The Case of Misleading False-Negative Returns


Total returns since inception may be artificially low (or negative), due to early losses which have far reaching effects on total compounded returns over the life of a portfolio. For this reason trailing N year returns should always be considered, when looking at the "true" performance of a portfolio.

Background on Time Weighted Returns

Returns are the key indicator as to the performance of your portfolio, and the the investment decisions you have made. In the simple case, with no external cash flows, the return for any given period as a percentage is defined by:

When you introduce cash flows into the equation, you would measure the value of the portfolio immediately before the cash flow, and apply that to the numerator:

Your total return is then obtained by linking the individual period returns together. Others have written about this much better than I have, and two good articles may be found on Investopedia and Wikipedia. In summary though, the key formula to understand is the following, which measures the true time weighted return:

Where in the above, is the value of the portfolio at period n, and are any cash flows occurring in period n (conventionally the cash flow is measured "immediately before" the valuation before period n+1).

False-Negative Returns

One key point to make is that when you are looking at returns, all things being equal, your return after a loss must be greater than the loss itself, to get back to where you started, on a percentage basis. For example, if your portfolio drops from $100 to $90, that is a 10% loss. However, to get from $90 to $100, you need an 11.1% gain. To further explore this example, consider a portfolio which is valued at $100 on Jan 1, $90 on July 1, and $100 on December 31. The return on the first period is -10%, the return on the second period is +11.1%, and the total return by linking those returns is 0%. So even though you did extremely well in the latter half of the year, your net return is still 0% overall (since you finished where you started).

So, for better or for worse, the TWR measures the true performance of your portfolio over time, reflecting every investing decision you have made. But when you are reviewing your total returns over time, you may have misleading results. Consider the following hypothetical portfolio from Jan 2000 to Dec 2002. In this portfolio, I have invested $100 on Jan 1, 2000, and the company I invested in tanked completely, losing me $98 on my $100 investment. Then on Jan 1, 2001, I heard of an even better opportunity, and invested another $1,000. Unlike the initial $100 investment, the second investment performed extremely well, more than doubling by the the end of 2002, after which point I closed off the portfolio. Overall, I have invested $1,100, and at the end of it all I have walked away with $2,260.33, a tidy profit of $1,160.33, or 105.48%; more than double my initial investment! But, if you look at my total time weighted return since inception (i.e. Jan 2000)—which includes every trade, both good and bad—my investment decisions show that I am actually down in excess of 95%!

Period Closing Portfolio Value Cash Flows during Period Period Return Return since Inception Total Invested Total $ Gain
Jan 2000 $0.00 $0.00
Feb 2000 $100.00 $100.00 $100.00
Mar 2000 $93.00 $0.00 (7.00%) (7.00%) $100.00 ($7.00)
Apr 2000 $81.00 $0.00 (12.90%) (19.00%) $100.00 ($19.00)
May 2000 $69.00 $0.00 (14.81%) (31.00%) $100.00 ($31.00)
Jun 2000 $57.00 $0.00 (17.39%) (43.00%) $100.00 ($43.00)
Jul 2000 $48.00 $0.00 (15.79%) (52.00%) $100.00 ($52.00)
Aug 2000 $39.00 $0.00 (18.75%) (61.00%) $100.00 ($61.00)
Sep 2000 $30.00 $0.00 (23.08%) (70.00%) $100.00 ($70.00)
Oct 2000 $19.00 $0.00 (36.67%) (81.00%) $100.00 ($81.00)
Nov 2000 $9.00 $0.00 (52.63%) (91.00%) $100.00 ($91.00)
Dec 2000 $2.00 $0.00 (77.78%) (98.00%) $100.00 ($98.00)
Jan 2001 $1002.00 $1000.00 (98.00%) $1100.00 ($98.00)
Feb 2001 $1057.00 $0.00 5.49% (97.89%) $1100.00 ($43.00)
Mar 2001 $1117.14 $0.00 5.69% (97.77%) $1100.00 $17.14
Apr 2001 $1176.24 $0.00 5.29% (97.65%) $1100.00 $76.24
May 2001 $1207.94 $0.00 2.70% (97.59%) $1100.00 $107.94
Jun 2001 $1195.88 $0.00 (1.00%) (97.61%) $1100.00 $95.88
Jul 2001 $1194.69 $0.00 (0.10%) (97.62%) $1100.00 $94.69
Aug 2001 $1276.98 $0.00 6.89% (97.45%) $1100.00 $176.98
Sep 2001 $1322.88 $0.00 3.59% (97.36%) $1100.00 $222.88
Oct 2001 $1355.91 $0.00 2.50% (97.29%) $1100.00 $255.91
Nov 2001 $1434.43 $0.00 5.79% (97.14%) $1100.00 $334.43
Dec 2001 $1516.08 $0.00 5.69% (96.97%) $1100.00 $416.08
Jan 2002 $1503.97 $0.00 (0.80%) (97.00%) $1100.00 $403.97
Feb 2002 $1585.07 $0.00 5.39% (96.84%) $1100.00 $485.07
Mar 2002 $1654.73 $0.00 4.39% (96.70%) $1100.00 $554.73
Apr 2002 $1735.71 $0.00 4.89% (96.54%) $1100.00 $635.71
May 2002 $1838.00 $0.00 5.89% (96.33%) $1100.00 $738.00
Jun 2002 $1894.92 $0.00 3.10% (96.22%) $1100.00 $794.92
Jul 2002 $1980.10 $0.00 4.50% (96.05%) $1100.00 $880.10
Aug 2002 $1980.10 $0.00 (96.05%) $1100.00 $880.10
Sep 2002 $2073.07 $0.00 4.70% (95.86%) $1100.00 $973.07
Oct 2002 $2104.14 $0.00 1.50% (95.80%) $1100.00 $1004.14
Nov 2002 $2192.43 $0.00 4.20% (95.62%) $1100.00 $1092.43
Dec 2002 $2260.33 $0.00 3.10% (95.49%) $1100.00 $1160.33

Clearly, this is misleading: I have walked away with more than double what I invested in overall, however due to a single bad decision at the outset, my total returns are dragged down completely. In fact, to gain ground from a 98% loss requires a staggering 4,900% return over time!!! The nuances of this are tied to the fact that time weighted returns take the geometric average of your historical returns: they multiply everything together, and due to the way the math works itself out, you are virtually never able to get back to where you started after a devastating failure.

Fortunately, there are ways to paint this picture in a different light. Observe what happens if we position the portfolio this way:

1 year return 2 year return 3 year return
49.1% 125.6% -95.5%

By breaking up the returns into tranches, the results look dramatically different.

The point of this is to illustrate that a single bad period can drag down the total return of a portfolio virtually forever. Similar to how when I review a firm I am typically only looking at 10 years of historical data, there is value in truncating the window at when one evaluates their returns as well; we learn as we move forward, and as long as on a historical basis we are increasing our returns, then we are doing relatively well. The final point is that while the "true time weighted return" is "true", one must review it with a grain of salt. True, on a percentage basis, the above example is still down 98%. However, overall the total return based on absolute dollar terms is in excess of 100%.

For the record, the above is a simplified version of my own portfolio. When I started investing in 2005 I followed “hot tips” from my coworkers who were “good friends” with traders on the trading floor, and I invested in two firms, First Calgary Petroleum (FCP.TO), an Alberta based refinery, and Paincare Holdings (PRZ.N), a US healthcare provider. Luckily I had only invested ~$1250 at the time: 50 shares of FCP.TO at $18.40/share, and 50 shares of PRZ.N at U$5.00/share. FCP.TO tanked, no pun intended, when one of their exploration operations did not pan out as expected. FCP.TO was eventually bought out by a foreign interest at $3.60/share, netting me a loss of 80%. Paincare Holdings was victim to a lawsuit, and the company eventually de-listed except for over the counter pink slips, and is now a private holding. The shares of PRZ.N virtually went to $0.00; they are actually still “in” my portfolio at BMO InvestorLine with a market value of $0.005, or U$0.0001/share, netting me a loss of 99.998% on that trade. As these are the first trades in my portfolio, they have been a constant drag on my true TWR. Since then, I definitely regained the original $1,250 investment in dividend income alone from other investments, so on an absolute (i.e. actual dollars profit) I am well ahead. So, if we carve out those outliers, every other investment I have completed has performed relatively well, something I hope to continue doing as time moves forward.

Exco Technologies Ltd. (XTC.TO) Analysis

Whilst looking for a new dividend grower, I came upon XTC.TO, a small-cap stock on the TSX:

Exco Technologies Limited, together with its subsidiaries, designs, develops, manufactures, and sells dies, moulds, components and assemblies, and consumable equipment for the die-cast, extrusion and automotive industries. It operates in two segments, Casting and Extrusion Technology, and Automotive Solutions. The Casting and Extrusion Technology segment designs and engineers tooling and other manufacturing equipment for automotive and other industrial markets. The Automotive Solutions segment produces automotive interior components and assemblies primarily for seating, cargo storage, and restraint for sale to automotive manufacturers and tier 1 suppliers. It operates in the United States, Europe, Mexico, Canada, South America, Asia, and other countries. Exco Technologies Limited was founded in 1952 and is based in Markham, Canada.

Source: Yahoo Finance

Based on my recommendation criteria, listed below, I would base XTC.TO as a hold, mainly driven by its current valuation at the end of F2015. However, based on current prices and forward EPS, I rate it as a buy, and I explain this below.

Criteria Value Threshold Pass?
Strong financial condition Current Ratio 2.27 1.50 YES
Earnings Stability Number of most recent years of positive EPS 5.00 3.00 YES
Earnings Stability Number of consecutive years of negative EPS 2.00 1.00 NO
Dividend Growth Compound Annual Dividend Growth 0.15 0.02 YES
Share Price Growth Compound Annual Share Price Growth 0.12 0.03 YES
EPS Growth Compound Annual EPS Growth 0.15 0.03 YES
Moderate P/E Ratio P/E 15.08 15.00 NO
Moderate P/BV Ratio P/BV 2.51 1.50
Moderate P/E × P/BV Ratio P/E × P/BV 37.87 22.50

The above criteria are based off of the F2005-F2015 annual reports:

Year EPS Dividend per Share Dividend Payout Ratio (EPS) Dividend Payout Ratio (FCFS) ROE P/E Ratio Book Value Price to Book Value (P/BV) Net Income (000s) P/E × P/BV
F2005 $0.2686 $0.0500 18.6170% 45.3986% 7.1927% 14.9308 $3.7340 1.0739 $11,132.00 16.0346
F2006 ($0.0148) $0.0500 (337.6013%) 20.0137% (0.4089%) (270.0811) $3.6222 1.1043 ($616.00) (298.2515)
F2007 $0.0739 $0.0600 81.2094% 44.4359% 2.0934% 67.6745 $3.5293 1.4167 $3,062.00 95.8751
F2008 ($0.3388) $0.0700 (20.6614%) 273.4050% (10.5751%) (5.3129) $3.2037 0.5618 ($13,934.00) (2.9851)
F2009 ($0.4341) $0.0700 (16.1245%) 38.6560% (15.3727%) (3.8699) $2.8240 0.5949 ($17,666.00) (2.3022)
F2010 $0.2465 $0.0800 32.4536% 29.6711% 8.4540% 13.9956 $2.9158 1.1832 $10,077.00 16.5594
F2011 $0.3617 $0.1050 29.0279% (257.3751%) 11.2945% 9.2336 $3.2026 1.0429 $14,807.00 9.6297
F2012 $0.6002 $0.1350 22.4921% 23.2983% 17.0085% 8.0638 $3.5289 1.3715 $24,449.00 11.0598
F2013 $0.5810 $0.1730 29.7772% 795.1354% 14.3980% 11.1363 $4.0352 1.6034 $23,632.00 17.8561
F2014 $0.7389 $0.1950 26.3920% 51.7543% 15.1204% 13.7374 $4.8865 2.0771 $30,656.00 28.5346
F2015 $0.9639 $0.2300 23.8611% 45.7759% 16.6417% 15.0844 $5.7921 2.5103 $40,759.00 37.8662

On a 10 year basis, I like this company. Both EPS and dividend have trended upwards since F2005, although EPS was hit rather hard during the financial crisis. As XTC.TO is a provider for various discretionary industries (e.g. automotive), this is not really a surprise. However, the management team managed to keep the dividend afloat, even when they were facing a loss of $0.43/share in F2009, and they were quickly able to grow it again the following year by 14.3% from $0.08/share to $0.09/share. Reviewing the 10 year growth, on a compounded basis (i.e. CAGR), dividend growth has been 14.9% and EPS growth has been 15.3%: EPS is growing faster than the dividend, which means there is plenty of room for continued increases. And this shows, in their dividend payout ratio (discussed below), which has generally been low (less than 30.0% since 2010, with a peak of 81.2% in 2007 during the entry into the financial crisis). Moreover, if we review the company since the financial crisis, EPS is on a clear upward trajectory: form a loss of $0.43/share in F2009 to a positive EPS of $0.96/share in F2015. The following following chart illustrates this:

XTC.TO Dividend, EPS, and Free Cash Flow per Share

XTC.TO Dividend, EPS, and Free Cash Flow per Share

One element of minor concern is the F2011 dip in free cash flow per share: for the period of F2011 it dropped into negative territory, which forced the dividend payout ratio per free cash flow share (FCFPS) to be in negative territory as well. What this means is that the XTC.TO paid cash out (via dividend), but also had net cash flows out of the firm as well, which is something I typically do not like to see. If a company is in a net-negative cash flow position, I question what the source for dividends is. However, reviewing the F2011 statements, XTC.TO comments that this overspending in capital expenditures (which ultimately reduces FCFPS) was due to their Allper acquisition, as well as some other miscellaneous spending. True to their word, FCFPS has been on a generally upward trend since then. There was another minor blip in F2013 where there was positive FCFPS, but the dividend payout ratio to FCFPS was greater than 100% (e.g. dividends/share > FCFPS), but again this was related to acquisitions and upgrades to existing facilities.

Reviewing the 10 year history of dividend payout ratios against EPS and FCFPS, there have been some extreme peaks and valleys:

Dividend payout ratios against earnings per share and free cash flow per share

Payout Ratios against EPS and FCFPS

However, if we exclude negative EPS and the FCFPS outliers, a healthier picture is presented:

XTC.TO Dividend Payout Ratios against EPS and FCFPS Excluding Outliers

XTC.TO Dividend Payout Ratios against EPS and FCFPS Excluding Outliers

Payout ratios in general against EPS are generally below 35%. More importantly, dividend payout ratios against FCFPS are generally at or below 50%. In other words: the increasing dividend is coming from an increasing free cash flow, leaving plenty of room for dividend increases in the future. While XTC.TO has not made an outright statement as to their dividend policy, if history is any indicator of the future, there should be healthy dividend increases to come.

With regards to valuation, P/E, P/BV, and P/E × P/BV have been generally healthy, illustrated below:

Price to Earnings, Price to Book Value, and Price to Book Value multiplied by Price to Earnings

P/E, P/BV, and P/BV × P/BV

In the early 2000s the company was generally over-valued, but since the financial crisis the P/E has remained consistently low at less than 15 (edging to 15.1 in F2015), and price to book value has also been somewhat decent, peaking at 2.5× in F2015. Based on the F2015 fiscal results, the company was overvalued with a P/E × P/BV exceeding our threshold of 22.50. However, that was based off of a F2015 closing share price of $14.54. The price is currently trending around $12.00, and if we review the forward EPS from analysis ($1.14 for F2016 based on 3 analysis, as listed by BMO InvestorLine’s equity research), and the historic P/BV ratio of 1.32, we get:

XTC.TO valuation as of Sep 16 2016
Current Price $11.83
Current Dividend $0.28
Mean Forward EPS $1.14
Dividend Yield 2.37%
P/E 10.38
Historic mean P/BV 1.32
P/E × P/BV 13.72

Based on a forward view, XTC.TO is undervalued.

Of course, there are some risks with this firm, the biggest one being the share price. If you are looking for a growth opportunity, where you will see plenty of consistent capital appreciation, this is not the stock for you; here is the 10 year price chart, with volumes, from Big Charts:

10 Year Weekly Close Price with Volumes

10 Year Weekly Close Price with Volumes

As you can see, there has generally been an upward trend, but it there are also some valleys to take into consideration. This means that if you need your capital back in a hurry, you may be selling during one of the downturns. Moreover, due to the low liquidity, bid-ask spreads may be very wide, which could have a negative effect on any selling activities.

As a final recommendation, I place this stock as a buy based on the current stock price, and the forward EPS. As a dividend income stream for my portfolio I feel it will do well over the long term, evidenced by its healthy 14.9% 10 year dividend CAGR, and consistently low dividend payout ratio—against both EPS and FCFPS—since the financial crisis. One final note is that the fiscal year end is September 30, 2016, so I will certainly be taking a closer look when the F2016 annual report comes out in a few months, to see how well the firm has performed this year.

Disclosure: Long XTC.TO as of Sep 16, 2016.

DRIP Investing

Dividend Reinvestment Plan investing, or “DRIP” investing, is a very cost efficient way of making passive gains in your portfolio. I have been a big fan of this type of investing for years, as it completely removes two types of investment friction: rounding friction, and commission friction. Well, the second one is a bit of a lie: you are exposed to some commission friction, but it is minimal in the grand scheme of things. But, before I get ahead of myself, I’ll explain what DRIP investing entails.

At its core, a company which offers a DRIP allows the shareholder to re-invest dividends issued by the company directly back into additional shares in the company. So if the share price is $5.00, and you received $10.00 in dividends, you will receive 2 shares. In addition to this core functionality, there may be additional benefits and/or constraints:

Item Description Potential Benefts Potential Constraints
DRIP Enrollment The process of enrolling in the DRIP May have a minimum number of shares required, e.g. you may need 100 shares to even sign up for the DRIP.
OCP/SPP Optional Cash Purchase or Share Purchase Plan. This is the ability for you to buy additional shares directly from the company. May offer a discount on additional shares, e.g. 2% off of the current share price.
  • May have a minimum cash amount required (e.g. $100.00)
  • May charge a small commmission per transaction
Automatic Contributions Automatically debit from your bank account on a periodic basis. This allows you to slowly build your position over time, virtually effort-free on your part. Same as OCP/SPP Same as OCP/SPP

So, how does this all work?

With DRIP investing, you normally have a share of stock in certificated form. Classically, this would mean that you have a physical paper certificate for the company in which you are investing. Today, there are alternatives such as the Direct Registration Sytsem (DRS), but the core of the matter is that the share(s) of the company are registered directly in your name. This differs from a typical stock trade through a brokerage where shares are held in street name (more info may also be found here), where the shares are actually in the name of your broker/agent, and not yourself.

This is important, because once an investment is certificated, you can start participating in the DRIP. You cannot participate in the DRIP if the shares are in street form.

Once you have your certificated share, enroling in the DRIP is as easy as filling out the requisite paperwork.

So, how is this a good thing?

As I mentioned above, one form of friction that DRIP investing eliminates is rounding friction. Recap the example ealier:

[i]f the share price is $5.00, and you received $10.00 in dividends, you will receive 2 shares.

I had picked those numbers for convenience, as they gave us a whole number of shares to re-purchase. However, what if the share price was $7.50, and you received $5.00 in dividends? With a normal brokerage, you would receive $5.00 in cash, and no shares, since the share price is greater than the received dividend. With a DRIP however, you can receive fractional shares. So your $5.00 in dividends will purchase you 2/3 of a share (since $5.00 is 2/3 of $7.50).

Let’s look at OCPs. If you have an extra $100 lying around one day, you might decide to purchase some stocks. Moreover, let’s say you own Telus (T.TO) in your DRIP. The current market price (as of business day close on Sep 9, 2016) is $42.03. If you were to buy shares at a typical broker, assuming $9.95 commission, you could only buy 2 shares, and be left with $5.99 in your pocket ($100.00 less $9.95, and purchasing two whole shares at $42.03). But, because Telus offer OCP/SPP, and no commissions, you can buy 2.379252 shares!

These fracitonal elements are important, because you can now take advantage of true compounding. As an example, let’s use Telus again, with the following assumptions:

  • Share price grows at 3%/year
  • The dividend grows at a rate of $5%/year

At a regular brokerage, after 5 years, here is what you have:

# Numbe of Shares Period Dividend Dividends Received Share Price Dividend Bank Shares Purchased Dividend Bank (end) Net Value
1 1 $0.46 $0.46 $42.03 $0.46 0.000000 $0.46 $42.49
2 1 $0.46 $0.46 $42.34 $0.92 0.000000 $0.92 $43.26
3 1 $0.46 $0.46 $42.66 $1.38 0.000000 $1.38 $44.04
4 1 $0.48 $0.48 $42.97 $1.86 0.000000 $1.86 $44.83
5 1 $0.48 $0.48 $43.29 $2.35 0.000000 $2.35 $45.64
6 1 $0.48 $0.48 $43.61 $2.83 0.000000 $2.83 $46.44
7 1 $0.48 $0.48 $43.94 $3.31 0.000000 $3.31 $47.25
8 1 $0.51 $0.51 $44.26 $3.82 0.000000 $3.82 $48.08
9 1 $0.51 $0.51 $44.59 $4.33 0.000000 $4.33 $48.91
10 1 $0.51 $0.51 $44.92 $4.83 0.000000 $4.83 $49.75
11 1 $0.51 $0.51 $45.25 $5.34 0.000000 $5.34 $50.59
12 1 $0.53 $0.53 $45.59 $5.87 0.000000 $5.87 $51.46
13 1 $0.53 $0.53 $45.93 $6.41 0.000000 $6.41 $52.33
14 1 $0.53 $0.53 $46.27 $6.94 0.000000 $6.94 $53.21
15 1 $0.53 $0.53 $46.61 $7.47 0.000000 $7.47 $54.08
16 1 $0.56 $0.56 $46.96 $8.03 0.000000 $8.03 $54.99
17 1 $0.56 $0.56 $47.31 $8.59 0.000000 $8.59 $55.90
18 1 $0.56 $0.56 $47.66 $9.15 0.000000 $9.15 $56.81
19 1 $0.56 $0.56 $48.01 $9.71 0.000000 $9.71 $57.72
20 1 $0.59 $0.59 $48.37 $10.30 0.000000 $10.30 $58.66

In the above, the “Dividend Bank” is where you would store all dividends received until you had enough to purchase one share, and “Dividend Bank (end)” is the money left over in the dividend bank after buying a share. But, as you can see above, we were never able to purchase any shares! This is because it would take us forever to save up enough of the dividend income to buy a share, plus we have to save up enough to cover the commissions as well.

Using a DRIP, with the same growth assumptions, here is what you have:

# Numbe of Shares Period Dividend Dividends Received Share Price Shares Purchased Net Value % Gain from Without DRIP
1 1.000000 $0.46 $0.46 42.030000 0.010945 $42.49 0.00%
2 1.010945 $0.46 $0.47 42.341740 0.010983 $43.27 0.02%
3 1.021927 $0.46 $0.47 42.655791 0.011020 $44.06 0.06%
4 1.032948 $0.48 $0.50 42.972172 0.011598 $44.89 0.12%
5 1.044546 $0.48 $0.50 43.290900 0.011642 $45.72 0.19%
6 1.056188 $0.48 $0.51 43.611992 0.011685 $46.57 0.29%
7 1.067873 $0.48 $0.52 43.935465 0.011727 $47.43 0.40%
8 1.079601 $0.51 $0.55 44.261337 0.012379 $48.33 0.53%
9 1.091979 $0.51 $0.55 44.589627 0.012428 $49.25 0.68%
10 1.104408 $0.51 $0.56 44.920351 0.012477 $50.17 0.84%
11 1.116885 $0.51 $0.57 45.253529 0.012525 $51.11 1.02%
12 1.129410 $0.53 $0.60 45.589178 0.013192 $52.09 1.22%
13 1.142602 $0.53 $0.61 45.927316 0.013248 $53.09 1.44%
14 1.155850 $0.53 $0.62 46.267962 0.013303 $54.09 1.67%
15 1.169153 $0.53 $0.62 46.611135 0.013357 $55.12 1.92%
16 1.182510 $0.56 $0.66 46.956853 0.014102 $56.19 2.19%
17 1.196612 $0.56 $0.67 47.305135 0.014166 $57.28 2.47%
18 1.210778 $0.56 $0.68 47.656001 0.014228 $58.38 2.77%
19 1.225005 $0.56 $0.69 48.009469 0.014289 $59.50 3.08%
20 1.239294 $0.59 $0.73 48.365559 0.015054 $60.67 3.42%

Where the “% Gain from Without DRIP” is the relative difference between a brokerage-based portfolio and our DRIP. Looking at the above, by using the DRIP, over our 5 year example time horizon we have gained 3.42%, all for doing nothing. And, if you throw OCPs into the mix (e.g. setting up regular contributions), your holdings grow even quicker.

Not all companies offer DRIPs. In Canada, two of the major providers are Computershare Canada and CST (the CST link takes you directly to their DRIP page). But even for those companies that offer DRIPs, not all DRIPs are created equal. Not all companies offer OCP/SPP. Some charge for DRIP, OCP/SPP, and/or withdrawals to/from the plan, and some have minimum balance requirements. That said, when I am looking for a company to DRIP with, other than my regular stock analysis, I look for those who offer and OCP/SPP, and as an added bonus, regular automated contributions by deducting from my bank account. Moreover, those that offer discounts on OCP/DRIP (e.g. Emera which offers up to a 5% discount on DRIP) are even better.

And OCP/SPP is key. The reason being, if you have only one share to start, it will take you forever to get to the point where you can take advantage of material growth through DRIPping.

How does one get started?

You only need one share to start a DRIP, and then you can use an OCP/SPP purchase to purchase any additional shares as needed. You can leverage places such as The DRiP Investing Research Centre‘s Share Exchange board to find individuals who are selling individual shares, or you can even post a message asking for a particular share. Typically individuals selling on these forums ask for a $10.00 convenience fee. This is pretty much in line with most discount brokerages, and since you can easily recoup this cost through the DRIP process itself, it is a small price to pay. Alternatively, you can purchase shares through a regular (discount) brokerage, and then ask the brokerage to withdrawal your shares in certificate form. DRIP Primer has a great list of brokerages, and the fees to do so.

One final thing to mention is synthetic DRIPs. With a synthetic DRIP, a brokerage will buy you any whole shares that it can when the dividend is issued, and any money remaining is given to you as cash. Looking back to Telus, if the share price were $42.03, the dividend were $0.46/share, and you had 100 shares, you would receive $46.00 in dividends. Your brokerge would take this $46.00, purchase one share, and leave the balance ($3.94) in your account as cash. The advantage to this is that the brokerage does not charge you a fee (i.e. commission) for the purchase. The disadvantage is that you cannot take advantage of the fractional shares as with a true DRIP; i.e. you are still subject to rounding friction.

To summarize:

  • DRIPs offer a great way to build compounding returns, through re-investing dividends and purchasing fractional shares
  • Often, companies offer discounts on DRIP and OCP/SPP, but not all DRIPs are created equal; some have better features than others
  • DRIPping does not save you from doing your research: as with all investments, only invest in companies after doing a thorough analysis

And some good resources:

Happy investing!

Yield on Cost vs. Yield on Price? It’s Opportunity Cost that Counts.

I read an interesting article on the Globe and Mail recently, about the “Yield on Cost Myth” (Archived copy may be found at this link). In a nutshell, the author argues that it is erroneous for an investor to consider the yield on cost when they are looking at the dividend yield for a stock; and as a dividend investor this is a very important topic for me. When you are looking at the cash flow stream from an investment, do you look at it from the perspective of what you paid for the stock, or what you would pay today for a stock?

First, some definitions. Yield on Cost is exactly what it sounds like: the total yield returned based on the original cost of the investment. Mathematically:

This compares to Yield on Price, or what typically we refer to as the normal “dividend yield” of a stock. This is simply the yield based on the current cost of the investment. Mathematically:

Now, I do agree that one should focus on the Yield on Price for a stock, not the Yield on Stock. The reason for this is opportunity cost. Let’s consider the example cited in the original article:

  • You purhcased BCE at an average cost of $30.00/share.
  • BCE’s current price is $62.95/share.
  • BCE’s current dividend is $2.73/share.
  • Shaw’s current price is $26.50/share.
  • Shaw’s current dividend is $1.19/share.

Summarizing all of that, let’s do the comparison of the different yields:


Company ACB ($) Price ($) Dividend ($) Yield on Cost Yield on Price
BCE 30 62.95 2.73 9.10% 4.34%
Shaw n/a 26.5 1.19 n/a 4.49%

The ACB and Yield on Cost for Shaw are n/a because we don’t actually own them yet. As pointed out in the article, at first glance it makes perfect sense to sell your shares of BCE, and purchase the shares of Shaw, and reap the additional 0.15% yield (which equates to a 3.55% relative gain between yields, since 4.49% is 3.55% greater than 4.34%).

The challenge with this is that it assumes that we live in a frictionless environment. By swapping your BCE shares, you’ll be victim to all at least two, and possibly three, types of friction that I mentioned in one of my earlier posts. Unless you are in a tax-deferred (e.g. RRSP) or tax-free (i.e. TFSA) account, you will be subjected to capital gains tax on the sale of the BCE shares. In addition to this, you will be hit with one, possibly two, commission charges by selling the BCE, and purchasing the Shaw.

However, the biggest challenge is with rounding friction. This is illustrated by the below table, which illustrates the net change in your cash flow stream, based on holding 10, 100, and 1000 shares of BCE:

Activity Scenario 1 Scenario 2 Scenario 3 Scenario 4 Notes
Number of BCE Shares 1 10 100 1000 What you started off with
BCE Share Price $62.95 $62.95 $62.95 $62.95
Shaw Share Price $26.50 $26.50 $26.50 $26.50
Commissions $9.95 $9.95 $9.95 Per trade commission
Proceeds of Selling BCE Shares $62.95 $619.55 $6285.05 $62940.05
Shaw shares purchased 2.38 23 236 2374 Number of shares you can purchase from the BCE proceeds
BCE dividend $2.73 $27.30 $273.00 $2730.00 Net dividend pre-swap
Shaw dividend $2.83 $27.37 $280.84 $2825.06 Net dividend post-swap
Delta $ $0.10 $0.07 $7.84 $95.06
Delta % 3.55% 0.26% 2.87% 3.48%
Implied Delta % 3.55% 3.55% 3.55% 3.55% The relative difference between the Shaw yield and the BCE yield.
Delta Variance (3.29%) (0.67%) (0.06%) How much over or under we are in our real gain in yields, relative to the base case.

Looking at this, you can see that the difference in yield is not necessarily as clear cut as one would think. Scenario 1 represents the base case in a frictionless environment, and from there we can see that the implied delta, and the actual delta, are equal. However, once we get into the real world (e.g. rounding, commissions), this quickly changes. Looking at 10, 100, and 1000, shares, the actual gain varies. You do come out ahead, but not by as much as the frictionless scenario. Moreover, this example assumes no taxes! When we introduce taxes, things get even worse, illustrated below:

Activity Scenario 1 Scenario 2 Scenario 3 Scenario 4 Notes
Number of BCE Shares 1 10 100 1000 What you started off with
BCE Share Price $62.95 $62.95 $62.95 $62.95
Shaw Share Price $26.50 $26.50 $26.50 $26.50
Commissions $9.95 $9.95 $9.95 Per trade commission
Proceeds of Selling BCE Shares $62.95 $619.55 $6285.05 $62940.05
Tax Rate 16.95% 16.95% 16.95% 2016 Ontario Tax rate for $83M-$86M income tax bracket, from
Available proceeds to purchase Shaw shares $62.95 $514.54 $5219.73 $52271.71
Shaw shares purchased 2.38 19 196 1972 Number of shares you can purchase from the BCE proceeds
BCE dividend $2.73 $27.30 $273.00 $2730.00 Net dividend pre-swap
Shaw dividend $2.83 $22.61 $233.24 $2346.68 Net dividend post-swap
Delta $ $0.10 ($4.69) ($39.76) ($383.32)
Delta % 3.55% (17.18%) (14.56%) (14.04%)
Implied Delta % 3.55% 3.55% 3.55% 3.55% The relative difference between the Shaw yield and the BCE yield.
Delta Variance (20.73%) (18.11%) (17.59%) How much over or under we are in our real gain in yields, relative to the base case.

Again, with Scenario 1 as our base case (no taxes, no commissions, no rounding), we see that our net gain is exactly 3.55%, which is what we would expect. However, the net result looks gloomier with 10, 100, or 1000, shares: our total income is less after we have made the swap!

At the end of the day, while yield is important, and understanding the difference between Yield on Cost and Yield on Price is important, it is opportunity cost which is the most important. Even though BCE’s Yield on Price was lower than Shaw’s Yield on Price, the cost to make the switch effectively cost us 14% in annualized net income!

High Liner Foods (HLF.TO) – August 2016

It has been over 3 years since I last reviewed High Liner Foods Ltd. To date, HLF.TO is still one of my favourite companies as it was as the first that I truly analyzed, and over the years it has been an impressive performer in my portfolio. At a high level, High Liner Foods is a supplier of quality seafood dishes and supplies to both the retail and commercial markets, here and in the US. They have operations throughout North America, and have grown over the years both organically and through acquisitions. Their own corporate snapshot best summarizes the firm:

High Liner Foods is the leading North American processor and marketer of value-added frozen seafood. High Liner Foods’ retail branded products are sold throughout the United States, Canada and Mexico under the High Liner, Fisher Boy, Mirabel, Sea Cuisine and C. Wirthy & Co. labels, and are available in most grocery and club stores. The Company also sells branded products under the High Liner, Icelandic Seafood and FPI labels to restaurants and institutions and is a major supplier of private label value-added frozen seafood products to North American food retailers and foodservice distributors. High Liner Foods is a publicly traded Canadian company, trading under the symbol HLF on the Toronto Stock Exchange.

Source: 2015 Annual Report


From an analysis standpoint, HLF is an interesting company.  The company is headquartered in the maritime provinces, and pays and reports its dividend in Canadian Dollars, but since 2012 they have reported their financial statements in US Dollars.  This requires us to make some minute adjustments to EPS and Cash Flow per Share calculations, to ensure we factor in the appropriate exchange rate.  Moreover, this can swing the YoY growth metrics, since a shift in the USDCAD exchange rate can have a drastic effect on their bottom line due to foreign exchange gains or losses.

Below are the key evaluation criteria for HLF:

Category Criteria Threshold Current Value Pass?
Strong financial condition Current Ratio 2.30 1.50 YES
Earnings Stability Number of most recent years of positive EPS 9.00 3.00 YES
Earnings Stability Number of consecutive years of negative EPS 1.00 1.00 YES
Dividend Growth Compound Annual Dividend Growth 0.21 0.02 YES
Share Price Growth Compound Annual Share Price Growth 0.12 0.03 YES
EPS Growth Compound Annual EPS Growth 0.23 0.03 YES
Moderate P/E Ratio P/E 16.20 15.00 NO
Moderate P/BV Ratio P/BV 2.39 1.50
Moderate P/E*P/BV Ratio P/E * P/BV 38.72 22.50

And here is some of the fundamental data underlying the above evaluation criteria:

Year EPS Dividend per Share Dividend Payout Ratio (EPS) Dividend Payout Ratio (FCFS) ROE P/E Ratio Book Value Price to Book Value (P/BV) Net Income (000s) P/E × P/BV
F2005C ($1.9639) $0.1000 (5.0918%) 30.2774% (60.5188%) (2.3168) $6.4903 1.4021 ($41505.0000) (3.2483)
F2006C $0.1531 $0.1000 65.3106% 21.0671% 4.4303% 28.5734 $6.9121 1.2659 $3156.0000 36.1710
F2007C $0.2910 $0.1000 34.3585% 19.0414% 4.6450% 16.5780 $12.5316 0.7701 $6079.0000 12.7659
F2008C $0.4400 $0.1100 25.0003% 13.8824% 8.5031% 7.9547 $10.3490 0.6764 $13252.0000 5.3805
F2009C $0.5370 $0.1350 25.1377% 17.0828% 12.5713% 8.6120 $8.5439 1.0826 $19747.0000 9.3236
F2010C $0.6208 $0.1650 26.5784% 10.3864% 13.5665% 13.0878 $9.1520 1.7756 $19985.0000 23.2383
F2011C $0.6016 $0.1950 32.4117% 12.9113% 11.2551% 13.5880 $10.6909 1.5293 $18180.0000 20.7806
F2012 $0.0725 $0.2100 289.7152% 7.9876% 1.4365% 217.4934 $10.1433 3.1085 $2203.0000 676.0686
F2013 $0.5491 $0.3500 63.7394% 26.1210% 16.9814% 43.5613 $6.0805 7.8678 $31356.0000 342.7317
F2014 $1.1463 $0.4100 35.7677% 16.4163% 15.3827% 19.7682 $6.4234 3.5277 $30300.0000 69.7371
F2015 $1.3284 $0.4650 35.0042% 20.7587% 14.7522% 11.7057 $6.5064 2.3900 $29581.0000 27.9761


HLF’s share price was on a bit of a tear up until 2014, and it has been dropping since then.  I don’t necessarily see this as a bad thing – in 2014, they were trading at more than 3.5× book value, so a pull back from that price provides more buying opportunities.  Another important point is that in December 2013 HLF was added to the S&P Canadian Dividend Aristocrats Index.  The addition to this index would theoretically increase trading volume as the any ETFs based on the index would be buying and selling shares of the underlying companies, HLF being one of them.  This addition was short lived how however: it was removed in February 2015 because it did not meet the average daily value traded criteria1.

High Liner Foods - 10 Year Stock Price - 2005-2015

High Liner Foods – 10 Year Stock Price – 2005-2015

As a long term investor who is more interested in the continuous passive income from holding the company in my portfolio, rising or falling share prices do not necessarily spook me. Falling share prices are a good thing, since they give me more opportunities to add to my portfolio, provided the underlying fundamentals remain strong. That said, I am more interested in the company’s dividend, its dividend growth, and the margin of safety for the dividend vis-à-vis the ability of the firm to consistently pay that dividend.

HLF.TO - 10 Year Dividend, EPS, and Free Cash Flow per Share

HLF.TO – 10 Year Dividend, EPS, and Free Cash Flow per Share

HLF.TO - 10 Year Dividend Payout vs EPS and Free Cash Flow

HLF.TO – 10 Year Dividend Payout vs EPS and Free Cash Flow

2012 is one year that stands out when examining the  historic fundamentals for HLF.  Their EPS over 2011/2012/2013 went—on a split and currency adjusted basis—from $1.20 in 2011, to $0.14 in 2012, and back up to $1.10 in 2013.  The main reason for this was due to one time write-down charges due to some of their acquisitions in 2011 and 2012, which reduced their net income from $18,180,000 in 2011 to $2,203,000 in 2012.  This one time charge drastically reduced EPS, and helps to explain the huge spoke in the P/BV × P/E value for the same time period, illustrated in this graph:

High Liner Foods - 10 Year P/E × P/BV

High Liner Foods – 10 Year P/E × P/BV

Notice how in 2012 the P/E × P/BV spiked at almost 700, but then dropped down to ~350 in 2013, before returning back to more realistic levels in 2014 and 2015 of 69.7 and 28.0 respectively.  All that aside, if we were to naively look only at the dividend payout ratio relative to EPS we would be very worried; dividend as a percentage of EPS was 289.7% in 2012!  However, if we inspect dividend payout ratio to the free cash flow per share (green line in the Dividend Payout Ratio (vs FCF) graph), we see that the dividend has consistently been below 21.1% since 2006 (it was marginally higher at 30.3% in 2005).  Moreover, notwithstanding the drop in 2012, the EPS on a year over year basis has been generally trending upwards; 2012 was the exception, not the norm.


Over a 10 year time horizon, HLF has had positive dividend growth, EPS growth, and share price growth, with compounded annual growth rates of 15.0%, 27.1%, and 11.8% respectively.  Even taking into account the pull-backs since 2013 in the share price, and the EPS drop in 2012, the stock over a longer time horizon (e.g. 10 years) has been very strong. My recommendation criteria would place HLF as a HOLD, primarily because the P/E × P/BV multiplier is very high at 28.0, which is higher than our threshold of 22.5. However, given the relative strength of the dividend, and HLF’s impressive 15.0% compound annual dividend growth over the past 10 years, I would consider purchasing it even today, unless there were more suitable companies to buy on the open market. Either way, I would purchase on dips: purchasing at any price strictly than $13.95 on the open market would push us below the magic 22.5 threshold for P/E × P/BV, based on the F2015 EPS and Book Value.


1. As per an email exchange with S&P Dow Jones Indices. Email me for more information or for a copy of the exchange.

Minimizing investment friction

Over the years, I have started to pay more attention to friction in my portfolio, which I define as any charges, fees, or penalties, which ultimately deter from my earning potential. When I am making decisions to buy/hold/sell investments, there are three primary types of friction I pay attention to, and try to avoid: Tax Friction, Rounding Friction, and Commission Friction.

1. Tax Friction

Taxes are a reality, and ultimately the tax man (or woman!) always gets his (her) due. In Canada, there are three key types of taxes to pay attention to with your investments. The first, is the capital gains tax, which is applied on any capital gains (i.e. profits) from your investments when you sell them. Following this, is taxes on dividend income; and finally, there are taxes on interest income.

There are a number of ways to reduce tax friction with your investments. The most obvious one, is to keep your investments in a tax free account; in Canada, this would be your TFSA, otherwise known as a tax free savings account. Any capital gains, dividends, or interest, you receive in the TFSA are received tax free. The reason for this is that any contributions you make to a TFSA (i.e. money or investments transferred into the TFSA) are made from after tax dollars, so you have already been taxed on the inflows to the account. The one downside to using a TFSA is that you cannot use capital losses incurred in the TFSA to offset capital gains outside of your TFSA.

The second vehicle at your disposal is to keep your investments in a tax deferred account, e.g. your RRSP. Similar to your TFSA, any gains, dividends, or interest, or not taxed in the account (well, not immediately; see the second key difference below). Moreover, any losses cannot be used to offset gains outside of the RRSP. That being said, there are two key differences between a TFSA and an RRSP. The first difference is that contributions to your RRSP lower your taxable income in the year in which you make the contribution1. As an example, say your salary in 2016 is $45,000, and you contribute $5,000 to your RRSP. This lowers your taxable income to $40,000, which means that your income tax for the year is on $40,000, not $45,000. Taking this even further, if you review the marginal tax rates for your province, you may actually move yourself into a lower tax bracket. In the example we just cited, in the province of Ontario, at $45,000 your marginal tax rate is 9.15%, but at $40,000 your marginal tax rate is 4.05%!

The second difference is that you are taxed when you take money out of the RRSP. The theory is that when you take the money out however, you will already be in a lower tax bracket. So while you may be in a $45,000 tax bracket today, when you take the money out when you retire, you will likely be in a lower tax bracket. Again, by forcing yourself into a lower bracket, you are ultimately paying less tax (and keeping more money in your pocket!).

The third way to reduce taxes is to leverage your capital losses against your capital gains. This option is only available to you in a non-registered account (e.g. not a TFSA and not an RRSP). With this reduction, you reduce the amount of tax you pay on your gains by your losses in that year. For example, if you sell a stock for a profit of $10,000, and you sell another stock at a loss of $4,000, you will only pay tax on $10,000 -$4,000 = $6,000. In general this applies provided you claim the gain and loss in the same reporting period (or carry forward any losses and/or gains to future years); seek advise from a tax professional for details.

2. Rounding friction

Rounding friction is exactly what it sounds like: losses due to rounding. As an example, assume we are able to trade stocks with no commissions, and with no tax friction (e.g. in our TFSA). For our example, say there are two companies, A and B, and we wish to sell company A and purchase company B, because the yield on B is higher:

Line # Company A Company B Notes
A # shares 100 20
B share price $12.34 $59.80
C total value $1,234.00 $1,196.00
D dividend yield 5.00% 5.10%
E dividend $ $61.70 $61.00

After we have completed all of our trades, our absolute dollar return is less even though Company B is the higher yielding stock. The reason for this is that we cannot trade fractional shares. When we sold Company A and took the proceeds of $1,234.00, the proceeds divided by the price of Company B would have had fractional shares: $1,234.00 ÷ $59.80 = 20.635 shares. But, since we can only trade in whole shares, we lost out on 0.635 shares. Even if we take into account the residual cash from selling Company A (i.e. the cash leftover from the trade), our net value is still less. Note that this is only in Year 1, however in subsequent years your net dividend income would still be lower as well with Company B due to the loss of 0.635 shares.

Line # Company A Company B Notes
A # shares 100 20
B share price $12.34 $59.80
C total value $1,234.00 $1,196.00
D dividend yield 5.00% 5.10%
E dividend $ $61.70 $61.00
F Cash in Lieu n/a $38.00
G Net Value $1,295.70 $1,295.00

The only way to get around this is to either luck out and fund companies where the net proceeds of the first will exactly pay for the net cost of the second, or to purchase fractional shares. Luckily, there are ways to perform the latter. If one uses Optional Cash Purchases for companies that allow it, you can purchase any number of shares, and the the total shares purchased will be exactly equal to the amount of capital divided by the going price for the shares.

3. Commission Friction

The most common type of friction, and often one of the hardest to avoid, is friction caused by commissions on your trades. As investors we are all familiar with commissions, and they are a cost of doing business when investing.

Other than choosing a (discount) brokerage which has very low commissions (Personally I use BMO InvestorLine, which charges $9.95/trade), to my knowledge there are really only two ways to get around commission friction.

The first, is to use Optional Cash Purchases for those companies that allow it, and that do not charge commissions on OCPs. Not all companies that offer OCPs do so commission free. For example, the McDonald’s OCP program charges $6.00 per share, whereas the Emera OCP program does not.

The only other way to reduce commission friction is to trade in larger quantities of stock, thereby reducing the average commission. For example, if you purchases 100 shares of a stock at $9.95 commission, your average commission per share is only $0.0995. But if you were to purchase only 50 shares, your average commission would be $0.1990. While you are not completely eliminating the commission, you are reducing it on an average basis.

Onward and Upward!

1 This isn’t exactly true. See a tax professional, but you can may be able to defer your contributions to a later year, hence reducing taxes in a later year.

My recommendation criteria

One of the key elements to being a successful investor is to have a repeatable, quantifiable, investment process, which makes recommendations to buy/sell/hold based on sound fundamental values.  This removes any emotion from the stock picking process, and allows you to easy trace your decisions, when reviewing your portfolio holdings.

As part of my research process, I have built up a number of models based on various books I have read, as well as courses I have taken on investing.  The lion’s share of my criteria are actually taken from Benjamin Graham’s The Intelligent Investor, and have been tweaked to fit my own investment style. Specifically, when I am looking at an investment, I review six quantifiable tests, and make a recommendation for Buy/Hold/Sell based on how many of those tests pass. As of August 2016, here is my recommendation matrix:

Recommendation Financial Strength Earnings Stability Dividend Growth Share Price Growth EPS Growth Undervalued
Strong Buy Pass Pass Pass Pass Pass Pass
Buy N/A Cond1 Pass n/a Cond1 Pass
Hold N/A Cond1 Pass n/a Cond1 Fail
Sell Fail Cond1 Fail n/a Cond1 Fail
Strong Sell Fail Fail Fail n/a Fail Fail

In the above, Cond1 means any of those tests pass. As an example, for a stock to receive a Buy recommendation, it must pass the Dividend Growth test, the Undervalued Test, and at least one of the Earnings Stability or EPS Growth tests.

But, what do each of those tests mean?

Financial Strength

Financial Strength is driven by the current ratio for a stock, which is defined as the Current Assets divided by the Current Liabilities. This measurement is always based on the most recent year of analysis, and a company will pass this test if this ratio is less than or equal to 1.50. The test is meant to ascertain whether a company can make its current liability obligations (e.g. short term loans, accounts payable, etc.).

Earnings Stability

This test is made of up two sub tests: the most recent number of years of positive EPS growth, and the number of consecutive years of negative EPS growth.

Realistically speaking, a company may experience negative EPS growth for any number of reasons. For example, they may have faced currency headwinds which had a short term (negative) affect on their bottom line. Or they may have wound down a division, and experienced an abnormal charge for severance pay to employees of that division. However, over a lengthy time period (>= 10 years), negative EPS growth should not be a recurring theme for any firm. This test is designed to examine how many years in a row we have had consecutive negative growth. If a company has had more than one year of negative growth, this indicates that there may be other underlying issues leading to that growth, or that the company is not learning from its mistakes.

The number of recent years of positive EPS growth is another indicator of a companies ability to build on its mistakes. For this test, I look for firms where the most recent three years of EPS growth have been positive. Passing this test shows that (i) a company hasn’t had negative growth in the past 3 years, and that (ii) the company has been in an upward trend for the past three years.

Dividend Growth

Dividend Growth by itself is not a key metric referenced in The Intelligent Investor, but since my personal investing style is on dividends, it is one which deserves a test on its own. For this test, we look for a compound annual growth rate of at least 2.00% over the past 10 years. Designing this test this way has two key benefits:

  • It removes growth only (i.e. those who do not pay a dividend) companies. I am a firm believer that if you are to hold a company, you should gain some current premium for holding it, and dividends are one of the only ways for a company to give you a current return for holding their stock.
  • It smooths out periods of slow or flat growth. Depending on the dividend investment methodology being used (e.g. US Dividend Aristocrats, Canadian Dividend Aristocrats, dividend achievers, etc), you may subject yourself to rules such as “increasing dividends every year, but one year of no growth is acceptable.” Because I am looking to invest for the long term (e.g. 10+ years), I expect the total dividend payout (in absolute dollars, not yield), to grow at a rate of at least inflation. Right now, that means I am using a target of 2.00% growth per year, compounded annually. By taking the CAGR over a 10 year horizon, we do not inadvertently screen out companies which have not had stellar dividend growth over the analysis period (10 years).  For example, High Liner Foods Ltd. had zero dividend growth for four years, but still has a hefty 14.99% dividend CAGR for the past 10 years.

Share Price Growth

All things considered, we still want the share price to be going up over time. For this test, I am looking for compound annual share price growth of at least 3.00%. This also indirectly screens out chasing after yields: if my dividend growth threshold is 3.00%, and my dividend growth threshold is 2.00%, then I am asking for my share price to grow faster than my dividend. This forces out high yielding firms (i.e. dividend remain high or stable while share price falls), since I am explicitly screening out firms whose share price may be falling, yielding to increasing dividend yields.

EPS Growth

One could include this test with Earnings Stability, but I prefer to separate it out, since there are also separate tests for share price and (absolute) dividends. EPS growth also has a minimum threshold of 3.00%. This builds an at-a-glance screen to ensure that dividend payout ratios (i.e. dividends divided by EPS) do not outpace EPS: since my EPS must grow faster than dividends, this ensures that our dividend payout ratio does not become too unwieldy.

Tied with the earnings stability, this gives a fuller picture of EPS: we are checking that companies have consistent growth, are recovering from bad periods, and have a minimum allowable EPS growth over time.


All things being equal, I would rather buy a good stock for a good price, and a great stock for more than it is worth. Leveraging two classic criteria, the P/E ratio and the P/BV (BV=Book Value), we can build a simple screen of P/E × P/BV. In this test, I check that P/E is less than 15, P/BV is less than 1.5, and that their combination is less than 22.5 (i.e. 15 × 1.5). This allows us to reduce the universe of stocks which are too expensive, but still allowing for stocks which may be too expensive on only one metric (e.g. if a stock has a high P/E ratio, but it is trading at less than book value, all things being equal it is likely still a good buy; by applying P/E × P/BV, we can handle these situations).


The tests are meant to be a simple way to quickly quantify a recommendation, however they should not be taken as gospel. Even when evaluating firms, I challenge myself if a company looks like a good (bad) prospect, but my model tells me to not buy it (or to buy it). For example, a company may have more than one year of negative EPS growth, but this could be due to a string of restructuring or spinoffs from the beginning of a 10 year analysis window; and since then, they have had nothing but positive growth.

Future considerations

This model is a work in progress, and as I am focused on dividend investing, it still ignores some key criteria:

  • Dividend Growth Trajectory. Looking at dividend CAGR of 10 years is meant to smooth out periods of no growth. However, it also allows periods of negative growth. All things being equal, we want a company who has had positive or flat dividend growth, but not one which has cut dividends in its 10 year history, and made up for the cuts at a later date.
  • Dividend Payout Ratio. This model does not check for our dividend payout ratio. While my analysis inspects this in general by (visual) inspection of the dividend payout graph, the model itself does not test for it. This means that some companies may pass all of the tests, even though they have dividend payout ratios in excess of EPS or Free Cash Flow.

This year I will be re-tweaking the model as I become more involved in my investing again. Stay tuned!

Reset button.

It has been a little over a year since my last post, and there have been a number of changes occurring personally, professional, as an investor, and with this site, all of which are intertwined.

The biggest event was that I was displaced in June 2015 due to downsizing at my former employer.  This was a massive hit professionally and financially, as I saw my defined benefit pension fly the coop, and I took a drastic paycut.  The summer of 2015 was a rocky one: instead of going to the beach, enjoying the weather in a park, or drinking on a patio with my mates in Toronto’s downtown core, I was hunkered down at home applying for jobs all summer.  Towards the end of August 2015 I landed a contract position, and from there started up my new life as an independent project management consultant.  So, in the end, things worked out, but it was still a bit of a professional roller coaster; and I will miss the defined benefit pension.

Personally, my family purchased a home earlier in 2016, just ahead of the massive Toronto Housing Bubble.  We lucked out; similar properties in the neighbourhood we moved into have gone up about 10% since we purchased our house earlier this year.  Needless to say, the market is hot, and I am certainly glad not to be part of that fire!

Which brings me to the changes as an investor.  The majority of my investments were being saved for the next big purchase, or retirement, whichever came first.  Needless to say, retirement is a far way off, so I ended up liquidating a number of my holdings to help pay for the house.  While the sting of selling off those holdings is still wearing off, I am happy that overall my previous investment decisions were good ones.  The biggest sale I had which contributed to the house was my long position of CCL Industries, which netted me a tidy return of 517.8%; I had purchased a while back in the high $30 range and sold in the $220 range.  I had some other big gainers (e.g. High Liner Foods returned in excess of 200%), but CCL was definitely my big winner!

Which brings us to today.

With the cashing out of my defined benefit pension, and the selloff of a number of positions in my portfolio, my portfolio has taken a net hit of about 17%.  Moreover, the tax distribution in my portfolio has changed drastically: before all of these major changes, 45% of my portfolio was taxable (i.e. non-registered), and 55% was in non-taxable or tax-deferred accounts, such as an RRSP or a TFSA (i.e. registered).  Now, the mix stands at 10% in the taxable portion, and 90% in the non-taxable.

This split is both good and bad.

The good, is that the majority of my US investments are now in my RRSP – this means I save an instant 15% of withholding taxes, since Canadians do not pay withholding tax on dividends from US corporations if they are in an RRSP.  Moreover, having 90% of my portfolio “locked away” means that I truly am saving for retirement: taking the money out of the registered portions of my portfolio would result in an immediate tax hit.

The bad, is that only 10% of my investments provide present day disposable income.  So, if I need to use any dividend income to offset present day purchases, I am unable to do so.

From a salary perspective, I am not yet at the point where I can pay myself the same salary as before I was displaced, since I have to build up some capital in my corporation.  My salary today is 17% less than one year ago, not including  any short-term bonuses, the losses of which may be even larger.  Contrary to popular belief, independent consultants are not rolling in cash!  Due to this change in salary, I am not able to invest as aggressively as before, which means my portfolio growth will be seriously constrained until I can increase my net cashflow.

As investors, diversification should be one of the primary objectives of our investment portfolios.  I’m happy to report that during the ups and downs of the past 24 months in the markets, my portfolios have done relatively well, all things considered.   With that in mind, the irony of the situation is that my income streams were not diversified.  While I received some income from dividend investing (in 2015, dividends attributed approximately 3% of my net cashflow), like most normal people, the majority of my income came from my place of employment.  So when your job changes, your net income could take a massive hit; such was my case.  With that in mind, I am looking at diversifying income streams as well.

I have moved this blog from a hosted site, to one hosted on my own servers.  This will give me more opportunities for revenue generation through the site; what that means, I am not quite sure, but at least the option is there.  You may see some ads on the site going forward, and clicking through to those will help me in keeping this site on its feet.

I started off by noting that it has been over a year since my last post, and I have a whole slew of ideas and things to write about.  While the original focus of this blog was on dividend investing, I will be branching out into new areas.  From an investing perspective, dividends are typically the payouts a shareholder receives from the profits of the company in which they own shares.  However, a broader definition is “anything received as a bonus, reward, or in addition to or beyond what is expected.”  That said, future posts will also focus on other methods of generating net positive cash flows: this could either be from hard inflows of cash (i.e. income), or cost avoidance, which ultimately results in more disposable income to use in other investing activities.

One thing is certain: I am certainly glad to be back here blogging and sharing my views and ideas, and I look forward to receiving criticism and feedback from my readers.

Welcome back.

Investing Roadmap Part 2: How much do you need to retire?

In my previous post, I spoke about having goals for investing. My goals fall into the second category, Investing to achieve some target and/or goal, and that goal is to not have to work.

Now, most people don’t want to work. Given the choice, I would rather sit on my balcony all day sipping an espresso reading books, researching companies, or in the living room watching a good film. However, work is a reality of life: we have to pay the bills somehow (how will I buy the espresso?). So, to be able to get to the point where I don’t have to work to make money, I need to have some inflow of cash which handles all of my regular expenses. This is a fairly mechanical exercise:

  1. Identify your monthly expenses, and multiply by 12 to annualize
  2. Add in any annual expenses (e.g. property tax on your residence, if you own a home)
  3. Add inflation up to the point that you wish to retire
  4. Factor in personal taxes

After the four steps above, you’ll have your required annual pre-tax income for when you wish to stop working.  Here is an example:

Monthly Expenses
Rent $1,500.00
Groceries $300.00
Entertainment $400.00
Insurance $100.00
Utilities $200.00
Transportation $200.00
Pet care $75.00
Mobile phone $85.00
Internet $50.00
Netflix / TV $10.00
Computer / Technology $100.00
Maintenance Fees $350.00
Emergency Funds $200.00
Total Monthly $3,570.00
Annualized $42,840.00
Annual Expenses
Vacation $5,000.00
Property Taxes $3,000.00
Total Annual Expenses $8,000.00
Total Expenses $50,840.00
Implied Tax Rate 40%
Total Annual (Gross) $84,733.33

From the example above, if I were to stop working today, I would need ~$84.7M ($M=000) in annual income to maintain my current lifestyle.

However, there is a small wrinkle in that this is in today’s dollars, and we need to factor in inflation (step #3 above).  For example, if we assume 2% inflation (i.e. on average costs will go up 2% next year), our pre-tax income shoots up to ~$86.4M.  And to further complicate things, inflation is an unknown: we don’t know what inflation will be.  Say for example I wish to stop working in 10 years, in 2025.  What inflation rate do I use for 2016, 2017, 2018, etc.?

My own workplace uses a 2.25% inflation assumption for each year.  I would prefer to account for some variability, and one way to account for this variability is to run a simulation, using a range of acceptable inflation values.  Specifically, a Monte Carlo simulation, wherein I have run 100,000 trials using an inflation assumption of 2.25% +/- 1.00% per year for the next 27 years.  One iteration of the simulation gives results such as the following:

Year Pre-tax income
(Jan 1)
Inflation Assumption Pre-tax income (Dec 31)
2015 $85,000 3.21% $87,729
2016 $87,729 3.13% $90,474
2017 $90,474 2.68% $92,899
2018 $92,899 1.29% $94,098
2019 $94,098 1.89% $95,876
2020 $95,876 2.56% $98,330
2021 $98,330 2.13% $100,425
2022 $100,425 2.67% $103,106
2023 $103,106 3.15% $106,354
2024 $106,354 1.39% $107,832
2025 $107,832 1.87% $109,849
2026 $109,849 1.93% $111,969
2027 $111,969 2.64% $114,925
2028 $114,925 1.67% $116,844
2029 $116,844 2.60% $119,882
2030 $119,882 3.24% $123,766
2031 $123,766 2.79% $127,219
2032 $127,219 2.88% $130,883
2033 $130,883 1.88% $133,344
2034 $133,344 1.91% $135,891
2035 $135,891 1.79% $138,323
2036 $138,323 2.36% $141,588
2037 $141,588 2.85% $145,623
2038 $145,623 2.85% $149,773
2039 $149,773 2.67% $153,772
2040 $153,772 2.89% $158,216
2041 $158,216 2.17% $161,649

As you can see, by the time we hit 2041, to live at my current lifestyle, I would require $158.2M in annual income.  The inflation also bounces around a lot, as each year the inflation is estimates to be somewhere between 1.25% and 3.25%.

Now, if we run this simulation 100,000 times, we get the following for the required income in 2041 (only first 10 entries shown):

Sequence # 2041 pre-tax income
1 $158,216.33
2 $160,945.75
3 $142,668.57
4 $160,712.46
5 $160,133.85
6 $160,235.08
7 $146,449.32
8 $150,616.91
9 $161,482.05
10 $152,456.35

But, what do we do with those numbers?  The answers is to perform some statistical analysis on each year, and come up with what we feel is a reliable number.  If we focus on 2041 as our example, here is the histogram:

Histogram of Required Income in 2041

For the above, we have a median required income of $154,922.16, and a mean income of $154,991.19.  However, the median and mean are the mid-point and average required incomes respectively.  Whilst the median is $154,992.16, there is a chance that it will be above that.  What I am interested in is the required income with a certain level of confidence.  If we do some more analysis on the histogram, we can break up all of the salary ranges into buckets, and from there interpolate the expected required income in 2041 with 95% confidence:

Bucket # Low High Count Cumulative Probability
1 $134,510.51 $135,685.09 1 0.0010%
2 $135,685.09 $136,859.67 0 0.0010%
3 $136,859.67 $138,034.25 1 0.0020%
4 $138,034.25 $139,208.83 6 0.0080%
5 $139,208.83 $140,383.41 12 0.0200%
6 $140,383.41 $141,557.99 55 0.0750%
7 $141,557.99 $142,732.57 156 0.2310%
8 $142,732.57 $143,907.15 338 0.5690%
9 $143,907.15 $145,081.73 682 1.2510%
10 $145,081.73 $146,256.31 1296 2.5470%
11 $146,256.31 $147,430.89 2098 4.6450%
12 $147,430.89 $148,605.47 3325 7.9700%
13 $148,605.47 $149,780.05 4653 12.6230%
14 $149,780.05 $150,954.63 6419 19.0420%
15 $150,954.63 $152,129.21 8000 27.0420%
16 $152,129.21 $153,303.79 9048 36.0900%
17 $153,303.79 $154,478.37 10070 46.1600%
18 $154,478.37 $155,652.94 10061 56.2210%
19 $155,652.94 $156,827.52 9678 65.8990%
20 $156,827.52 $158,002.10 8773 74.6720%
21 $158,002.10 $159,176.68 7376 82.0480%
22 $159,176.68 $160,351.26 5833 87.8810%
23 $160,351.26 $161,525.84 4249 92.1300%
24 $161,525.84 $162,700.42 3006 95.1360%
25 $162,700.42 $163,875.00 2057 97.1930%
26 $163,875.00 $165,049.58 1224 98.4170%
27 $165,049.58 $166,224.16 721 99.1380%
28 $166,224.16 $167,398.74 453 99.5910%
29 $167,398.74 $168,573.32 214 99.8050%
30 $168,573.32 $169,747.90 126 99.9310%
31 $169,747.90 $170,922.48 43 99.9740%
32 $170,922.48 $172,097.06 14 99.9880%
33 $172,097.06 $173,271.64 7 99.9950%
34 $173,271.64 $174,446.22 5 100.0000%
100000 100.0000%

Based on the above, our required income, at 95% confidence, is $162,647.28.  In other words, I can say with a degree of confidence that my required income in 2041 will always be at, or less than, $162,647.28; put another way: there is only a 5% chance that I will need more than $162,647.28 in annual income to live comfortably in 2041.

However, that is only for the year 2041.  It would be nice to see a bunch of years, say, from 2026 to 2041.  I won’t display all of the histograms and such, but here is the summary table:

Year Income Required at 95% confidence Mean Income Required Median Income Required
2026 $114,667.71 $111,013.30 $110,991.02
2027 $117,397.60 $113,512.43 $113,484.70
2028 $120,183.67 $116,061.47 $116,037.66
2029 $123,019.43 $118,672.26 $118,654.49
2030 $125,975.59 $121,345.28 $121,319.06
2031 $128,935.52 $124,077.19 $124,044.14
2032 $131,995.18 $126,871.97 $126,845.13
2033 $135,073.08 $129,724.75 $126,845.13
2034 $138,286.34 $132,644.87 $129,688.96
2035 $141,521.77 $135,624.14 $129,688.96
2036 $144,833.57 $138,672.78 $138,639.86
2037 $148,260.68 $141,794.27 $141,765.55
2038 $151,705.86 $144,983.10 $144,948.96
2039 $155,291.29 $148,242.42 $148,193.00
2040 $158,933.22 $151,579.05 $151,517.82
2041 $162,647.28 $154,991.19 $154,922.16

At the outset of this post, I said that my goal was to not to have to work.  From the above, I now know how much income I need in any given year, to maintain my current lifestyle, while factoring in inflation.  So, if my investments happen to generate at least $114,667.71 in income in 2026, I know that I can then quit my job and not have to worry about anything.

In one of my upcoming posts, I’ll talk about forecasting my expected income, which is the flipside of this discussion.

Why do you invest?

A few people may stumble into financial security. But for most people, the only way to attain financial security is to save and invest over a long period of time. You just need to have your money work for you. That’s investing.

Simply put, you want to invest in order to create wealth. It’s relatively painless, and the rewards are plentiful. By investing in the stock market, you’ll have a lot more money for things like retirement, education, recreation — or you could pass on your riches to the next generation so that you become your family’s Most Cherished Ancestor. Whether you’re starting from scratch or have a few thousand dollars saved, Investing Basics will help get you going on the road to financial (and Foolish!) well-being.

Now that the markets are showing signs of life, the pundits and financial writers are pumping out investing articles of all kinds. Gold is prominently mentioned as are a wide variety of stocks, mutual funds, and exotic ETFs. More so than ever, when I read these articles I ask myself this question: Why should I invest in that? Or taken one step further, the question becomes: Why do I invest?

I actually struggled for a long time on how to open up this post, but taking a page from Finding Forrester, sometimes it is easier to let someone else write the intro for you.

It should come as no surprise that many folks have asked the age old question of, “why?”.  In fact, everything that I say in this entry, has likely been written in greater detail, depth, and clarity, by someone else.  However, it is a necessary step in my overall roadmap of investing.

So, the question as it stands, why do you invest?  And as an extension to that, how do you know that you did it well?

The three quotes cited above contain a wealth of information on the how and why of investing.  At the end of the day, If we ignore the mechanics of investing (e.g. compound interest, “buy low, sell high”, “long time horizons”, etc.), the reason that any of of invest is a deeply personal one.  However, in my view the reasons for investing can be broken down into one of three categories:

  1. We invest for personal gain
  2. We invest to achieve some target and/or goal
  3. We invest for someone else

Fundamentally, these three reasons cover pretty much every scenario.  Saving for retirement?  That is #1 or #2.  Helping a relative?  That is #3.  Saving for school?  #2.

The reason that I have broken everything down into three categories, is that the why of investing is useless without some type of barometer as to how well you are investing . If you are saving for school, you know if you are successful if you have enough for your tuition.  If you are saving for retirement, then you have enough if you know that you can be financially secure after you stop working.  If you are saving for personal gain (e.g., “I just want to be rich”), you are successful if the personal decisions you make in your investing are better than those that would be made if you paid someone else to handle your money (e.g. a financial advisor).

There are really only two ways to monitor your performance: absolute, and relative.  In absolute measurements, you have some fixed, quantifiable goal against which you are measuring yourself.  If you are saving for your child’s education, and you know that the total cost will be $50,000 with tuition, books, and residence fees, then you have an absolute target against which to work.  Contrasting this are relative measurements.  These measurements are typically against some benchmark, and fundamentally reflect the opportunity cost of investing relative to some other means.  For example, if your benchmark is one of the couch potato portfolios, the performance of your investment decisions shows how much better (worse) you have done by managing your own money, instead of following the couch potato formula.

With the above in mind, the question should not be “Why do I invest?”.  Rather, it should be, “Am I meeting my investment goal?”  Defining your investment goal will lay the foundation on which you base all of your future decisions.