Sep 222016
 

Lower Cost with Interactive Brokers

Everyone likes a discount, especially personal finance enthusiasts. We tend to get hyped over even marginal deals. 😀

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Speaking of margin-al discounts. I recently lowered my stock margin rate from 4.45% to just 1.95%. Hot damn! It’s even lower than my mortgage now, haha. 😁

One of the best things investors can do to increase our net returns is to reduce the cost of investing. When it comes to leverage, or borrowing money to invest, the best way to reduce our cost is to find a broker which charges the lowest interest rates. 🙂

In the past I have held my margin account with TD Direct Investing. The current interest rate they offer is 4.25% or 4.75% per year, depending on which currency investors borrow in.

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Although TD’s rates are already competitive relative to the other large banks in Canada, it is not the lowest. After doing some research online I’ve discovered that a U.S. based brokerage firm called Interactive Brokers offers the lowest margin rates, and has cheap trading commissions. So I recently transferred my entire margin portfolio from TD to IB to reap the benefits of lower cost borrowing. 🙂

Interactive Brokers Advantages

Here are 4 reasons why I switched to IB.

  1. Reduced margin rates for more cost-effective leverage. I currently have about $54,000 of margin debt. I was paying on average 4.45% a year for this massive loan with TD. But with Interactive Brokers I’m now paying only 1.95% on average because I have both US and Canadian dollars. This represents a difference of 2.50% between the two brokers, which translates into $1,350 of interest rate savings every year! 😀 “BM” in the table below refers to the benchmark rate set by Central Banks.16-09-interactive-brokers-margin-rates
  2. Cheaper trading commissions. TD and many other brokers charge a flat fee of $9.99 per trade when buying stocks. But IB charges 0.5 cent per share for U.S. accounts, and 1 cent per share for Canadian stocks. The minimum cost per transaction is $1. For example if I buy 200 Shares of BMO (Bank of Montreal) shares, then my total commission would be $2.00 CDN. My trades are typically worth between $1,000 to $3,000. This means I rarely buy more than a few hundred shares of anything because most companies I prefer to own are dividend growth stocks, which tends to be priced at $20 per share or higher.
  3. Access to global markets. This isn’t a big deal for most people, but for more advanced investors Interactive Brokers allows trading in foreign currencies outside of North America. This means we can buy European stocks in Euros, or Australian stocks directly from the ASX using Aussie money. 🙂 TD used to have a platform that lets Canadians like myself trade internationally, but they cancelled that service last year. 🙁 I’ve mentioned in a previous post, that I want to diversify into other countries and there could be some good opportunities in the U.K. after the Brexit event earlier this year. So having access to a global trading platform is important for my financial goals. 😉
  4. Great for options trading. $0.70 per contract; $1 minimum order; volume discount available. And in the unlikely chance that our open options are exercised or assigned, there is $0 assignment fee, unlike $43 for TD or BMO.

Disadvantages of IB

Here are a couple drawbacks with IB.

  1. Penalty for not being an active trader. If investors do not spend at least $10 in commissions per month, we will be charged the difference. Furthermore, there’s a $10 fee for real-time quotes each month which is waived if at least $30 in commissions is spent. I typically trade once or twice a month so I will be paying these fees.
  2. $10,000 USD minimum balance to open up an account. This isn’t an issue for me, but some investors might have trouble coming up with $10K.

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Jul 182016
 

Advantage of Long Term Thinking

There’s an advantage in the business world for thinking long term. If a company only makes short term goals then it will be forced to compete with many other businesses in the same industry. It doesn’t take a lot of foresight or planning to run a company for 1 or 2 years, so that’s what a lot of other competitors will do. But if a company is willing to invest in a longer period of time, such as 5 to 10 years, then it will gain a competitive edge because there are fewer companies that set those kinds of lofty goals. 🙂

For example McDonald’s owns the real estate of its fast food restaurants. Leasing might be cheaper in the beginning, but owning property directly is more profitable in the long run.

New video games that take a long time to create, such as the Grand Theft Auto franchise or The Elder Scrolls series are typically released once every 5 years or so. Not many game studios spend 5 years developing a single product so these types of games will often have less competition in their genre, and receive more favorable critic and user reviews due to their quality than other franchises which have a much shorter development cycle, such as Call of Duty.

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Netflix would have higher earnings if it focuses more on near term profit and not spend so much cash on creating new original content. But from a long term perspective its executives have decided that investing in additional content with more market penetration is better for shareholders in the long run, because there’s not a lot of other streaming services with that level of long term dedication to their brand. But Amazon.com is another company that thinks long term.

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Apr 152016
 

This is a guest contribution from my friend Ben Reynolds at Sure Dividend.  Sure Dividend uses The 8 Rules of Dividend Investing to find high quality dividend growth stocks trading at fair or better prices.

Successful investing can be simplified into two aspects:

  1. Maximize returns
  2. Minimize risk

Point one could not be more straightforward.  The more money you make from your investments, the better.

Minimizing risk sounds straightforward, but in practice it is much more complex.  This article takes a look at the ‘standard’ risk measures in the stock market – and whether they are truly useful in reducing risk.

Common Stock Market Risk Metrics

The words Beta, standard deviation, and volatility are often used to describe the risk of individual stocks.  These financial metrics are the backbone of stock market risk measurement.

Beta refers to a specific securities’ sensitivity to overall stock market moves. A Beta greater than 1 shows more price sensitivity. If the market declines by 10%, one would expect a stock with a Beta over 1 to decline by more than 10%.  Alternatively, if the market goes up by 10%, a stock with a Beta greater than 1 would see gains of greater than 10%.

Stock price (return series) standard deviation is the most commonly used risk metric. It is calculated as the annualized stock price standard deviation of a given security.  It measures how ‘bouncy’ returns are.  The more big swings there are in the return series, the greater the stock price standard deviation.  Volatility is the same as stock price standard deviation.  It is another word for the same idea.  Volatility and standard deviation are synonymous in investing.

Fun with Numbers

Everything is a nail to a man with a hammer. Similarly, finance professors like to come up with nice tidy formulas for messy real-world problems. Beta and volatility are proxies for risk. The idea is that riskier securities will see their prices move up and down more.  This means that beta and volatility can measure underlying risk in theory. In the real world, this isn’t true.

Here’s a nice thought experiment:  Imagine you have your pick to invest in 2 different businesses at equal prices. One business makes $1,000 a year every year like clockwork.  The other business makes between $1,000 and $5,000 a year every year. Any rational person would pick the second business even though it has more variability (‘risk’ as academics see it) in its returns. In the stock market, the business that makes $1,000 a year would almost certainly have a lower beta and standard deviation than the $1,000 to $5,000 business because its returns are more ‘stable’.

What Risk Really Is

Real risk can’t be quickly calculated with stock price data. Real investing risk comes from a permanent impairment (loss) of your investment. When you are investing in businesses (stocks), you can understand risk far better by qualitatively analyzing the business.

Is Coca-Cola (KO) less risky than a biotech startup?  Most certainly.  Can I say it is 3.2x less risky?  No, because qualitatively I know Coca-Cola’s business model is proven, but I can’t put numbers to exactly how less risky it is than an unproven biotech startup.  You can say it is much less risky, however.

Some people like precision and exact numbers.  I certainly do.  But you can’t always have them.  Sometimes using exact numbers leads to worse results because the numbers don’t mean much.

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Apr 112016
 

The New York stock exchange regularly releases information about how much margin (or debt) investors are using to invest. Based on the latest reports from the NYSE market data, Doug Short who writes for advisorperspectives put together the following graph which conveniently compares the credit balance of investor’s accounts to the S&P 500 over the past two decades. We can clearly see some correlation between the two sets of data.

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The blue dotted line represents the nominal performance of the stock market index since 1995. The set of red and green bars represents the net credit balance inside investors’ accounts. This credit balance is basically the sum of free credit in cash and margin accounts, minus margin debt. Red bars show that investors have negative credit balances (borrowing money to invest,) and green bars mean they have excess cash or credit.

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Mar 282016
 

Is the Stock Market Overvalued?

My opinion is yes. This post will explain how I came to this conclusion. Thanks to reader Bricks for bringing up this topic.

We’ll be looking at the S&P 500 because it’s a popular index and there’s a lot of data available for it. 🙂 This index basically represents a basket of 500 large publicly traded companies in the United States. We can analyze the following 7 metrics to determine how cheap or expensive the market is. And naturally each of these ratios below can be applied to individual stocks as well. 😉

  1. Trailing P/E ratio
  2. Forward P/E ratio
  3. Forward P/S ratio
  4. Price vs Forward Earnings
  5. Shiller P/E Ratio
  6. Operating Margins
  7. EV / EBITDA ratio

Useful Ratios to Value the Stock Market

1) P/E Ratio – The price to earnings ratio, or sometimes known as the trailing P/E ratio or TTM P/E ratio, is a popular measurement to help determine the valuation of stocks. A low P/E ratio signals a cheap valuation. Historically the P/E ratio of stocks in both Canada and the U.S. hover between 10 to 20 most of the time. However, as of today the P/E ratio of the S&P 500 index is about 22, which signals it is overpriced relative to the norm. (image source)

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2) Forward P/E Ratio – Unlike the trailing P/E ratio, the forward P/E ratio uses projected future earnings. Of course nobody knows how much money companies will make in the future, but this metric provides a sentiment of how profitable the market feels about the next few earnings seasons. According to a FactSet report, the forward P/E ratio of the stock market is 16.5, which is above the long-term average of 14.2. So based on this data stocks are currently about 16% more expensive than what they should be.

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3) Forward P/S Ratio – The price to sales ratio compares the total market value to revenue. It usually moves in the same direction as the P/E ratio but can provide a smoother, more accurate depiction of the market’s valuation (see yellow line in chart above.) This ratio is currently over 1.6x for the S&P 500, which suggests the market is overpriced, even compared to 2008 levels.

4) Price Change vs Forward Earnings Change– The price of the stock market is mainly determined by its future profitability. But recently the price has diverged away from future expected earnings which suggests stock prices are too high.

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Notice what happened after the last time price diverged higher from the forward expected EPS in 2006 and 2007. 🙁

According to John Butters, senior earnings analyst at FactSet, for the first quarter of 2016 it appears 92 companies have issued negative EPS (earnings per share) guidance and only 26 companies have issued positive EPS guidance. This depicts a rather bearish outlook. However, stock prices have not come down nearly enough to reflect these estimates. 😕

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