Nov 092017
 

tl:dr. The answer is yes, Enbridge is a good buy. ūüôā

Fair Market Value of Enbridge (ENB) 

Canadian pipeline company Enbridge is currently trading at around $47 per share. But based on¬†Benjamin Graham’s formula for valuing stocks, which I’ve discussed before,¬†the fair market value of Enbridge should be around $62.

Enbridge stock’s EPS is $1.96. The growth rate (g) is 10.5% a year according to Nasdaq.com.¬†And long term high quality corporate bonds currently yield 4.1%, which represents the (Y) variable in the equation above. So we can see that (1.96x(8.5+2×10.5))x4.4/4.1 = $62

$62 per share is in line with what most analysts have determined as well. For example TD Equity Research recently posted a 12 month target of $62 for Enbridge. Here is the full research paper for anyone interested. This indicates that ENB may be oversold right now.

If Enbridge climbs to $62 per share that would be a 37% increase in total return. That’s pretty darn good! ūüėÄ This is why I believe Enbridge is potentially oversold right now and is a good buy. ūüėÄ Over the past decade ENB dividends have increased by 10% annually. Enbridge plans to continue growing its dividends by at least 10% every year through 2024.

Enbridge has one of the strongest economic moats of any company. Since pipelines require a lot of capital and regulatory approval, it’s not an industry where anyone can easily get in. Much like the railway industry, it’s pretty much an oligopoly without much competition.

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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. ūüėÄ

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. ūüôā 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. ūüôā But if it lands on 5 or 6, we lose¬†$10.

So should we play? The answer is¬†a resounding yes every time! ūüėÄ 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? ūüėÄ 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. ūüėČ

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. ūüėÄ 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. ūüėČ 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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Apr 202017
 

Some people suffer from areophobia, the fear of flying. But this is plane silly. Flying is¬†statistically safer than driving. Yet some people live entire lives without ever getting onto a plane due to this irrational fear. They believe merely walking into an airport could give them a¬†terminal illness. ūüėĄ

Borrowing to invest is similar to flying. Nobody ever has to do it, but it can make life a lot easier. I can certainly take a train to get from Paris to Z√ľrich. However, flying is much faster. I can retire comfortably some day without ever going into debt. However, using leverage will enable me to get there much faster. ūüôā

If we tend to pick bad investments, then we should probably pay a professional to help manage our portfolio. But on the other hand, if we have a history of making mostly good investment decisions, then rationally speaking we should double down to boost ours returns unless evidence suggests otherwise. Leverage doesn’t change our odds of winning. It merely enhances our gains or losses based on the inherent odds of the underlying investment decision.

Using leverage removes the problem of not having any money to invest. It allows us to be fully invested at all times, but still have access to instant liquidity. This gives investors a huge advantage. Just ask any MBA graduate.

Next week I¬†will blog about my 3 fundamental rules of leveraged investing. A lot of readers have requested this so I will break down my thought process and method. The extended¬†bull market cycle we’ve been in has helped my investments tremendously. But when I use leverage, I also follow¬†specific¬†criterias that are meant to¬†reduce downside risk in recessions and bear markets. ūüôā

 

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Random Useless Fact:

Foxes are smarter than most, but not all, dog breeds.

 

Jan 042016
 

No Santa Clause Rally

The economy is struggling. The bad news is my net worth dropped a little¬†in the last month of the year. But the good news is it still managed to climb higher overall in 2015, so¬†that’s a relief. ūüôā

*Side Incomes:

  • Part-Time Work =¬†$1100
  • Dividends =¬†$600
  • Interest = $200
*Discretionary Spending:
  • Fun =¬†$900 (holiday shopping)
  • Debt Interest = $1400

*Net Worth: (MoM)15-11-networthiq_chart

  • Assets:¬†= $922,400 total¬†(-1,000)
  • Cash = $3,500¬†(+1000)
  • Stocks CDN =$97,700 (-4100)
  • Stocks US = $72,700 (+800)
  • RRSP = $62,700 (+1300)
  • MICs = $15,800
  • Home = $259,000
  • Farms = $411,000
  • Debts: =¬†$501,900 total¬†(-100)
  • Mortgage = $190,900 (-400)
  • Farm Loans = $197,900 (-400)
  • Margin Loan CDN = $30,500
  • Margin Loan US = $30,800 (+1800)
  • TD Line of Credit = $23,000 ¬†(-500)
  • CIBC Line of Credit = $10,000
  • HELOC = $18,200
  • RRSP Loans = $600 (-600)

*Total Net Worth = $420,500 (-$900 / -0.21%)
All numbers above are in $CDN. Conversion rate used: 1.00 CAD = 0.72 USD

Using OPM To Get Ahead Financially

It’s easy for the rich to make more money because they already have a lot of productive financial assets. Since I¬†don’t have that level¬†of wealth yet¬†I choose¬†to use¬†other people’s money (OPM) in order to¬†acquire those same productive assets for myself, without having to save a huge amount of money first. This allows me to potentially shorten¬†the number of years it would take to become a millionaire.

Since using¬†OPM is risky, I¬†only buy assets that have a high probability of generating long-term, profitable gains. Most loans will be paid back using regularly scheduled payments so the debt will eventually take care of itself. ūüėÄ Since this blog finally has some history we can see how effective this leverage strategy can be. Below is a look at my net worth over the past 6¬†years. Feel free to dig through the blog archives for more info.

Dec 2015Dec 2014Dec 2013Dec 2012Dec 2011Dec 2010
Assets$922,400$837,400$742,500$497,500$317,900$279,200
Debts$501,900$517,800$533,600$357,200$215,600$216,300
Net Worth$420,000$319,600$208,900$140,300$102,300$62,900

.

The basic premise is that whenever I purchase a new investment using debt, an equal amount of value is added to both my Assets and Debts. However, simply through the passage of time the nominal value of my new asset grows while my debt naturally shrinks. ūüôā It’s only over 10+ years that the magic¬†can really shine, but even in a 6¬†year window we can already tell it’s working.¬†Time in the market will beat any attempts at timing¬†the market. ūüėÄ

This plan works best in a low interest rate environment like in Canada today. In terms of managing debt,¬†I pay about $16,000 a year of interest on my $502K total debt load. My passive income from my invests can easily cover that. Over time as my debt balance slowly falls, the¬†annual¬†cost to service my debt will decrease too! Not only that, my passive investment income is expected to increase every year thanks to the compounding effects of¬†DRIPs and the dividend growth stocks in my portfolio. When the Prime lending rate climbs back up to 4% I may change my plan,¬†but I have no immediate reason to deleverage. ūüėČ I monitor interest rates twice a year.

Breaking Down my $100,000 Net Worth Growth in 2015

I’m a bit¬†surprised by how much my net worth has grown. After all, the stock market didn’t even perform that well. But then again, I don’t invest like a couch potato and throw everything in index funds. ūüėõ

Real estate, farmland, and mortgage funds all had positive returns in 2015. Lucky for me about 75% of¬†all my assets are invested in these¬†3 categories. ūüėÄ Even though my Canadian stocks are slightly down, my overall investment portfolio still performed very well. Phew. The biggest winner last year was actually the U.S. dollar! The rise of the U.S. currency alone added $15,000 to my wealth because I calculate my net worth in $CDN. Let’s break down the $100,000 increase. All numbers below are rough estimates.

  • $16K – Net debt repayment. I paid down some higher interest debt.
  • $38K – Farmland appreciation. I adjusted my¬†farm’s price¬†by¬†a conservative¬†+10% for 2015.
  • $5K – Apartment appreciation.¬†Inflation rate was¬†2% in 2014 so I¬†adjusted¬†my home’s value in 2015 by the same amount.
  • $15K – Currency fluctuation. The CDN$ went from¬†$0.85 USD in Jan to $0.72 USD by Dec, an 18% devaluation.
  • $23K – New investments. Buying new stocks &¬†bonds using personal savings.
  • $3K – Investment portfolio appreciation. Small increase¬†thanks to fixed income assets and¬†huge gains from tech¬†giants like Alphabet¬†and Amazon.com. Technology was one of the few sectors that outperformed¬†last year. By the way, does anyone like computer¬†jokes? I certainly don’t. Not one bit.
  • Total = $100K

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Nov 202015
 

Investing in Energy Infrastructure –¬†TransCanada Corporation

Pipe dreams can come true. We just have to find the right pipeline company to make it happen. ūüôā In today’s post I’ll explain how to earn a tangible profit in the stock market with minimal effort and risk. And the best part is we don’t need any savings¬†to do this. ūüėČ I actually use this strategy a lot for my retirement planning. It’s known as the Stable Leveraging technique.

The purpose of stable leveraging is to use credit in a low-interest rate environment to harness the high yielding potential and long term stability of energy infrastructure companies in order to make some easy money. And it only takes a few minutes to set up if we already have a discount brokerage account.

 

How does Stable Leveraging work?

We simply use borrowed money to invest in common shares of pipeline companies. Then we use the earned dividends from the investment to pay off the interest incurred from the loan until the economic situation changes.

This investment philosophy is very different than “I have $X. What should I invest it in?” because Stable Leveraging¬†assumes¬†we have no money to begin with and therefore puts the risk of investing on both the borrower, and the lender.

What do we need to make the stable leveraging strategy work?

  1. A publicly traded, large-cap, blue-chip, dividend growth stock in the pipeline¬†sector that’s been operating for at least 50 yrs.
  2. This stock must also be trading at a discount relative to its peers, and its own historic P/E ratio.
  3. A reliable source to borrow cheap money from, that costs at least 1¬†percentage point less than the pipeline¬†stock’s yield.
  4. A 10 year investment horizon minimum, and the stomach to deal with market fluctuations.
  5. An exit strategy.

These 5¬†criteria are the essential ingredients to pulling off this maneuver successfully with minimal risk. ūüėČ One company that foots the bill is TransCanada Corporation.

15-11-transcanada-pipeline-corp-stock-investment

Earlier this week I purchased 100 shares of¬†TransCanada Corp (TRP) using 100% borrowed money. I will use¬†my example to demonstrate the advantages of implementing stable leveraging. TransCanada is publicly traded¬†on both Canadian and U.S. stock exchanges. ūüėČ

15-11-purchase-100-trp-shares

I paid commission of $9.99 to make this trade, so the total cost is $4,209.99. For the purpose of this post I’ll use $4,200 to make the calculations look cleaner and to make the strategy simpler to explain and understand.

I used my margin account at TD to borrow about $4,200 to buy 100 shares of TRP at $42 per share.¬†The rate of interest I incur on this borrowed money is 4.25%, which would be the same as anyone else using TD’s services. But¬†since I borrowed the money to invest, my 4.25% annual interest rate is tax deductible which makes my effective after-tax cost 3.0% per year on the $4,200 loan.

I used the loan to purchase 100 shares (for $4,200) of TransCanada Corp, which at the time, had a dividend yield of 5.0%. Since these dividends are eligible for the Federal Dividend Tax Credit, my after-tax dividend yield is 4.8% per year.

Since my effective cost of borrowing is currently 3.0%, and I’m¬†earning 4.8% on my TRP investment, the difference between the two (1.8%) is how much I take home each year. 1.8% of $4,200 is about $75. It’s not much, but it’s $75 of passive income¬†nonetheless. The balance of my loan will remain at $4,200. The principal does not get repaid. Dividends are deposited into my account, and interest payments are withdrawn automatically. ūüôā

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