Jun 222017
 

The Largest Name in Retail Continues to Grow

Amazon.com (AMZN) recently announced it’s taking over the trendy supermarket chain, Whole Foods. At the beginning of this year I wrote an article which included a prediction that this would happen. Maybe Amazon’s CEO Jeff Bezos got the idea from reading my blog. 🙂

Whole Foods sells healthy, organic products. Most items in the stores can be expensive, but  if you want to grab a quick and healthy lunch, you can buy half a pizza for $7 CAD, which isn’t bad. I remember my first time visiting Whole Foods. I didn’t really know what it was so I had no idea what’s in store. 😉 But after going in I quickly understood why the retailer attracts so many yuppies and hipsters like myself. Shopping there is an experience. 😀

This acquisition is a very good deal for both companies. Whole Foods Market Inc has been suffering from declining same-store sales year after year. Whole Foods stock (WFM) peaked in 2013 and has been falling every year since. 🙁 So it needs a larger company to help turn things around. Amazon has already been experimenting with grocery stores since last year with its Amazon Go project. The idea is consumers can walk into a store, buy the food they want, and leave without lining up or checking out. The in-store scanners do everything automatically so people can just walk out of the store and get charged the correct amount. It’s a really neat concept, but the service is only in the U.S. for now. By merging with a grocery chain, Amazon can expand its grocery business, and can also transform unused Whole Foods real estate into Amazon warehouses. 🙂

Whole Foods stock is up about 25% in the last 5 trading days and now sits at $43. Amazon stock is now at $1,002 per share. I like shopping with both retailers, and I look forward to see how they collaborate.

Disclaimer: I own 10 shares of AMZN, and no shares of WFM.

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Random Useless Fact:

 

May 082017
 

How to Invest in U.S. Infrastructure 

Donald Trump’s policies focus on building infrastructure and prioritizing America first. With the U.S. economy growing stronger than Canada’s, I believe this is a good time to look south of the border for opportunities. Thanks to the Trump rally, the S&P 500 market index in the U.S. is up about 7% year to date. It appears the market could reach even higher by the end of the year. 🙂

One way to invest in a country’s growing infrastructure is to buy ownership in stable, and profitable cement and construction companies! But the concrete business isn’t always what it’s cracked up to be. 😄 There is a lot of competition in this space so it’s important to invest smartly. I have done research into several companies such as Martin Marietta Materials (MLM), Vulcan Materials (VMC), and others. But the company I liked most was Summit Materials Inc (NYSE:SUM)

Summit Materials is in the business of cement and small rocks called aggregates used to make roads and buildings. In addition to supplying aggregates to its customers, the company also uses its materials internally to produce ready-mix concrete and asphalt paving mix production. I like the widespread geography that Summit is operating in. It conducts business in over 20 states, including Texas, which borders Mexico. I’m looking forward to that wall being built. 🙂

I guess you can say this company rocks. 😄 Valuation wise SUM is slightly expensive, but is actually fairly valued when compared to its competitors in the market. Over the last year the company earned $0.88 per share. According to analysts, the company is expected to grow its earnings at 10.5% a year over the long run. We can use the Graham Formula which I’ve explained here, to determine the fair market value of this stock.

Doing so will give us a Graham value of $25.96 per share. (V = 0.88 x (8.5 + 2 * 10.5)

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Apr 242017
 

Today we’ll explore a common question I get asked all the time: What is my thought process behind leverage?

The short answer is simple. I want to make high returns without being exposed to high risk. Normally the two go hand-in-hand. But leverage allows me to separate them.

For example, a speculative marijuana stock may grow 20% to 50% a year. But it could just as easily lose half its value. The potential reward is tempting. But the high risk is not worth it.

Instead, I’m looking for a lower return, lower risk investment such as an established pipeline company known for its predictable earnings, dividend growth, large economic moat, and low stock volatility. Using historical data and fundamental analysis I may determine that there is a very high probability this stock will appreciate 4% to 10% a year. I can then apply a leverage multiplier of 5 times on this investment which means my actual expected rate of return is 20% to 50%.

In other words, I do not subject myself to the high risk that is typically associated with juicy returns. But I still get those juicy returns! Awww yeah. 😀

That’s pretty much it. The long answer requires some further explanation. Let’s start with the 3 criteria I look for before I borrow to invest.

 

The 3 fundamental rules of practicing leverage

  1. A 10+ year investment time horizon.
  2. An adequate diversification strategy.
  3. An asymmetric risk-return opportunity.

The first and second rules are straightforward. Billionaire Jeff Bezos recommends we think in 7 year terms to remain competitive. I suggest taking that up to 10 years just to be safe. 🙂 In terms of diversification it can mean more than just having stocks and bonds.

 

Seek Out Asymmetric Returns

Now comes the fun part. Rule number 3. As we all know there is no investment without risk. The third rule is about knowing which investment has a favorable risk to reward ratio. This simply means comparing the odds. For example, let’s say we are asked to roll a normal 6 sided die. If it lands on 1, 2, 3, or 4, we win $10. 🙂 But if it lands on 5 or 6, we lose $10.

So should we play? The answer is a resounding yes every time! 😀 We have a 66.7% chance (4/6) of success. So from a rational perspective this has an asymmetric probability in favor of us winning.

 

Analyzing Probable Returns with a Bell Curve

We can use a normal distribution to help identify favorable investment opportunities. In statistics, a normal (bell curve) distribution outlines all the possibilities with the most likely outcome being in the middle. The standard deviation can be used to measure the variation in a set of data. Let’s see how we can put this bell curve to use when we overlay it on top of a chart that shows how many times the stock market returned a specific amount over any 10 year period between 1916 to 2016. (source)

So over the last century, any 10 year period of investing in the S&P500 index would have returned somewhere between 6% to 11%, 40% of the time, or within 1 standard deviation of a normal distribution curve. Additionally, returns were between 3% to 14%, 72% of the time, within 2 standard deviations from the mean.

This strongly suggests that we have a 95% chance (95/100 possibilities) of making at least 3% annual return from the stock market in any given 10 year period. Pretty neat eh? 😀 Time in the market reduces risk in the market, and creates a huge asymmetric advantage to investors!

But enough theory. Let’s see this at work in a real life example.

 

Banking on Leverage

A couple of years ago I used leverage to buy RBC Royal Bank stocks. Let’s go through my thought process behind this decision.

Large cap, blue-chip dividend stocks are ideal to use leverage on. They don’t come much bluer and larger cap than RBC. It’s the largest company in the country. Plus, there’s a lion in the logo. That’s how you know it’s a top quality company. 😉

I borrowed $4,000 to buy 55 shares of TSE:RY and contributed $0 of my own money. I wrote a full analysis on RBC and explained why I thought it was a good stock to buy at the time. The reason I used leverage was because I didn’t have any cash and the investment fits my 3 rules of leverage.

  • First rule: I planned to keep RY stock for the next 10 years.
  • Second rule: I made sure RY would only be a small part of my total portfolio.
  • Third rule: RY’s P/E ratio, peg ratio, and other fundamental measurements looked appealing in 2015. The stock was expected to grow 8% to 10% a year for the foreseeable future. Historical data showed strong earnings growth and stock appreciation. RY’s dividend would be enough to cover the interest cost of the debt. Thus, this would have a favorable asymmetric risk-to-reward ratio.

My return on this investment so far, net of margin interest cost, is about 37% or $1,500. Not too shabby. 😀 But this shouldn’t be a big surprise. After all, stocks are fundamentally priced based on their earnings. And RBC has an impressive history of consistent earnings growth. Back in 2015, RY was expected to earn $7.35 per share by 2017. Fast forward to today, it appears RY may actually be on track to hit $7.40 EPS this year. We shall see.

This leveraging strategy is also recession resistant. For example, let’s say I did the exact same thing in 2007 at the peak of RY’s market capitalization, (the worst possible time to use leverage) right before the greatest recession of our generation. Yikes! Well despite the unfortunate timing, 10 years later I would still end up with a 70% positive return, net of interest expenses! This is why I am not concerned about future recessions. 😉 I know I can just hang on to RY until the stock market recovers like it always does after a major correction.

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Mar 302017
 

Recent Purchase – Yellow Media Ltd

Although most of my investments are in blue-chip dividend paying companies, it can be fun sometimes to speculate on smaller companies as well. It’s kind of a risky play, but I recently picked up 120 shares of Yellow Media (TSE:Y.) I paid on average $8.14 per share, plus commission.

The stock is trading at 0.61 Price/Book ratio, so its net assets are worth more than the company. The forward P/E ratio of 11.8 is also quite attractive. The phone book industry is dying, but Yellow Media is transitioning into the digital world. The reason I decided to buy now is because the company just hired a new CFO and the stock has started to go up again. 🙂 It has greatly reduced its debt over the past several years. Although its print business is suffering, it plans to organically grow its digital revenue between 5% to 8% a year. Yellow Media already owns a lot of online content and gets tons of internet traffic. 🙂

I first came across Yellow Media when I read Nelson’s post on The Fool last month. He analysis appears to be sound. I believe (Y) has potential to come back from its current lows. But it’s far from a guarantee. The stock currently trades at about $8/share. In 1 year from now, Yellow Media stock will either grow to over $12/share (50% gain) or drop to something like $6/share. I’m investing because the upside potential outweighs the possible downside for me.

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Mar 232017
 

Earlier today I was feeling kinda lonely. đŸ˜„Â So I decided to buy some shares.
Ah yes. It sure feels good to have a bit of company. 😄 And that company is called Costco.

In this series of blog posts I’ll explain how I determine which stocks to add to my portfolio based on strategic valuation methods. 🙂

How to Value a Stock: The Graham Formula 

Today, we’ll look at one of the most common formulas to determine the intrinsic value of a company; it’s call the Benjamin Graham Formula, named after the famous value investor who taught Warren Buffett. 🙂

The Graham formula looks like the following:

Benjamin Graham Formula

This should give us an idea of how much we should pay to buy a stock. Let’s go over the variables.

V = Intrinsic value, or what the stock should be worth today.
EPS = Trailing twelve months earnings per share.
8.5 = P/E base for a no-growth company.
g = Expected long term earnings growth rate.

 

Is Costco Stock Undervalued or Overvalued?

This formula works best with blue-chip, large cap, value stocks. We will use Costco Wholesale Corporation as an example since I just purchased some recently. 🙂

So to find out the intrinsic value of Costco (NASDAQ:COST) we need to look up the earnings per share (EPS). This information can be found on Google Finance.  We see that it’s $5.41.

Next in the formula, we need the “g” value. We can find this information on the Nasdaq.com website, and see that it’s 10.71%.

 

Finally we can now plug everything into the formula to see the result.

 

So as of today, March 23rd, Costco should be worth around $162 per share according to the Benjamin Graham formula.

But of course the stock is actually trading at $167. This means Costco is currently overvalued because its shares are trading at a premium compared to the fair value we just calculated.

Nevertheless, I still went ahead and purchased 10 shares of Costco this morning. The 3% premium I paid over the intrinsic value isn’t a big deal for me. Plus Costco recently announced an increase of membership fees to $60 per year. Like most other Costco shoppers I have decided to keep renewing my membership with them. But at least now I own 10 Costco shares, which entitles me (as a shareholder) to receive US $54 of after tax profits every year. This amount converted into Canadian dollars is more than enough to cover the expense of my annual Costco membership, haha. 😀

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