What to do with a $1,000 SolarShare Bond

Occasionally one is faced with a windfall of money and they have to determine what to do with it. A few years ago, I purchased a SolarShare bond (https://www.solarbonds.ca/) as a way to add some diversification to my portfolio. When I purchased it, the bond was yielding 5%, and it matures this month on January 31, 2020. SolarShare reached out to me and provided me with the option of either cashing out, or rolling the bond into a new issuing which would yield 4% (versus the current 5%). Before pulling the trigger on how to invest I wanted to see what would be best in the long term.

Option 1: Purchase a new bond

This is the easiest option: a click of the mouse and my $1,000 5% bond would be rolled into a $1,000 4% bond. Doing so would guarantee me $40/year in income for 5 years, with my principal repaid in 2025. Doing so would present the following cash flows:

Year Cash out Cash in Net
Year 2020 $1,000 $40 ($960)
Year 2021 $40 $40
Year 2022 $40 $40
Year 2023 $40 $40
Year 2024 $1,040 $1,040
Totals $1,000 $1,200 $200

This would net me $200 cash at the end of the day, which makes sense since it would be 4% a year for 5 years. A $200 return on $1,000 would be 20%, which seems pretty good at face value. However, you have to take into consideration that that is 20% over 5 years, which is actually 3.71% compounded annually. E.g. if you took $1,000 and found a vehicle that would re-invest the interest at 3.71%, you would end up with the same end value:

Start of Year Interest End of Year
Year 1 $1,000 $37 $1,037
Year 2 $1,037 $39 $1,076
Year 3 $1,076 $40 $1,116
Year 4 $1,116 $41 $1,157
Year 5 $1,157 $43 $1,200

When you look at the return on a compounded basis, it is not as attractive as the 4% coupon of the bond, but 3.71% guaranteed return is still pretty decent.

Option 2: Savings Accounts

The challenge with this is that you need to find an investment vehicle (e.g. a savings account or something similar). Popping over to ratehub.ca, as of January 22, 2020 the top high interest savings accounts (HISAs) are only yielding 2.45% at their best:

In addition, there is no guarantee on the HISA will maintain its “high interest” for the foreseeable future, so are now exposed to interest rate risk.

Another option would be a Guaranteed Investment Certificate (GIC), but looking at ratehub.ca again, the highest GIC rates are below what we need to meet or exceed SolarShare:

Moreover, we’d have to ensure that the GIC could re-invest the interest, otherwise the interest would only be applied on the original investment.

Option 3: Equity Investing

The most obvious alternative option would be to find a decent company with an attractive yield and invest the money outright. I wrote previously about investment friction (link). Ignoring tax friction, in a normal trading situation—even with a discount brokerage—you would still be victim to commission friction and rounding friction, the reason being that it would be very hard to purchase stocks that totalled exactly $1,000 (less commissions).

But we can poke at this a little more. I also wrote previously about DRIP investing (link), of which I am a huge proponent. If I were to invest in one of my DRIPs:

  • I would not pay commissions
  • The full $1,000 would be invested (i.e. I would be able to purchase fractional shares)
  • When the DRIP triggered, I would get full reinvestment, i.e. true compounding

So, DRIP investing sounds like a good option. At present I own shares (or units) in the following companies that offer a DRIP:

  • National Bank
  • CAE Inc.
  • Fortis
  • Telus
  • Bank of Nova Scotia (Scotiabank)
  • BCE Inc.
  • Emera
  • Manulife

The $1,000 question is: would one of these companies be a better choice for capital allocation, than the SolarShare bond?

A cursory look at the latest data (as of January 22, 2020) for each of the companies yields this, sorted by ascending yield:

Price Quarterly Dividend Yield P/E P/BV P/E × P/BV
CAE.TO $38.25 $0.1100 1.15% 27.5 4.5 123.0
FTS.TO $57.54 $0.4775 3.32% 1.7 14.8 25.0
MFC.TO $27.25 $0.2500 3.67% 11.3 1.2 13.1
NA.TO $73.40 $0.7100 3.87% 11.3 2.0 22.5
EMA.TO $59.71 $0.6125 4.10% 18.2 2.0 35.7
T.TO $51.98 $0.5825 4.48% 17.4 2.9 50.6
BNS.TO $73.35 $0.9000 4.91% 1.4 10.9 15.3
BCE.TO $62.20 $0.7925 5.10% 18.0 3.3 59.8

Recall that the minimum yield we need (if fully re-investing) is 3.71%. Intuitively that would remove CAE Inc., Fortis, and Manulife immediately. However, one reason these companies are in my portfolio is because they consistently increase their dividend. Because of that, we must look at both the current yield and the forecasted yield based on how much we feel the dividend will grow over the five years I would hold the shares. If we look at the 5-year CAGR for the dividend, and assume that same rate of growth, the total investment for each becomes:

Price Quarterly Dividend Yield P/E × P/BV 5-year dividend CAGR Total Income
CAE.TO $38.25 $0.1100 1.15% 123.0 9.70% $1,071.78
FTS.TO $57.54 $0.4775 3.32% 25.0 6.89% $1,205.51
MFC.TO $27.25 $0.2500 3.67% 13.1 10.53% $1,247.76
NA.TO $73.40 $0.7100 3.87% 22.5 6.94% $1,242.83
EMA.TO $59.71 $0.6125 4.10% 35.7 9.37% $1,272.97
T.TO $51.98 $0.5825 4.48% 50.6 7.61% $1,289.52
BNS.TO $73.35 $0.9000 4.91% 15.3 6.43% $1,311.92
BCE.TO $62.20 $0.7925 5.10% 59.8 5.08% $1,315.69

The only real change was that Manulife, which had a lower yield, ends up with a slightly higher return than National Bank. The difference can be attributed to the higher compounded growth of the dividend.

The question then becomes which company would be good to purchase. Not surprisingly, when valuing each company by it’s Graham Multiple, the higher multiples corelate to a lower yield, which intuitively makes sense: a high Graham Multiple indicates that the stock is overvalued (i.e. too expensive), which would be reflected in a lower dividend yield. Ignoring the most expensive companies (CAE Inc., BCE Inc., Telus, and Emera) leaves us with:

  • Fortis, 3.32%, $205 forecasted income
  • Manulife, 3.67%, $248 forecasted income
  • National Bank, 3.87%, $243 forecasted income
  • Bank of Nova Scotia (Scotiabank), 4.91%, $311.92 forecasted income

The forecasted income should be taken with a grain of salt since that assumes the CAGR remains constant. All things being equal, Bank of Nova Scotia is the clear choice: highest yield of the four, undervalued with a Graham Multiple of 15.3, and a 6%+ 5-year CAGR. Even if there were no dividend growth, at 4.91% yield it would still exceed the SolarShare bond.

The Final Choice

Looking at the options, there are risks and benefits to each:

Benefit(s) Risk(s) / Downside(s)
SolarShare Higher guarantee of at least receiving your principal back
  • Non compounding interest
  • At maturity, new issuing interest rate may be lower than 4%
Savings Account Guarantee to protect your capital Interest rates may drop
Equity Investment
  • Preferred tax treatment (form dividend tax credit)
  • Fully reinvested (i.e. “compounding” the returns)
  • Potential for capital growth
  • Potential for capital loss, principal declining below initial $1,000 investment
  • Dividend could be cut or reduced

The catch however, is that I am using the investment as a cash flow mechanism: meaning that I am likely to not sell the investment in five years. Given that, the risk/downside of capital loss is really not an issue, and the real risk is that the dividend could be cut or reduced. However, given the track record of these companies, I feel that that risk is minimal.

I’ve elected to purchase equity investment because I believe that the long-term gains are better. If I were considering cashing out the investment in five years, I would lean more towards the bond to guarantee my capital; if I went with an equity investment and needed at least my capital back, I may need to wait if the stock market is soft.

Onwards and upwards!