A Shift in Focus
Money can’t buy happiness. But it can help us look for it quicker, in a BMW. 😉 In order to maximize our chances to earn more money we have to reassess our investment strategies from time to time and be flexible to changing market conditions. Currently the price to earnings (P/E) multiple for the S&P 500 is around 25 times, compared to 16 times per historical average, suggesting the stock market today is probably overvalued.
If we invert the P/E ratio we would get the earnings yield, which is currently 3.9% for the index. 🙁 This means if we invest in the S&P 500 today, we can expect to make 3.9% return by next year. That doesn’t sound very attractive does it? And it’s not much better for Canadian stocks. The S&P/TSX Composite index has an earnings yield of 4.3%.
This is why I’ve been focusing a lot on fixed income investments over equities in 2016. I can get 7% or 8% on high yield bonds or mortgage investment corporations, with arguably the same or even lower risk than buying stocks. 🙂 I prefer to buy individual junk bonds because ETFs are too mainstream for me. 😉 But if you want to buy a basket of high yield bonds in a neatly packaged fund, Nelson from Financial Uproar wrote an informative post on high yield bonds with some useful ETF suggestions.
Anyway, last week I purchased $5,000 face value of Baytex Energy junk bonds. Here is how I did it using my broker, TD Direct Invest. Other brokerages may have similar procedures.
How to Purchase High Yield Bonds
On the main account page.
On the next screen.
On the new pop up screen.
I now hold 3 individual high yield bonds in my retirement account.
About Baytex Energy Bonds
Type of bond: High yield (junk) and callable.
S&P rating: BB-
Maturity: July 19th, 2022
Yield to Worst (YTW): 11.7%
Yield to Maturity (YTM): 8.2%
Here are some reasons why I think these Baytex bonds are worth investing in.
- Their current price is below par. I was able to buy $5,000 face value worth of bonds with just $4,925 including $30 in commission. That’s a 1.5% discount. 😀
- If the bond matures in 2022, then I will get $5,000 back. My broker, TD bank, quoted to me the yield to maturity is 8.2%. This sounds like a great return!
- There’s a chance Baytex will call back its bonds in July 2017. But if that happens, it will pay bond holders $1.032 on the dollar, which is a 3.2% premium. Overall this would give me about 11% return.
I don’t see any downside to this investment, other than the possibility of Baytex filing for creditor protection sometime in the next five and half years. But that’s unlikely to happen.
Baytex (BTE) stock is at $7.15/share and has a market capitalization of $1.3 billion. The company made a recent acquisition and projected increase production in 2017. Baytex announced its CEO succession plan today and the stock price jumped 11%. BTE has been around for decades, and it’s funds from operations (FFO) currently cover all of its capital expenditures. It’s net debt to EBITDA ratio is 4.6 times. Most analysts rate the stock as a HOLD right now meaning they have a neutral stance on the company’s ability to increase profits in the future. The average 12 month target for the stock is about 9% higher than it is today.
So overall I think Baytex is very capable of keeping on top of its debt obligations. I don’t know what the economy will look like 10 years from now. But for the 5.5 years remaining on this bond, I’m fairly confident Baytex and its creditors will be fine as long as crude oil stays above $40/barrel.
Being able to buy high paying bonds at depressed prices during times of uncertainty is how I’m currently positioning my new investments. I also purchased $3,000 of MICs recently. I increased my holdings in both Atrium Mortgage Investment Corporation (AI) as well as Timbercreek MIC (TF.) The average yield between the two MICs is about 7.5%. Of course the purpose of buying mortgage funds is to receive a steady stream of passive income, not to seek growth or capital appreciation.
My primary investment strategy for the long run is still dividend growth. But that doesn’t mean I won’t try to balance out dividend stocks with other asset classes along the way if the right opportunities are there. 😉
Random Useless Fact:
Learning how to properly budget is a very useful skill.
” I don’t see any downside to this investment, other than the possibility of Baytex filing for creditor protection sometime in the next five and half years. But that’s unlikely to happen.”
That’s actually LIKELY to happen. Hence the BB- rating, (see 5yr default rates, etc). The bond’s negative convexity suggests limited upside and huge downside. I like your use of E/P analysis, but compared to bonds, stocks are still cheap currently which really is what you are evaluating in your article. Best of luck, but I would limit bond exposure currently.
Sorry, that was probably too pointed of a comment. Not trying to be harsh! 🙂
Well put. I agree that bond exposure should be limited because bonds could be in a bigger bubble than stocks. That’s why only 1% of my assets is in bonds right now, including this new Baytex purchase. According to Adam Powell’s site, the average default rate for B+ bonds is only 2.36% per year. I imagine BB- rated bonds would be even safer. I believe this is an acceptable level of risk for me. 🙂 adampowell.com/invest/bond-ratings/
Liquid what do you think about hot.un railroad hotel REIT. Ive been invested for a little over a year and enjoying that 8% yield.
I don’t know much about this REIT, but it looks like a nice asset to own long term. It’s price to FFO looks quite attractive. Too bad it had to cut its dividend earlier this year, but I think it should be sustainable now. 🙂
I am enjoying the income stream from HOT.UN as well as your AI, and TF recommendations 🙂
Nice. Thanks for sharing…a potential 11% return from a bond isnt bad whatsoever. In this environment, those are fantastic returns. And since you hold hte actual bond, you dont have to worry about changing interest rates as long as you hold it to maturity.
Thanks for sharing
Yup. I’m basically building myself a high yield bond ladder. 🙂
Liquid I applaud your venture into MICs as they have a good yield, but take the investment 1 step further and own the mortgages directly cause the MICs are shorting you 2-3% as a managing fee. You’ll need a larger investment (25K+) but yields will be much higher – currently have a first mortgage in my TFSA that’s up 11% in 7 months (penalties).
Oh, that’s a good idea. I’ve seen people put private mortgages inside their RRSPs, but this is the first time I’ve heard about a mortgage structured inside a TFSA. I’ll have to do some more research on owning a mortgage directly, like how much the initial securitization process will cost to set up with a lawyer and a financial institution.
You don’t pay any legal fees or financial origination fees as they are rolled up into the loan and charged to the borrower. For example if you wanted to borrow 25K and the legal fees were 2K and financial origination fees were 3K the borrower would just take out a loan for 30K.
Came here for Baytex bond and found this – Sorry – I lost you guys on this one? What type of investment is this and how does one access it? Any further information is greatly appreciated. (RE: First Mortgage)
Just wondering what you think of the “UNIV OF ONT INST OF TECH ” bonds being offered at a 6% yield? There is no S&P rating on them though?
Are you referring to the one maturing in like 2034 or something? I’m personally not really interested in that one because any money I could invest in that bond would probably be better used in dividend stocks over an 18 year period. Also, I don’t have any more room in my RRSP or TFSA so if I buy new bonds now it would not be very tax efficient. Also, I don’t know enough about that institution to assess its credit risk.