Dividends

     Warren Buffett once said "the stock market is designed to transfer money from the active to the patient."  This is holds true in today’s market on so many levels.  One of our rules to investing is to let the market come to you rather that you chase the market.  This takes patience, but, it will eventually prove to be more profitable over the long run.

     Today’s market takes time to create buying opportunities.  In the meantime, we are constantly rewarded with cash dividends and a nice tax credit (if one qualifies) while we wait for bargains.  It is these dividends that end up creating a large chunk of ones overall returns.  This is evident on page 6 of our publication.

     There are a number of factors to look at before choosing a dividend paying stock.  Dividends are measured by yield, and are calculated by dividing the dividend into the share price.  The yield will tell an investor if the stock is properly valued, or if the dividend is at risk of being cut.

     A stock with a dividend that is at risk of being reduced, or cut all together, will trade a lower price causing the current yield to be abnormally high.  The price, at which the stock will fall to, tends to be the level the market believes the new dividend will deliver a competitive yield.  If the dividend is eliminated, the stock price tends to realize a substantial decline.

     As the chart of $25,000 invested below clearly highlights, the benefit realized by waiting for a higher yield is tremendous.  An investor who waits 4 years for a nice yield (5% in the chart) will make nearly 40% more than the investor who jumps right into the market in order to earn a 2% yield.

     Using the chart again, one who is able to wait for a severe market correction, which tend to occur nearly every 7 years, and gain a 7% yield will nearly double the gains in two-thirds the time compared to settling for the lower yield.

     When researching a company’s dividend, an investor should look at the following:

1.  Are dividends paid from earnings?
2.  Does the company have sufficient financial resources to cover liabilities as well as dividends?
3.  Is there a lengthy history of increasing the dividend?
4.  Is the company in an industry that offers price stability and low competiton?

     ***** has raised its dividend by 3 cents a share quarterly.  The company started paying dividends in 2006, and since then has raised the payout at least once every year.  Its financials today are rich enough that there could be another increase in 2013.  With over $50b in the bank, it is nearly a guarantee an increase will occur.

     ****** announced that it predicts its profits will grow by roughly 10-to- 12% a year for the next 5 years.  As a result, it will most likely increase the dividend each year accordingly.

     ****** is the major shareholder of *******.  In this relationship, ***** usually realizes part of their dividend increases from the subsidiaries.  This means that ***** will be increasing their payouts.  It has done so for 7 of the past 8 years.  ****** oilfield operations should be in full production within the next 3-6 months, meaning higher profits in the future, leading to more dividend increases.

     We have strongly recommended buying dividend paying shares since the inception of this publication.  More importantly, we tend to concentrate on companies that increase the payout on a routine basis.  There are plenty of these companies around.  Bay Street never recommends these stocks because it equates to only one commission since there is rarely any reason to ever sell them.

     Sometimes it becomes a hard decision to know when to sell.  Before the recent credit crunch and the collapsing real estate market, ******** and ********** had the best dividend growth record in the industry with 15 years of increased payouts.  We did not suggest selling ******** because we believe in the future of Canada.  Plus, the yield is still respectable.

     Both companies, as did others, have raised their payouts in 2012.  Will ***** and ****** be back in a race for the best record?  Let’s hope so.  It is worth noting that ******* has one of the best records in the world for paying a dividend, over 110 years.

     A key point to our system is that, based on our purchase price and after numerous dividend increases, our portfolio yield grows.  For example, ********* yields 12.1%; ******* 11.8%; ********* 6.5%, and so on.  Plus, these shares have made huge capital gains.  The 3 mentioned above have gained 136%, 100%, and 148%, respectively.

     Even companies that do not raise payouts on a regular basis hold up due to reasonable yields.  *******, ********, and ******** fall under this category.

     ****** used to have one of the better TSX dividend growth records.  However, they have stopped increases because, along with most companies in the industry, it is being hurt by the zero interest policy.  These company profits will increase with interest rates.  Once this occurs, the dividend increases will follow.

      Nobody knows the future, but history helps to guide us for tomorrow. It is telling us that we are in for a sustained period of flat growth.  As a result, most stock markets profits will be via dividends.  It has been proven, time and again, dividends must be part of any investment portfolio if it is to grow.

Vancouver Love Affair

          I moved to Vancouver in October. This is the second time I have lived in the city. I have always loved living here. It is ranked amongst the top ten in the world for good reason. However, like all cities, it has its faults. Vancouver’s main one is real-estate. The citizens of Vancouver honestly believe that prices cannot correct. Every excuse in the world is used to justify the price of the asset. Unfortunately, the common sense used in the reasoning is as rare as the household income needed to justify its price.

          According to the Real Estate Board of Greater Vancou-ver's (REBGV), there were 2,853 sales through the Multiple Listing Service in May, a 15.5% decline from a year earlier. May sales were the lowest for the month since 2001 and 21.1% below the 10-year May sales average. At the same time listings increased by 6,927, a 16.8% increase from a year earlier. New listings for May were 15.3% above the 10-year average for the month.

          The REBGVD’s average price for all residential properties in Metro Vancouver ( Vancouver, North Vancouver, Surrey, Burnaby, Delta, Richmond, Fort Langley, and Coquitlam) was $625,100 in May, up 3.3% from May 2011. Specifically, detached home prices jumped 5.1% from a year ago to $967,500, apartments increased 1.7% from a year ago to $379,700 and town-home property prices rose 0.9% in May from a year ago to $470,000. However as pointed out by Garry Marr of the Financial Post, "using actual average prices instead of the index, average detached home prices are down 12.2% from a year ago, town-homes are down 0.2% and condominiums are off 1.1%."

          While I am unable to find any data for commercial property, I am certain that it is in worse shape than residential. My reasoning is all one must do is walk down any street to witness at least one empty store front or a "For Lease" sign on office buildings. This is true no matter what part of the city I visit.

          Values have become so crazy that even our financial institutions can no longer justify them. Our banks have started to jump on the price decline band wagon this spring with various calls for price declines ranging from 10 -20%. We feel this is very bullish on their part. However, the fact that banks (which are in the business of lending money and cannot create fear) are openly projecting price declines, it is safe to say the top of Vancouver’s housing market was in 2011.

          A collapse in real estate prices in Vancouver is going to have a profound impact on the city. According to Statscan, the median household income in the city is $67,500. Yet, people live as if it is double that. The city has industry and commerce, but not enough to justify its cost of living. Therefore, it is very reasonable to conclude that the local economy is very dependent on home equity. Should home prices collapse, home equity will be squeezed and spending will contract. The outlook for the local economy does not look promising.

          Vancouver home values are a gift to those who purchased decades ago. If you are one of these people and have thought of cashing in, now is the time. Prices are correcting and will continue. Invest the principal in low risk assets (see page 6) and the income will more than cover the cost of renting in the lifestyle you are accustomed to. Sure, price will eventually recover and break new highs, but, it will most likely not occur for at least a decade after the trough.

The Decline of Canada's Middle Class

                I was sitting at the dog park eavesdropping to the conversation at the bench next to me.  The couple, clean-cut and most likely in their late 30’s, were discussing the decline of the middle class. Both sported a large Starbucks coffee.   

                Whether the middle class is actually declining is open for debate.  Statistics provide evidence that it is not actually happening, because the majority of Canadians remain within an average income bracket used most often to describe the middle class.  In fact, the average household income in Canada increased 8% between 2005 and 2009.  However, it can be said that it is becoming poorer. 

                Perhaps what those who believe in the declining middle class should concentrate on is the loss of purchasing power realized by the majority.  Incomes have increased with the “rate of inflation” over time.  But, the prices of many things have increased faster.  As a result, the middle class can no longer afford goods in the quantity and size we have grown accustomed to.  Shelter and food being the most often debated.

                There is no doubt that the world has become smaller.  Today, consumers are able to purchase goods from all over the world with relative ease.  As a result, many consumer brands have started dominating the global market.  There are many benefits to this; manufacturing en-masse lowers the per-unit cost and the savings are passed onto the consumer via lower prices.  This is evident in computers, travel, and clothing to name a few.  However, by favoring an international brand that has no manufacturing ties to your community, province or country, one is essentially guilty of contributing to what many believe is a shrinking middle class.     

                One of the easiest ways one can contribute to a wealthier middle class is by being conscious of where one spends money.  Depending on the product, buying local may cost a little more but the profits will more than likely stay within the community.  It is these profits that create a wealthy middle class as the local profits trickle down creating investment and jobs.

                At the beginning of the article I noted the two were drinking Starbucks.  I found it ironic that these two could be concerned about Canada’s middle class while consuming a coffee whose profit is exported to Seattle.  As of the last annual report (October 2011), Starbucks had 17,003 stores.  None of these are considered franchises where the profits remain with the franchisee.  However, 47% are “licensed” to large institutions such as those in grocery stores and Home Depots. These outlets account for only 9% of the company’s total revenue.  The profit realized from these outlets is exported to the host company’s head office. 

                The remaining stores, the numerous ones you see around town, sometime one across the street from another, are all corporate and the revenue from these stores represented 82% of total revenue in 2011. For arguments sake, we will assume the same for profit.       

                Assuming that profits are in line with revenues, the 82% of profits realized by the 9,031 corporate stores averaged a profit per store of $113,100 in its fiscal 2011 year.  This profit would be better utilized within one’s own community; instead it is used by Starbucks to expand in other markets, leaving little-to-no economic benefit to the host community other than a few jobs that can still exist via a mom-and-pop shop or a franchised brand.

                This is transferable to many products and retailers. We as Canadians should educate ourselves to become more conscious consumers and try and support those products created in Canada before any other. We need to walk past the Starbucks to the family owned. Keeping profits as close to home as possible is the easiest way to support a stronger middle class in your community. 

Shale Gas-Published March 2012

             Last issue we showed a map of the natural gas shale basins located throughout the U.S..  It covers about half of the country.   This is also true for many other nations as well.  These shale gas reserves, and to a lesser extent shale oil, is about to change the marketplace. 

             For consumers, it could equate to savings that could last for decades.  Our local gas distributor, Fortis, announced that the average homeowner should experience a $100 cut in their annual home heating bill with the price of natural gas below $3.  With today’s price of $2.12, additional reductions should follow. 

             Unfortunately for governments, this will most likely be a  drop in tax revenue.  For the energy sector, only a few with deep pockets will remain in the gas exploration business.  Since there are huge gas reserves building, this should take pressure off rising oil prices. 

             For investors, money should be invested in those companies that build gas plants and pipelines only.  We recommend one avoid all gas shares.  Over the past month some small gas exploration companies have either cut or eliminated gas exploration due to low gas prices.  These actions make it obvious there are no profits to be made.  The next step will be to cap smaller gas fields.  Doing so will not make any difference to the growing world-wide supplies and falling prices. 

             It is estimated both China and the U.S. could have 200 years worth of reserves.  Qatar has one of the world’s biggest gas reserves, estimated to be up to 400 years.  One pool alone is expected to hold over 100 years supply.  This pool will not be touched for decades as existing fields are so huge that Qatar will not need any more gas to export. 

             Lower gas prices hurt Qatar.  Yet it should still make lots of money when prices fall to the $1.50 area within 2 years. Whether it is luck or foresight, the country has built gas plants, ocean tankers, and storage tanks in Europe.  Their infrastructure is already built and operating giving Qatar a nice competitive advantage. 

             There are huge shale gas reserves in Queensland, Australia. There is believed to be one of the world’s biggest unexplored shale gas reserves under the Mediterranean sea, between Cyprus and Israel and pockets near the Dead Sea.  Oil has been found there before, but only in tiny amounts.  If it is shale oil rock then Israel could possibly become energy self-sufficient. Eastern Europe may also be sitting on huge shale gas rock deposits. 

             If the latter is true, the political ramifications can be huge. Eastern Europe has relied on Russian gas for decades. As a result, the Russians have been blackmailing Eastern Europe for years, often slowing, if not cutting off the gas flow in the process. This will not happen anymore. In a few years time, Eastern Europe will no longer rely on Russian gas and Russia will be heading into tough times, and maybe even social unrest. Russia not only needs the foreign currency, but relies heavily on the political influence the commodity delivers. 

             Russia most likely has huge shale gas rock reserves.  Most of this will not be tapped for years for the simple reason there will not be a market to sell it. This is the case both internationally and domestically.  Natural Gas has been one of the main money earnings for the Kremlin. Now there will be little money left to bribe the Russian citizen and other countries. The Mafia is in trouble.

             China will most likely develop very little of it’s shale rock reserves in favor of cheap reserves from Australia and elsewhere. In 50 to 100 years gas prices will move up substantially as the West’s reserves are depleted. When this occurs, the West reserves will be very expensive to mine, while China will still be sitting on its cheap undeveloped shale gas rock.

             On the one hand, there are definitely some potential positives from shale. Specifically, if the auto industry can figure out how to mass produce cars using natural gas, the savings being passed onto consumers would be huge.  If this is the case, other industries will most likely follow.

             On the other hand, this gas will destroy solar and wind industries because they are not competitive with current prices. Established wind farms, such as those near Lethbridge, Alberta, off the coast of Copenhagen, and near Costa Del Sol, Spain, will survive.  But, as far as industry expansion is concerned, good luck!  It is most likely a dead industry for now.

             It will take anywhere from 3 to 7 years before the full effect of shale gas hits the marketplace.  New gas plants will have to be built, existing ones retrofitted, and more pipelines laid. Shale is going to alter many industries. We anticipate most new homes and buildings will be built utilizing gas.

             On the plus side, we are probably only 1 to 2 years away from oil prices moving below $100 and staying there for years, maybe even decades.  Similar to natural gas, there is plenty of oil available today. Currently in the U.S., there is the highest amount of surpluses since 2009 because oil production has increased by 1m b/d. The problem is that there are not enough pipelines to handle the increased production. Furthermore, no one talks about the potential of shale oil rock of which there is plenty. 

              Shale aside, both Canada and Russia are adding oil production on a monthly basis. Current supply is also being exacerbated by a massive oil field off the coast of Brazil; Iraq is producing the most oil in over 30 years; and Libya will soon do the same. If the glut was not real, Saudi Arabia would not be forced to shut in close to 4m b/d due to no buyers. Sorry Doomsayers, Peak Oil has been delayed by at least 50 years, probably much longer . 

               As more shale rock is discovered, the more downward pressure on oil will increase. We can see $70 to $80 being the new norm within 2 years, and bouts of $40 to $50 during world recessions. This is good news for the consumer because cheaper energy equals additional spending elsewhere which will also be good for stock markets. 

              The only threat to cheaper energy prices is government. Politicians might raise energy taxes to offset the falling revenue and hope the consumer will not notice. In B.C. and elsewhere, many energy taxes are based on a percentage basis, as the price rises, so does their take. Have you noticed not one government in Canada has spoken out about rising gasoline prices? Of course not. The politicians are making too much money from of it.

              If $70 to $80 is going to be the new norm it will hurt the Middle East, OPEC, and Russia. It could easily create social unrest in the latter. For China and Indonesia, this will be a bonus because  the economies will continue to grow and both will become more prosperous. If this turns out to be true, both will need Canadian and Australian resources.

              Interestingly, if Australia and Indonesia can agree on drilling in the disputed Timor Sea, which is believed to hold one of the world’s biggest untapped gas and oil reserves, it could make Indonesia self sufficient in both. Similarly, Australia can also become energy self-sufficient with shale rock.

             The only sure thing is the world will be a different place by 2015 than it is today. Energy prices will change the way many countries operate and governments will face shrinking energy taxes unless they raise them. There is no doubt about it, we are entering into interesting times.

China's Way of Thinking-Published February 2012

          It is common knowledge China is purchasing natural resources at an alarming rate. The most popular theory as to why is simple; a growing population, coupled with mass migration to cities as people demand a Western style of living. This is true. However, there is a high probability that the Chinese government is also planning long term, by this we mean 50 years down the road.

          Going over recent facts, it is becoming clear China is planning for the very long distant future. This bodes well for the Chinese economy for decades to come. However, everyone is missing one important fact about China; in many instances, the country is self-sufficient in most goods. Yet, it continues to buy resources from other countries when it is not necessary.  The most obvious reason is to stock-pile. 

          It has become apparent the Chinese government has decided to use other countries resources and leave most of theirs available for domestic use in the future. Coal is a perfect example, the country has over 200 years worth but they remain the biggest buyers of Australian coal. Plus, they buy from Canada, Brazil, and to a lesser extent, from America. In 50 years time Canadian, Australian, and Brazilian coal will be very expensive to mine. Meanwhile, China will still have plenty of cheap coal left in the ground.

          As mentioned in earlier issues, they have bought and are managing thousands of acres of rich farmland in Botswana. When my Father visited Botswana 5 years ago, he saw no Asians working the land. Wisely, the Chinese do not advertise what they are up to and employ only locals. This is a cheap form of insurance for years when Mother Nature is not kind to the Chinese farmer. For Botswana, this equates to investment, tax revenue, and more importantly, jobs.

          China is now buying up Australian farmland. It would not be surprising to find out they have bought land in Canada, the U.S., and France for their wheat. If they have made such purchases, they, along with the local politicians that govern the land, will attempt to keep it quiet as long as possible. Other nations buying large tracts of land could create a political nightmare amongst the people for both nations involved.

          China has signed long term contracts for Australian natural gas. Given the collapse in the price, we suspect they will demand, and most likely receive, a cut in the price they agreed to. Natural Gas is in a free fall and is likely heading to $1.50. If it came to crunch time, China will simply walk away from any contract they do not like. Similar to coal, China would rather buy cheap offshore natural gas and save their own for a future date. It is estimated that China has up to 200 years worth of gas stuck in shale rock.

          The Chinese have been forced to think long term. For the first time ever, urban population is at 51% of the total population. In order to control the growth and limit unemployment, they forced 20m people back to the countryside twice last decade. However, this did not slow the influx.

          Australians are basing their future solely on China being a major buyer of all their goods. Sadly, you can not trust the Chinese. They honor only contracts that suit their interests and do not care about the West. For Canada, Norway and a handful of others, no matter what, China will always demand our forest products. They simply cannot grow enough trees to meet their growing population.

          We are the only ones who think China is preparing for their own future.  When they decide, if ever, to go at it alone, as they did for over 50 years last century, many countries and businesses in the West will be hit very hard. They could easily drive some countries like Australia into recession. This, we believe, is why many large companies have been hesitant to invest directly in the country. If this was not the case, more large Western corporations would be investing directly in China.

          The one thing they have done, and will pay dearly for, was to redirect rivers that were flowing into the Yangtze River to help build the Three Gorges Dam. Some water soaked areas, especially within 100 miles of Beijing, have now turned into rock hard soil and is now unusable. It will take decades to clean up this mess, if ever. Water will be the biggest source of trouble for China. Without it, there is no future. China has time on its side, but as we all know, time goes by too fast. We have to assume China is currently working on this problem.

          China will be an ongoing story for years to come. It will unravel completely different from today’s thinking. They are planning long-term, something the West does not understand or do.