where equilibrium should be, then the Toronto market for example goes from being balanced at ~$420k for the typical house to being over-valued, with a target of ~$308k to get to equilibrium, a drop of over 25%. Heck, just adding in the amortized transfer costs for owning real estate vs renting (taxes, closing costs, commissions) would up the equilibrium by a percent or two, again indicating that house prices should fall and are not at equilibrium.

That would also bring it more in line with the rules of thumb I’ve read about: for instance, that a house is overvalued when the price is more than 200X monthly rent; a 5% yield (as for the balanced Toronto market in the paper) translates to about 240X, whereas using my arbitrary 7% is a more reasonable 171X. ~125X should be the buy range, which is a gross yield in this sense of 9.6%.

Of course, the more pressing issue is perhaps how they managed to figure in anticipated appreciation into their return. Leaving aside the validity of attempting that at what they admit might be the top of a cycle, it leads to positive feedback and chasing performance: the markets that have gone up a lot then have more anticipated appreciation, so they’re not considered overvalued, whereas the markets that might be in equilibrium are considered overvalued because they didn’t have the price run-up, and so don’t have the same amount of anticipated appreciation to offset high house-to-rent values.

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The days of bidding wars seem to be coming to an end, but I’ve always wondered about that mispricing. It’s often newsworthy when a house sells for significantly over asking price (sometimes 20% or more). My question/revelation is: how could the house have been so mispriced to begin with? Shouldn’t the selling agent take a drubbing for that one for being so off on setting the asking price? Shouldn’t the buyer’s agent take a drubbing for letting things get so out of hand that a bidding war sent things up that far above the asking/market price? I never see any such issues for the realesnake agents…

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A recent New York Times op-ed says that the subprime mess wasn’t all bad. After all, “only” ~15% of subprime borrowers defaulted, so those subprime loans helped 85% of people who took them buy their own home, and that’s a good thing… right?

I don’t necessarily see it as good that some of these sub-prime borrowers got to become home owners. Everyone needs an (affordable) place to live, but not everyone needs to be a homeowner. Should young single people be homeowners? It was never really something I thought of single people doing, but there are a lot of condo projects out there with a lot of bachelor/1bedroom units, and a lot of young people jumping into the market earlier in their lives thanks to loose lending. Especially when they’re buying on zero-down — home ownership carries risks and potentially costly maintenance, so these people should have been showing that they could save and budget by coming up with a down payment.

Plus the rampant home inflation/bubble prices caused by suddenly opening the floodgates and letting everyone get credit to buy meant that people who would have been traditional prime buyers suddenly found that housing costs were going up faster than their downpayments were growing, and that they needed to become subprime borrowers themselves in order to “get in before they were priced out forever”.

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By its illiquid nature and the way the data is kept and tracked, it’s difficult to say what the health of the real estate market is until months after the fact. The anecdotal evidence is not looking too good: it may not be a subprime wasteland in Ontario, but things definitely look to have slowed down. Of course, anecdotal evidence is so unreliable it almost isn’t evidence at all… but that said, I saw my first set of houses up for auction here in London today. They were all student rentals near the university that had been on the market for a while (I think — hard to say if it’s the same houses when I only bike by every couple of weeks). I can’t tell if it’s a bank/foreclosure auction, or if the seller is auctioning themselves just to get things moving.

Well, today was a bit of a nasty day on the stock market. Oil stocks were hammered in particular, though financials didn’t escape without a haircut, either. Oil is coming down, and yes, I have officially been proven wrong in my prediction back when oil was $140 that it would pull back, but not below ~$120. However, I look at these oil stocks and think that the sell-off might be a little over-done. Oil is still above $100 a barrel, yet the oil company stocks have fallen to where they were when oil was less than $80/barrel. I don’t want to catch a falling knife, but my value senses are starting to tingle so I’m going to do some research, particularly into Husky (HSE), Petro-Canada (PCA), Opti-Canada (OPC), and Russel Metals (RUS). HSE and PCA are mature, integrated oil companies — they do everything from getting the oil out of the ground to refining it to selling gas at the pumps, so they get a bit of exposure to everything, though PCA has a much higher proportion of its business that is refining/retailing, which partly explains why it’s been underperforming lately. OPC is a pure oil sands play — they’re not even into full production yet, but their Long Lake project has been built using a new type of steam assisted gravity drainage which will hopefully cut the costs of getting oil from the tar sands by using less natural gas. They’ve gone down over 12% today alone, which might be overdone, unless there’s something I’m missing (though a few days ago it was reported that their Long Lake project wasn’t ramping up production at the expected rate). RUS isn’t an oil company per se, but they make steel that is used in the oil patch, and so tend to move around a bit with the perceived health of the oil and gas industry. They offer an attractive dividend; I bought in around $25 last year, and sold around $30 a few months ago. Today they’re back into the $25 range, and I’m wondering if I like them again at that price.

One more stock of note is Potash (POT). It’s way down over the last month, and has also been hit by another 7.5% today, down to $150. I find this stock almost defies value analysis, and is so volatile I really don’t want to touch it, as cheap as it may seem at the moment.

It looks like I’m going to spend some time tonight doing some research to see if any of these are values, in my opinion anyway, and start thinking about what to do from there. As I mentioned a while ago, I don’t actually have any cash left to invest, so any values would have to be compelling enough to get me to sell something else. Teranet’s had a few takeover offers and is up nicely on the news. I’d like to hold on to it through the bidding process to see where it can go, but at the same time it might be about as high as I can expect now, and it might be decent to lock those profits in and move on to another value… or, I could do some leveraging, and borrow money to invest in an attractive oil patch investment now, and repay the loan with Teranet once the buyout goes through (if one materializes).

Update: Well, Opti is a tough one to analyze since they’re in the early stages, it’s more a gut feeling than anything at this stage of their development. I’ll continue to watch, but being behind schedule isn’t giving me the warm and cuddlies with everything in the oil sector being down.

Petro-Canada is coming out as one of the best-looking bargains. It closed at $39.09, and my spreadsheets are telling me that $42 is the point to start looking at buying (including a small safety factor). Husky is close with $36 coming from my spreadsheets, vs $39.43 at the close; I’m a little more tempted to go for Husky at the moment because of their higher dividends and because they do more oil extraction, while Petro-Canada has more refining/retail business which can be a bit of a drag if/when oil prices spike again.

Russel metals did well for me once, and I don’t see too much that’s changed there, so I’d buy it again around $24 if it continues to be driven down.

Since I don’t have any cash I’m not going to jump the gun and won’t put in any bids tonight, but I’ll be keeping a close eye on the market in the morning!

Disclosure: I’m an amateur investor, and really only looked at how thick Security Analysis by Benjamin Graham was before reading Value Investing for Noobs [or something like that], and even then I’m doing it wrong. This is not advice, and listening to me can lose you money. Speak to a financial advisor, or better yet give all of your money to me. I’m building a rocket that will take it to the moon, where it will be safe, and where you will certainly never see it again.

Well, I mentioned that a distribution cut was priced into QSR.UN, and now that their Q2 results have been released that’s indeed what has happened. The cut was towards the steeper end of what I figured, down to $0.60/year going forward (5 cents per month), and 90 cents for 2008 (including the 63 cents already paid for the year) even that is still at about a 90% payout ratio, so the cashflow looks to be managed. The stock jumped ~5% on the news, but closed up just 2% after a fall in the last minute or two of trading. At $3.50, that’s still a yield of 17%, and I think it will probably move up over the next few days on the news, and my new price target is $4 (going to a yield of 15%). I’m somewhat tempted to buy more, especially if it stays down at $3.50 tomorrow. It would be over-concentrating in a mediocre company to an uncomfortable degree, but I think it could possibly jump 10% or more in a few days as the news percolates out — and if not, I can live with a 17% yield; the question being of course, how sustainable that will be going into the future.

There are some big questions raised here. The world does not look to be ending for Priszm, and the fundamentals, from what I see, indicate that it is a value at this price. However, there is an issue of trust and faith in the management raised now. Just a few months ago they were fairly bullish in raising their distributions back up to $1.20/year — to a level that was immediately recognized by the analysts as being unsustainable. Then they cut it down, to about a 50% payout, far beyond what the analysts were calling for and what the cash flow would dictate, surprising investors. They over-promised, and under-delivered.

We’ll see what the analysts have to say in the morning.