Investing in Energy Infrastructure – TransCanada Corporation
Pipe dreams can come true. We just have to find the right pipeline company to make it happen. 🙂 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. 😉 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?
- A publicly traded, large-cap, blue-chip, dividend growth stock in the pipeline sector that’s been operating for at least 50 yrs.
- This stock must also be trading at a discount relative to its peers, and its own historic P/E ratio.
- A reliable source to borrow cheap money from, that costs at least 1 percentage point less than the pipeline stock’s yield.
- A 10 year investment horizon minimum, and the stomach to deal with market fluctuations.
- An exit strategy.
These 5 criteria are the essential ingredients to pulling off this maneuver successfully with minimal risk. 😉 One company that foots the bill is TransCanada Corporation.
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. 😉
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. 🙂
Let’s go through the 5 criteria to understand why this works.
1.) TRP is a dividend growth stock because it increases its dividend payments regularly. Here’s a look at its astonishing dividend growth over the past 15 years.
TRP is a large, blue-chip stock which means it has a greater chance than other smaller companies to bounce back from market corrections. The reason why pipeline companies are particularly good candidates for stable leveraging is because pipelines and utilities are generally less volatile than other sectors of the market. Notice how the great recession in 2008 didn’t negatively affect the company’s dividend payments at all. Since dividends are distributed out of a company’s profits, this suggests that TransCanada’s profits held up well over the financial crisis. Consumers who use natural gas to heat their homes, gasoline to drive their cars, and electricity to run their appliances will predictably always have a demand for energy. 🙂 This is important for the leveraged investment to work properly because we require the stable profitable nature of these pipeline businesses to continuously supply us with dividend income, so that we can pay the interest on our borrowed money.
2) Valuation wise TransCanada is relatively a good deal right now. It’s current price to earnings ratio is 18.5x, which is lower than the 23.9x for the industry average. This is the lowest P/E ratio for TRP in several years. Also, according to Thomson Reuters, out of 14 stock analysts who cover TRP, their average price target for the stock in one year from now is 33% higher than the current price, which signals to me that they believe this is an fairly undervalued stock.
3) Famous investor Charlie Munger believes that we should choose investments with a “margin of safety considering the normal vicissitudes of life.” He means we should give ourselves a cushion to swing the odds in our favor. My cushion with TRP is 1.8%. This means that my cost of borrowing will need to be 180 basis points higher before I start losing money on this transaction. Central banks in North America will likely increase rates at 25 basis points at a time so I currently have a significant margin of safety. Furthermore, if interest rates remain low, and TRP continues to stick with its plan to grow dividends for shareholders by 8% to 10% annually, even after the U.S. rejected the $8 billion Keystone XL pipeline, then my margin of safety will actually grow. So that’s what I’m hoping will happen. 😀
4) This strategy works best with a long term investment plan. If for some reason we were forced to sell our stock within the next few years then we could lose money if the share price of our stock is lower than our initial purchase price. But after holding the stock for 10+ years, our chances of being underwater is significantly reduced, although it’s still a possibility. 😕
5) My exit strategy will be to sell when the cost of borrowing becomes too expensive and my margin of safety diminishes to less than 50 basis points. At that time, even if it’s prior to the 10 year mark, I will sell my shares and pay back the loan. A change in economic conditions means a change to the original plan. The $4,200 debt will be easier to pay back in the future anyway due to the effects of inflation.
The risk of stable leveraging is being forced to deleverage when the stock is in the middle of a correction. But historically it is not often that interest rates would move up while the stock market goes down. Pipelines are relatively good at holding their value anyway in harsh economic times. During the last recession TRP shares fell 25%, while the general stock market index dropped 50%.
When we take on debt, and invest that borrowed money into a financial asset, our net worth doesn’t change. However, we can earn extra income this way, in my case, $75 a year. This income can be saved which actually does increase our net worth. This means we can essentially produce something from nothing.
This strategy is a major part of my net worth growth plan. I’ve done this dozens of times already and I’m earning thousands of dollars in net passive income every year that I wouldn’t otherwise be making if I didn’t borrow. The cost of this benefit is the risk of losing money on the investment as mentioned above. But following the 5 criteria outlined in this post can help reduce a lot of that risk and stress. Is going into $4,200 of debt worth earning $75 a year, plus potential dividend increases and capital gains? It will be worth it to some, but definitely not to others. It depends on people’s risk tolerance and their understanding of money. I’ll write a follow-up post in 2025 to give everyone an update and share my personal results. ?
Random Useless Fact:
Sheep are really good at hiding.