Friday, October 7, 2022

The Bank of Nova Scotia - Thoughts

Although I try not to spend too much time hanging out on Twitter, @thedividendguy had an interesting question last week about why people buy the Bank of Nova Scotia ("BNS") over other Canadian banks. The question was worthwhile given BNS has underperformed its peers over the past five years, and is down about 20% over that period if you don't include dividends received. Reading through the answers of others, and then writing my own, made me wonder if BNS was worth owning at all. Without diving too deep into numbers, I thought it would be worthwhile to think about some of the top reasons BNS is worth investing in, and the key risks it currently faces.

Reasons
1. Total return potential: As of the time I'm writing this, BNS has a dividend yield just north of 6%, and it looks pretty safe given it only represents about 50% of net earnings. Not only is BNS priced relatively low compared to its Canadian banking peers (current P/E is ~8%), its multiple is below its own historical average of ~10% - 11%. Assuming BNS makes it through what feels to the inevitable recession in Canada, you'd be looking at a 9-10% return if the bank can get back to its own historical multiple. 

2. New CEO incoming: Although I don't profess to know very much about incoming CEO Scott Thomson, I wonder if Brian Porter "retiring" isn't a chance for the bank to move past some of their past missteps taken under Porter's leadership. It seems fair to say that Porter's bets in Latin America have at best underperformed, and the bank exiting all but four markets in the region (Peru, Chile, Mexico and Colombia) appears to be a first step in admitting a mistake. Call me crazy, but I think Mr. Thomson is more likely to consider exiting one or more of those remaining markets, and blaming the miscue on his predecessor. 

3. Canadian results remain strong: Although BNS reports on four segments, their Canadian banking segment results accounted for almost half their net profits through Q322, growing 23% year-over-year. As stated above, I do think Canada will inevitably go though a recession in the next year, but BNS has the capital base and experience to make it through to the other side. Between their expansive branch network, ability to cross-sell through various subsidiaries and platforms (Tangerine, Scotia Itrade, etc.), and their credit card business, it's hard to avoid dealing with the bank.

Risks
1. Reliance on Canada for profit generation: In fairness to BNS, I think this is a material risk for all Canadian banks, and Scotia might be the least exposed to the Canadian economy of any of the big six banks. That said, a long recession in Canada, a severe correction in home prices, or a series of large corporate defaults would greatly impact BNS's results.

2. New CEO could be ineffective: Based on a recent article in the Globe that explored how Mr. Thomson went from running the Board of Directors committee responsible for hiring a new CEO, to being named the new CEO of BNS, in a manner of months, I'm unsure if he represents an upgrade from Mr. Porter. Although he has some banking experience with Goldman Sachs in his distant past, it's rare for Canadian banks to hire relative outsiders as CEOs. Apparently, his former company also struggled with some issues in the South American countries it operated in. Lastly, as a Board member at BNS, I would think he would have shared any ideas to improve the bank's results with Mr. Porter, instead of saving them in case he eventually took over the bank.

3. Regulatory / ESG Risks: From December 2020, to November 2021, the Office of the Superintendent of Financial Institutions, that regulates banks in Canada, halted banks from increasing their dividends in order to conserve capital. After his Liberals won the last federal election, Prime Minister Justin Trudeau announced that banks (and insurance companies) would see a 3% increase in the tax rate they pay on their profits in excess of $1B. When considering how ESG concerns have made banks decrease financing of environmentally unfriendly industries is added to the two examples of regulatory risk outlined above, I become concerned that BNS will have a difficult time managing new rules/regulations/standards imposed on them. 


Although on balance I think the reasons one might invest in BNS slightly outweigh the apparent risks, the risk/reward relationship is far from optimal, with little margin of safety. For this reason, although I don't intend to sell my position at this time, I'm not confident enough to add to it either.


Sunday, September 18, 2022

Less Dividends, More Growth Experiment

As I've touched on in my Transactions Journal this year, I'm experimenting with owning some companies that are less inclined to pay dividends, and more focused on pursuing growth strategies. This is clearly a departure from my usual dividend growth holdings, and I wanted to provide context around my thinking behind the experiment.

One of primary reasons for undertaking the experiment is that my current Investment Holdings are doing a great job of generating rising income through dividend/distribution growth. The big downside of that growing income is that by living in a province with one of the higher marginal tax rates in Canada, during a stage in my professional career when my earnings have exceeded my expectations, my dividend income gets taxed quite aggressively. Simply put, if I can identify companies that reinvest their profits, instead of paying them out to shareholders, it is in my short-term and long-term best economic interests.

Another reason for pursuing growth oriented companies is to help switch my focus from income to total return. Although conceptually I know total return is more important to pursue than a rising income stream, my actions haven't reflected that knowledge. It's probable that by being motivated by "financial freedom" and avoiding scarcity, I have ventured much too far into the income oriented mindset. As I nudge closer to the next phase of my life, focusing on total return and adopting an abundance mindset will help me enjoy my time.

Lastly, I feel that by looking for companies that don't pay part of their earnings out to shareholders will help keep me mentally sharp. As I've bought and added to my positions in the same 25-or-so Canadian companies over the past decade, I missed opportunities to invest for total return. I've noticed in slowly building my experimental portfolio that there are compelling growth stories in Canada, that are worth devoting some time and effort. I'm reminded of a quote in a recent podcast featuring Tren Griffin, during which he talked about "choosing the paths in life that lead to the best stories".  His strategy of optimizing for memories really hit home with me.

So what types of companies am I experimenting with investing in? A couple characteristics are important:
- Above-average revenue growth
- Strong profit margins
- Runway for further above-average growth
- Consolidators are especially interesting
- Managed by good capital allocators

At this point, I've taken the plunge into three companies that match most of the criteria above:
- goeasy Ltd (TSX: GSY)
- Constellation Software (TSX: CSU)
- Dye & Durham Limited (TSX: DND)

Although the above names have all fallen since I initiated my small positions (pretty common for anything I invest in), I choose to reframe the lower prices positively as it speaks well for the potential return prospects in the future if the companies stick to their strategies, show good results, and price multiples return to their pre-2022 averages. In the meantime, I'm thinking about adding another position or two by year end, possibly one related to the environment and/or healthcare. Looking forward to seeing how this experiment turns out!





Sunday, February 27, 2022

Two Stock Portfolio - ETF Experiment Continued

In May 2016, I posted about my ETF experiment involving buying VCN (Vanguard FTSE Canada All Cap Index ETF) and VXC (Vanguard FTSE Global All Cap ex Canada Index ETF) for my son's Registered Education Savings Program ("RESP"). Although this was a clear departure from my normal dividend growth investing strategy, the main reason that I pursued the strategy was simplicity. Having added my daughter to the RESP after she was born in July 2017, the two stock portfolio continues to be straight-forward, as shown in the below diagram. 

On a yearly basis, I spend about fifteen minutes on the strategy. The first five minutes relates to re-learning what is a needlessly complicated bill payment I have to use to make the annual contribution through Scotia itrade. A day or two later, after the contribution "magically" appears in the RESP account (sadly, I'm not making that up), I spend another five minutes calculating how much VCN to buy in order to keep the position sizes relatively equal, accounting for future government matches (both federal and to a lesser extent provincial) and upcoming dividends that will be added to the account. The last five minutes are split between buying VCN, and then waiting to see that both government matches hit the account before buying VXC.

Some of the advantages of this two stock RESP include:

- Very simple: Compared to the amount of time I spend on my normal portfolio, 15 minutes a year is awesome!
- Good country diversification: With half the portfolio allocated the Canada, VXC provides me exposure to the U.S., Japan, China, France, Switzerland, Germany, etc. at a very reasonable 0.27% management expense ratio. 
- Minimal cost: Beside VXC's 0.27% management expense ratio, VCN has a management expense ratio of only 6 basis points, and the two buys a year cost me a total of $20 in commissions. 
- Can do it all online: It's only been in the last three years that Scotia itrade hasn't required I send in a physical cheque to fund the annual contribution. 

On the flip side, there are disadvantages to the two stock RESP as well:

- Owning companies you'd rather not: With market capitalization being a dominant factor, there are a handful of companies in VXC I'd rather not own (i.e. Tesla, Facebook, etc.).
- VXC's holdings are not reflective of global market capitalization: VXC is heavily tilted toward the U.S. (60.5% of the ETF's holdings), and ignores some large international companies that are publicly traded (i.e. Saudi Aramco). 
- Scotia itrade's shortcomings: Charging $10 for buying an ETF, seeing your annual contribution disappear for a couple days, waiting an extra day or more to pay out dividends...all the frustrating parts of being a client of itrade continue to impact this RESP strategy.


The longer the two stock RESP experiment runs, the more I continue to love the simplicity of the strategy. I fully plan to stick to the strategy until my daughter turns 16, at which time the federal and provincial governments will no longer partly match the contribution. The only change I envision is potentially moving away from Scotia itrade given the shortcomings outlined above. 

Sunday, February 6, 2022

Water Your Flowers, Not Your Weeds

 "Selling your winners and holding your losers is like cutting the flowers and watering the weeds."
- Peter Lynch

An ongoing theme of my purchases in recent months is adding more to my positions in companies whose shares have increased in value ("winners"). Acknowledging this reality led me to explore the reasons behind this choice. Below are some of the key reasons why I have chosen to follow Peter Lynch's advice.

Accelerate the Compounding Process
Letting the power of compounding work for you by not selling winners early can lead to huge gains. My small October 2013 purchase of Microsoft grew to one of the largest positions in my portfolio. Before adding to this position in December 2021, I simply let the compounding process happen, but didn't accelerate it by adding additional shares. The choice to add to one of my biggest winners seems obvious in hindsight, but felt challenging over eight years given most of the metrics I track never led me to believe Microsoft's stock price would continue to rise.

Momentum is a Strong Force
Newton's first law indicates that "an object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced force". Extrapolating to a company's shares would seem to imply that stock prices will continue to go up unless there's a good reason they should stop or reverse course. Historically, I haven't put much faith in momentum when it comes to the stock market, and mentally have a very hard time "averaging up" my purchases. However, having seen the negative impact of averaging down on a couple of holdings (including Nortel around 20 years ago), I decided to make momentum my friend instead of fighting against it.

Lower Fear of Missing Out
After going through a phase of selling companies after I thought they became over-valued ("cutting the flowers"), that included exiting Home Depot prior to it tripling in price, managing my fear of missing out became more of a priority to tackle. Although I don't know who said it first, the idea that a company's stock price can always climb higher than you think is reasonable is something I've been trying to park at the front of my mind. Instead of trying to profit off of short-term stock price movements upward, being a long-term investor, I'm more interesting in sticking around for years when stock movement becomes indicative of business success.

Be Comfortable with Larger Positions
For years, I have tried to limit position sizes to a maximum of 5% of my portfolio. I have no idea why I used 5%, nor do I remember where the thinking came from. As I have tried to decrease my holdings over the past couple years, I started to question the 5% maximum, and now realize it's less realistic given only 35 holdings. Going forward, I'm scrapping 5%, and am comfortable if my large positions best represent my conviction and confidence in certain holdings. 


Clearly, the concept of adding to winners, and not averaging down on losers has been difficult for me. That said, I consider the implementation of the philosophy to be a journey, that will likely lead to a better destination as I follow this new path.

Sunday, January 16, 2022

14 Monthly Paying Canadian Dividend Growers for 2022

The 15th and last day of the month are special to me as I receive dividends from some companies in my portfolio that pay monthly. On the 15th, I receive dividends from Granite REIT, Canadian Apartment REIT, CT REIT and Realty Income. On the last day of the month, A&W Revenue Royalties Income Fund pays me my monthly distribution. If you get pleasure from seeing regular dividends coming into your portfolio each month, and you especially enjoy seeing them grow over time, the following table might be of interest to you. 

Using the Canadian Dividend All-Star list from December 31, 2021, I determined the monthly dividend growers for 2022. To be included, companies had to pay a monthly dividend, increase their distribution at least once in the last 12 months, and have a minimum 5-year history of annually increasing their payouts. From the 93 companies appearing on the initial Canadian Dividend All-Star list, there were only 15 who paid dividends monthly (the rest are quarterly payers). Sadly, I had to remove Chartwell Retirement Residences who had not raised their distributions in almost two years <- probably a good thing given the pandemic they have been navigating. The resulting 14 companies included nine real estate investment trusts (REITs). As the payout ratios and valuations of REITs are usually calculated based on funds from operations (FFO) or adjusted funds from operations (AFFO), looking at the EPS payout is not particularly relevant for these companies. For your browsing pleasure, here are the 14 monthly dividend payers heading into 2022:

CompanyDividend Growth Streak1-Yr Stock Price ReturnDiv Yield % (CAD)

[USD Ex = 1.2641]
1-yr DGR
'21
3-yr DGR
'19-'21
5-yr DGR
'17-'21
TTM EPS Payout Ratio %
Granite REIT1135.30%2.94%3.30%3.30%4.40%23%
Allied Properties REIT1016.20%3.87%3.10%2.80%2.50%59%
Canadian Apartment REIT1019.90%2.42%2.10%2.40%2.60%20%
Canadian Net REIT1020.00%4.25%17.40%14.20%13.30%35%
Firm Capital Property Trust REIT1025.20%6.55%1.90%3.50%3.80%26%
First National Financial Corp100.20%5.65%14.80%6.80%6.60%64%
InterRent REIT1026.40%1.98%5.00%6.30%7.10%15%
CT REIT910.50%4.85%3.80%4.10%3.90%169%
Parkland Corporation9-13.90%3.55%1.70%1.70%1.80%135%
Savaria Corporation932.50%2.61%4.40%9.10%17.80%105%
Global Water Resources Inc.813.80%1.72%1.00%1.00%2.50%225%
Badger Infrastructure Solutions Ltd6-16.40%1.98%5.00%6.40%10.10%n/a
Killam Apartment REIT537.90%2.97%1.70%2.60%2.80%29%
Summit Industrial Income REIT572.20%2.40%3.00%2.50%2.00%9%
Averages:8.7119.99%3.41%4.86%4.77%5.79%70.35%

As with any other screen, the above list is simply a starting point for further research. Clearly, a deeper dive is required based on the average EPS payout ratio over 70%. That said, the above list had an average return of 20% in 2021, including a 3.4% dividend payout and appears to be growing distributions by about 5% yearly, all very impressive figures.

As always, if you know of any other Canadian monthly dividend payers with a history of boosting their payouts, please reach out to me so that I can correct the above list.