Lessons from Value Investing and Moat Analysis

Being a dividend growth investor does not stop me from learning lessons from other investing philosophies. After reading The Little Book of Value Investing and The Little Book that Builds Wealth, I feel value investing and searching for companies with moats that create sustainable competitive advantages will help me in my investment research. A couple key takeaways from both books are outlined below.

Value Investing:
- Searching for low Price-to-Book and Price-to-Earnings stocks is a good way to identify companies that might be set to earn superior returns in subsequent periods if they can exhibit growth.
- There's value (pun intended) in identifying stocks in which company insiders are buying. Afterall, who better to know if a stock is undervalued than the company's employees and management?
- The list of successful value investors is long, and includes such names as Benjamin Graham, Warren Buffet, and Bill Miller. All of these investors were contrarians who didn't follow the herd mentality of the markets.

Searching for Companies with Moats:
- Sources of moats include intangible assets (brands, patents, or regulatory licenses - i.e. telecoms, waste removal), customer switching costs (due to integration with a customer's business - i.e. Oracle, Adobe), network economies (value of a product increases with users - i.e. credit cards, Ebay), and cost advantages (stemming from process, location, scale, or access to a unique asset - gravel pits, Walmart).
- Moats only exist if the company can benefit by having above-average profitability over an extended period of time (measured by ROA, ROE, etc.)
- Morningstar provides moat ratings on the companies it covers, indicating if the company has no moat, a narrow moat, or a wide moat.

I'm in the process of looking to add a US stock to my RRSP next month, and will be keeping the above information in mind when undertaking my analysis. Buying a company that's relatively cheap, with a moat that will help ensure above-average long-term returns can only help identify even better dividend growth stocks.

Blog Name Change

In order to keep things fresh, interesting and accurate, I decided to change the name of my blog from “Adventures in Canadian Dividend Growth Investing” to “Dividends in Hand”.

The new name is a play off of Myron Gordon and John Lintner’s ‘Bird In Hand’ theory which postulates that investors prefer stocks with high the certainty of dividend payments to the possibility of potentially higher future capital gains.  Admittedly, I’m a subscriber to the Bird In Hand theory as it’s very much in-line with my level of risk aversion. Why speculate on potential future gains when I can limit my downside risk by investing in a company with a history of raisings its dividends to shareholders in line with their profitability?

I also felt that “adventures” in my previous blog title was a little misleading. As a dividend growth investor, boring is my best friend. I’ll leave adventures for those inclined to bet their money on the next hot IPO, day traders, and commodity speculators. Having a portfolio of investments that consistently grow their payouts is much more in-line with my temperament and preference to let my portfolio churn out regular, worry-free returns.

Here’s hoping your investment process allows you to increase the dividends in your hands!

Check-Up H&R REIT (TSX:HR.UN)

As a dividend growth investor, I get a little frustrated when a company I add to my portfolio does not increase their distributions at regular intervals. I can appreciate that sometimes companies have challenging years, and aren’t able to increase their dividends as they have in the past. That said, even though I consider myself quite patient, when a company goes 18-months without increasing their payout, my initial reaction is to sell the investment and move onto a company that rewards its shareholders regularly.  

I’ve held shares of H&R REIT (“H&R”) in my non-registered account (not the smartest decision for tax purposes) for the last three years. I bought shares when the company was regularly increasing their distributions (about every six months) as they acquired new properties that allowed them to grow their funds from operations (“FFO”).  H&R acquired Primaris in December 2012, allowing them to become Canada’s second largest REIT. Ever since that acquisition, their distributions have been stuck at $1.35/unit. After tolerating a stagnant distribution for 18-months, I took a deeper dive to determine if this investment was worth keeping in my portfolio.

While reviewing their quarterly filings, press releases, and news for the past six months, I came across two pertinent pieces of information.

-          Despite the fact that they have kept the distribution static, H&R’s FFO per unit was up nicely from $0.44 / share in Q113 to $0.47 in Q114. This tells me the company can afford to increase its payout since their payout ratio as a percentage of FFO dropped from 75.6% to 72.3% over the same period.

-          H&R got approval in April for their plan (announced in February) to repurchase up to 25 million shares of their units. The 25 million shares represents about 9% of their outstanding shares. I’m not normally a fan of share buybacks, as I’m not looking to tender my shares. However, if management actually buys back 9% of outstanding shares over the next year, and H&R continues to operate as efficiently as they have in the past, the value of my units could rise substantially.

I’ve decided that I’ll hold on to H&R to see how the share buyback impacts the value of my shares. With a current distribution yield around 5.8%, the P/E about 20X, and management running the company efficiently, I’m curious to see how things shape up in the next six months.  If the company’s shares are undervalued (as I assume management thinks given their 25 million share buyback plan), the value of my holdings should increase, making up for the lack of distribution raise.

(Full Disclosure: Long HR.UN)

Restructuring RRSP - Bought Telus

Over the next 18 - 24 months, I plan to sell my Canadian stocks currently sitting in my RRSP in order to create some room to invest in US and international stocks. Considering my investment portfolio currently consists of almost 75% Canadian companies, international diversification is a must for me. However, when I sell the Canadian stocks in my RRSP, unless I am terribly overweight in them, or that I think the security is overvalued, my plan is to buy the same amount of stock in my unregistered investment account (thus the process taking me 18-24 months). 

After Canada's Industry Minister let it be known that he planned on tilting the next spectrum auction in favor of new entrants and bit players, Mr. Market depressed the prices of the big three Canadian telecom companies yesterday. Knowing that the Government of Canada has been favoring smaller players and new entrants in spectrum auctions for the past 6 or 7 years, and that the strategy has been an absolute failure (the big three telecom companies control about 95% of Canada's wireless market), I saw this as a great opportunity to start my RRSP-to-non-investment account shift strategy. With my Q3 contribution to my non-investment account, I bought shares in Telus at $38.20. 

In order to be safe, comply with Canadian tax law, and not have to realize a capital gain on my Telus shares inside my RRSP, I'm planning to wait at least 30 days before I sell an equal number of shares of Telus inside my RRSP. Although this seems complex, Canadian tax law as it relates to capital gains is a bit of a challenge for my simple brain. I'm very happy to have bought the shares of Telus at what I consider to be a decent bargain in the current elevated market. Today, Telus has already bounced back about 1.5%, and is trading over $39.00. 

Even before this trade, Telus was my largest individual company holding across my investment portfolio. Since it accounted for less than 10% of my total portfolio, I'm likely going to maintain my current position in the company. Telus has a great record of announcing dividend increases in advance, fallowing through with previously announced regular dividend raises, and growing revenue/earnings in order to keep the dividend sustainable.  Telus is a pretty great company to buy when Mr Market gets depressed. 

(Full Disclosure: Long Telus, Bell, and Rogers)

The Little Book of Behavioral Investing - Lessons Learned

I've been on a behavioral finance reading spree lately, consuming Inside the Investor's Brain (Richard Peterson), A Random Walk Down Wall Street (Burton Malkiel), and Behavioral Finance (William Forbes) in the last month. As much as I enjoyed those books, The Little Book of Behavioral Investing - How Not to Be Your Own Worst Enemy by James Montier was my favorite of the bunch. In a little over 200 pages, Mr. Montier went over many of the common mistakes/biases investors make, and suggested ways to over come them. A couple of my key take-aways are outlined below.

Less Information Is More
When looking at a public company as an investment opportunity, it's overwhelming to consider all the information available. Concentrating on a few key facts, such as yield, payout ratio, history of dividend increases, EPS growth, and P/E for a dividend investor yields far better results than trying to incorporate every piece of data available.

Focus on Facts, Not Stories
Just because a company has a great story, it doesn't mean the company is a great investment. Don't get me wrong, I enjoy hearing how Tesla is attempting to move consumers away from gas-guzzling cars, I wish First Solar lots of luck in installing solar solutions around the world, and I hope Go Pro can live up to the hype of their IPO, but I wouldn't invest in any of these companies. Their facts simply don't fit into my investment criteria, and I doubt they ever will.

There is Great Value in Doing Nothing
The media, the investment industry, and financial intermediaries all encourage investors to trade frequently to build wealth. Due to transaction costs, over-trading kills investment returns. Furthermore, investors suffer from biases of trading out of winners too soon, and holding onto losers. Unless there's a compelling reasons for me to trade, I'll simply sit on my investment portfolio, and invest new cash in the most promising investments.

It's All About the Investment Process
Mr. Montier encourages investors to focus on their investment process, as opposed to the outcomes. He suggests investors keep a trade journal (much like I've used this blog) to keep track of their process and how they came to their buy/sell decisions. Since the market is largely out of the investor's control, focusing on the process allows the investor to see flaws and correct them going forward. One particular lesson I learned in this area is to document my trade decisions when selling a winner. I fall into the group who sells winners too soon (i.e. Home Capital, Walgreens, Canadian Western Bank, etc.) and I have to figure out why I do that. Holding on will help my investment returns in the future.

The Little Book of Behavioral Investing has helped me see flaws in my investment process and thinking, and I'll be adding it to my permanent investing library. I'd encourage all serious, long-term investors to give Mr. Montier's book a thorough read. You'll be happy you did.

Update on Investment Goals for 2014 at June 30th (H114)

It was another fantastic quarter for my investment portfolio, with many of my goals for 2014 accomplished or well on track.

Increase my portfolio value by 17% :

My portfolio increased in value by about 18% in H114 vs YE13. This was impressive, even with my RRSP contribution for the year.  I also made another contribution to my non-registered investment account. My portfolio value would even be higher if not for the CAD appreciation to its US counter party. 

With this goal accomplished, I'm not re-adjusting it, or increasing it for YE14. I'm hoping for a market downturn so I can focus effort on improving progress toward my next goal even more dramatically.  Buying stock in companies at a cheaper price would be a dream at this point in time. I feel the market is fairly valued, and bargains are hard to come by.

Total Dividends Received Up 18%:

I accomplished this goal in the last couple days in June, with forward dividends up a little over 18% since the start of the year. Six of my holdings increasing their dividends in Q2 (Bank of Montreal, Laurentian Bank, Telus, National Bank, Realty Income, and Alaris Royalty).

In contrast with my portfolio value goal, I've decided to set a stretch revised goal for YE14. Instead of 18%, I'm now aiming for my forward dividends to be up 25%. 

Maintain US Holdings at About 30%:

My US holdings accounted for about 27% of my portfolio at Q114.  After selling a few US holdings in the first half of the year (Walgreens and Western Union) and replacing them with Canadian equities, I knew this goal would be a hard to maintain at June 30th. Add the depreciating US dollar into the mix, and my portfolio consisted of about 25.1% of US stocks at H114. That said, my plan is to slowly sell my Canadian holdings in my RRSP, and move into US stocks to increase my international diversification. I figure the entire process could take my upwards of 18 months, but I should be back around 30% by YE14. 

Doubling Down on Comfortable Holdings:

I continue to make good progress against this goal. I recently added some shares of Pfizer to my RRSP, and will look to use the proceeds from stock sales of Canadian holdings in my RRSP to add to positions in US holdings. 

Get rid of all companies who haven’t raised their dividend in the past 18 months:

After selling Western Union and Intel, two companies who didn't raise their dividends in over 18 months, during Q1, I don't have many stragglers (non-dividend raisers) left in my portfolio. The only two exceptions might be Riocan REIT and H&R REIT...both of which would be mega-tax headaches for me to sell. I'll wait closer to December to see if these two companies raise their dividends in 2014 as I thought they would. 

Figure out what to do with cash in excess of $500 (especially in TFSA and RRSP):

After thinking about this goal, I'm happy I didn't choose a vehicle to invest cash in excess of $500 in my TFSA and RRSP. I have a couple positions in both of these accounts that I'd like to slowly add to, and amounts around $1,000 will buy a nice amount of stock in the companies I'm looking to increase my holdings in. Plus, with a $10 trading cost, transaction costs will only be about 1%.

Obviously, half way through the year, my portfolio is far ahead of where I imagined it would be. During the second half of the year, I'm going to focus more on increasing my forward dividends, and slowly moving Canadian holdings from my RRSP to my taxable account.