Blessed by the Potato

First off, I’ve been getting a flood of spam comments recently. All ~20 per day seem to hit right around midnight each day, and I think I’ve managed to clean them up every day before anyone else has to see them, but just in case I’ve tightened up the spam filter, so if anyone wants to leave a comment it’s very likely going to get flagged and held until I clear the queue. So if you do decide to comment (assuming there are any readers at all left out there), an FYI that if it doesn’t get posted right away, that’s probably where it is.

After a fairly hectic few months, I finally got around to tabulating the household budget from March through June. Personally, I find the feedback stage one of the most important parts of budgeting — seeing where all the money is actually going, and how close to our targets we actually were. It’s never quite exact: some receipts I don’t get (e.g.: I’m not going to ask Tim Horton’s for a receipt for my muffin), or I forget to put them in the pile (or a note of the amount spent if I didn’t get a receipt). Nonetheless, I try to get as exact an estimate as I can, and guess at approximate monthly spending for certain areas as placeholders (both for the planning budget, and the monthly review budget).

Typically, these spring months (and Jan/Feb to an even greater extent) are our catch-up months, where we generally come in below our planned monthly budget, to make up for the excesses that always occur around Halloween and Potatomas. This year however I was really dreading adding up the spending because I just knew we were going to come in over — we ate out more than we had been, we had a fairly pricey car repair (though the bigger recent one won’t hit until July’s budget), and thanks to some sales at Pharma Plus we also stocked up on a year’s supply of ColdFX and Lactaid. Despite all that though, it actually came out as a fairly normal few months.

A part of that was due to the fact that I was running scans nearly every weekend here in London, so we didn’t go back to Toronto nearly as often. When I first moved out here I used to go back all but one weekend a month! Eventually that settled down to something more like half of them (so two or three in a month), but with all the scans I think I went back only 4 or 5 times in the first 6 months of the year. Even when I stopped scanning we still didn’t get right back to driving back — the biggest reason to drive in to Toronto of course is to see our friends and family, but as we get older our friends are getting, well… busy. So there were many times (perhaps half of them or more) where we’d spend 2 hours on the 401 to drive back, and no one would have time to hang out with us. We decided to stop going back quite so automatically, and wait until those weekends when there was a bit more of a reason to (i.e.: instead of showing up and figuring out what to do, we make plans, like grown-ups. Ugh.). It is kind of nice — 4 more hours in the weekend, we get to have some time around the house, and we don’t have to worry about the cat being all alone or always avoiding grocery shopping on Thursdays and Fridays. One other small benefit is that we save ~$30 in gas money every time we don’t go back — which more than offset our increased eating out!

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(Yes, ~$60/mo does make a difference in a grad student’s budget)

InnVest (INN.UN) is a smallish real estate investment trust that focuses on hotels (in particular, the Choice Hotels brand). For a long time I’ve always had a preference for the Choice hotels when on vacation since they seemed to hit the sweet spot for me between affordability and quality. The opportunity to own some came in the stock market meltdown last fall, and I picked up “half a position” in November around $3.85. Now as it turns out I could have got it much cheaper just a few days later, and I recognized that I might be grabbing a falling knife at the time, which is why I only invested about half as much as I typically put in any one stock. For a long time I was sorely tempted to buy more while it lingered around $3, but never did because I wasn’t sure that it would come through the recession unscathed — after all, everyone expects hotels to fare poorly when discretionary spending/vacations gets cut back by squeezed families. Of course, a lot of bad news was priced in at $3 (and even as low as $2.40!), and a distribution cut bringing a small margin of safety was behind it, hence the internal debate. In the end I never went for it, and now with reports of a potential flu epidemic, I would expect things to be even bleaker.

However, InnVest has actually out-performed the market since the March lows — bouncing back roughly 80%. True, it was getting ridiculously low, and it probably still has some good upside left to it (the current yield is over 15%, and it’s still down over 50% from its highs last year). Nonetheless, I can’t help but wonder if this is a good time to take some profits. While I didn’t buy all that close to the bottom, I am still up over 20% so far (~14% from the capital appreciation, and 8% from distributions to date — less 2% for commissions). The first-quarter results are due at the end of the week, and there’s never any telling what will happen when those come out.

I don’t know why this one appears to be immune to the fear of a pandemic, perhaps losing Mexico will mean more Canadians vacation within Canada this summer, but I’m starting to get a bit of a gut feeling to bail. I generally try to invest with my head though, and INN looks like it’s still a hold at this level.

In more general investing news (well, for myself anyway) this spring rally has been pretty decent. I did sell a few stocks as it ran up, prematurely in all cases, because the bear market had made me fearful of rallies, but it’s still going strong. Despite the minor goofs (and I can’t really call keeping liquid cash available until I know my tax bill a mistake, even if I could have done better staying invested), as of today I finally have some outperformance relative to the TSX and S&P500 indexes. Of course, I expect to outperform, not because I think I’m good (but I hope to for that reason, otherwise trying to be an active investor is a waste of my time and commission fees), but rather because this has been a down market, and I’ve been investing over time as I managed to save money (and as I shifted from ~80% stocks to ~100% stocks in my savings). Just from (accidentally) timing the market, I should be outperforming. Since January of 2008, I’m down ~24%, compared to the indexes at roughly -28% & -36%. Of course, my returns include dividends and distributions, whereas I don’t think Google Finance’s reporting of the index values does, so it’s still not all that impressive. Nonetheless, at least it’s some kind of improvement: it was getting depressing when for over a year, despite averaging down, I was tracking roughly an 80/20 split of the Toronto and New York markets. So finally seeing a bit of outperformance is good… though I’m sure I’ll get depressed all over again if I bothered to see how I’d be doing if instead of just comparing over the last 16 months I instead looked at what would have happened if I just averaged into the TD e-series funds… (which, yes, I own some of, which helps pull my returns towards those of the index, for good or for ill).

I’m always happy to answer reader questions, especially since there are so few of them, even if I have to research the answer myself. However, if you have a burning personal finance question and would like to ask some people with their minds in personal finance mode full-time, then MG, CC, and NurseB are taking questions for an upcoming Personal Finance Clinic. More at:

http://themoneygardener.com/2009/05/personal-finance-clinic.html
http://www.canadiancapitalist.com/the-personal-finance-clinic/
http://www.nurseb911.com/

Cash held beyond simple transactional needs exists solely to deal with fear.

That’s a very loose paraphrasing of John Hempton’s point in a recent post on banks hoarding cash.

Liquidity can be a very important thing, especially if you have to sell something in a hurry (whether that’s due to an emergency in your life, or a margin call). A lack of liquidity is a risk factor, whether individually or in a business. Recently I talked about investing in individual companies and some of the tools to research how to do that. I also mentioned something about efficient markets — the idea that there is a pool of well-informed investors out there buying and selling the same companies you want to buy and sell, so the market price should closely reflect the market’s assessment of the company’s value. That leads down the deductive path to the conclusion that you can’t beat the market, so the best thing to do is focus on reducing your costs when investing.

Now, like I said, I think that indexing is a great idea and is probably the best way to get investing in the stock market. A large portion of my investments are indexed (with TD’s e-series index funds), and that’s also the part of my portfolio where my new savings are going every month. Nonetheless, I try to beat the market with the half of my savings that are not indexed, which are invested in individual companies. Generally, I don’t bother trying to do this with large-cap blue chip stocks: while they are great investments, they’re followed by a lot of people, so I don’t think that’s an arena where I can get a leg up (sure, looking at the charts, especially in these volatile times, it looks like there are some inefficiencies to exploit, but I’m not sure I’m the one to pick them out). Plus, that’s largely what the indexes are made up of.

Instead, I tend to gravitate toward smaller stocks that are ignored. One of the reasons many of these are ignored is that they aren’t liquid enough. That is, there aren’t enough shares traded every day for a large investor to safely get in. If a large investor decided that to make following a company worthwhile they might need to buy say 10,000 shares, but if only 5,000 are generally traded each day then their actions could drastically affect the market. If they had to sell in a hurry for whatever reason, they might have to accept a much lower price for their shares to find the extra buyers. They could be trapped by the lack of liquidity, so they will often ignore smaller, thinly traded companies. Since a lack of liquidity adds to the risk, these companies should trade at a discount to reflect the additional risk. Extra risk (and inefficiency) can also come into play from the actions of insiders, who typically represent a larger portion of the overall float when dealing with small- and mid-caps.

Since I’m pretty much the smallest of the small investors, there are very few companies where the volume of shares I’d be dealing with would affect the daily volume, so I’m more willing to accept liquidity risk.

Of course, “very few” is not zero, as I found out with one particular company when liquidity dried up — it would go weeks without a single trade, and the bid/ask spread was over 100% (e.g.: bid $1.50, ask $3.50) [the company was later delisted, but not before I managed to bail with an impressive loss]. So it is important to be aware of the liquidity situation before you invest in something — not just stocks, but also some mutual funds can restrict your ability to bail (though usually with just a back-end fee if you don’t hold for some minimum period).

Liquidity, or rather lack thereof, is in fact a part of what triggered the collapse of the market last year. Asset-backed commercial paper (ABCP) was all over the news this time last year, and it wasn’t necessarily that all those bundled mortgages to people in torn vests were worthless (though they were almost certainly overvalued by a not-insignificant percentage), but rather that the market seized up: faced with uncertainty (and an inability to leverage) nobody wanted to buy any more, and those that had to sell were forced to accept very low bids. In times of stress and fear, liquidity (different from “liquid courage”, coincidentally also sought out in times of stress and fear) can become very important, and very valuable. This also helps to explain why earlier in the year banks were seemingly driving away their line of credit customers with a stick.

Aside: I’m not 100% happy with this draft, and as you can see by the page number I’ve been sitting on it for a while. I was hoping MG would put it up as a Potato Wedges column at themoneygardener — perhaps with some suggestions for edits — but I sent it to him last Friday and haven’t heard anything back all week… Now TMW has a long interview up (with more to come) with Nurse Brad and Preet on analyst research, so the time seemed right!

There are a lot of important tools to tap when investing, especially if you’re going to go about trying to pick individual companies to invest in.

Of course, any discussion about picking individual stocks should start with a reference to efficient market theory, the idea that one can’t outperform the market as a whole with any certainty or consistency, so the best option is just to buy the index and relax. I personally don’t believe in efficient market theory: it’s pretty obvious that the market is not efficient. It’s emotional, with wild swings and overshoots in both directions, and corrections to news events — while quick — are not instantaneous. Plus the record of investors like Warren Buffet are too good to be due to chance alone, so they must be somehow outsmarting the market. However, while the markets may be inefficient in a theoretical sense, that does not mean that you could outperform the market. Indeed, I’ve been trying this, and it has lead to nothing but fail.

Nevertheless, if you think you’ve got what it takes to outperform and are going to try your hand at stockpicking, then you’re going to need a dartboard.

…Research! I meant you’re going to have to do some research! Not throw darts, that’d just be silly. You can go about your research in any fashion that you see fit — it’s your money, and I’m not particularly talented or qualified to be handing out advice in this area. That’s not going to stop me from writing about it, but faithful reader, you should be aware at all times of who is giving you your information and how trustworthy it is — and my issue is that I’m still fairly new at active investing and stock research in particular. So that said, your first step is to come up with an investment idea. There are simply too many companies out there to just start researching all of them, so the criteria here can be very loose, but somehow something about a company has got to catch your attention to make you want to look into them further: maybe a mention in the news , or a featurette in a blog you read every day, or just a good consumer experience in your everyday life (which would be the Peter Lynch philosophy). Then you can start looking for resources to make a decision: the economic environment, first-hand experience, the company’s financial reports, and other resources varying from technical analysis to analyst reports.

Odds are, your broker (especially if they’re an arm of a big bank) has some analysts on staff covering the larger, more liquid companies in Canada. They may also (or only) provide access to 3rd party analyst reports, such as those from S&P or morningside. These analyst reports are great things to read for the most part since they often highlight the important numbers in the fundamentals, they give you a sanity check on your own analysis, and they can also give you a summary of the business and the key outside influences. However, the thing they are best known for, the headline buy/sell/hold (or equivalent ranking) rating is, IMHO, one of the less valuable components of the reports. I have been impressed with TD’s record when they go out on a limb to rate something an “action list buy” instead of just a buy or hold, and if I see one of those in a morning report I will often have at least a cursory glance at a company before deciding to not bother… but generally, someone who relies on those ratings alone to make their investing decisions is asking for trouble.

First off, those headline ratings sometimes seem at odds with the detailed analysis. Whether this is caused by an overall sense of bearishness/bullishness at the broker (and RBC seems to suffer from these bouts of rating everything high or everything low in a given month, in my limited experience), or other less savoury factors is unknown. Most analysts do disclose conflicts of interest, for example when their firm is doing business with the rated company, but disclosing bias is not quite the same as being unbaised. Sometimes it’s pure momentum: a stock is hot, so they rate it a buy, even if it’s already overshot the fundamentals they talk about in the fine print.

Note that no where in there did I mention personal finance bloggers. They are actually a good resource to read to get new ideas and new perspectives on things, but for the love of all that is starchy, you must resist the urge to blindly follow their advice (especially mine — go back to my archives and see just how poor my advice has been over the last year!). Of course, my pleas to not blindly follow advice is becoming something of a mantra, so I’ll leave it at that. (Aside: one should read personal finance blogs daily, even if you don’t follow the advice. And click on the advertising links. Twice.) I suppose the important theme here is: can you follow the logic?

The issue of analyst coverage has come up a fair bit lately, which is what prompted me to try to dust off this column and actually get it out. If you haven’t yet heard of the minor spat between the John Stewart show and MSNBC/Jim Cramer’s Mad Money then you should watch at the very least the relevant episode of the Daily Show. I thought that John Stewart had a very good point to make, which was that the financial news shows were not asking the hard questions, they were not digging into the stories, and they were being naive about whether executives they were interviewing were lying to them. That they, like the corporate world in general, were too focused on the short-term movements and didn’t have the interests of the long-term investor (or the stability of the economy as a whole) in mind. If you call in to listen to a conference call for a company’s quarterly results, you often will hear the real analysts asking the hard questions. Sometimes they come out of the gate with an answer in mind, as I seem to recall an RBC analyst in full bearish mode harping on the Yellow Pages management about dividend cuts, how big they’d be, and when they’d come, and if they’d cut it just because the share price was low so the yield would then look more normal, and maybe they could cut, just to give some more breathing room, and the management having to brush all this off… but the analysts should, at some point, be getting the important questions answered for you.

Stock analysis reports were also the topic of discussion recently at Canadian Dream and Four Pillars. Nurse Brad, of Triaging My Way To Financial Success fame has started to sell some of his stock analysis reports, and there was some minor debate on what to charge, and whether they would sell.

Now, I haven’t read one of these yet (I probably should have dropped him a line and bugged him for a review copy before writing this column, but that would deprive me of the ability to make two columns out of the issue), but at the suggested price of $20, I have to wonder how worthwhile they’ll be. Don’t get me wrong, they sound like fantastic learning tools, and I’ve been very impressed by the depth of Brad’s research in the past, in particular his on-site visit to a brewery to uncover inefficiencies. It sounds like you’ll get plenty of content and research to show for your money. However, for a small-time investor like myself, a $20 fee can represent something like 1% of a position in a stock, so to be worthwhile this research would have to improve my returns by at least 1% just to break even*. And of course most analysts’ research comes to a “hold” conclusion — that a given stock doesn’t look like it will drastically over- or under-perform the market as a whole. That’s probably true for most companies, perhaps axiomatically, but that doesn’t make you feel any better if you shelled out $20 for “meh”.

* – that’s not quite true, since I could amortize the cost of the report over a few years, in which case I might only need say a quarter of a percent (per year) outperformance to make the research worthwhile; on the other hand if the data became stale in less than a year, then the improvement would have to be better.

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