Value Insight - November 2008:

With another month of market turmoil coming to an end I thought I would take a few moments to give readers a look into what I've been up to in the month of November with my two portfolios.

Yield, yield and more yield was one major theme for the month as stock prices came down even further than I expected them to after a horrible September and disastrous October in equity markets. What's become immediately apparent to me while watching the markets the past few months has been the glaring distance of spreads between the bid & ask prices for equities. Investors looking for immediate liquidity have been more than happy to unload their shares at very attractive valuations for the long-term investor. Opportunities have been surprisingly swift; especially in the preferred share market with valuations of highly regarded issues yielding at times well above historical spreads. While an income investor won't want to overload their portfolio with preferred shares these equities provide a meaningful source of additional income to help fuel further purchases of common equities and are highly tax efficient.

Stocks Bought:

DivG:

Newalta Income Fund (NAL.UN): Management recently announced their intention to convert back to a dividend paying corporation with a targeted annual payout of $0.80 per share. The moneygardener had brought this to my intention earlier in the month and after further review of the company I determined that their operations and prospects for growth in waste management services was a solid long-term opportunity from a risk/reward standpoint. Their market remains highly fragmented with relatively smaller competitors and the company is diversified adequately from its oil & gas operations with landfill and alternative revenues. While I expect continued volatility in this stock over the short-term I expect this company to conservatively grow its portfolio of services and operations and raise its dividend in the future.

Canadian Pacific (CP) & Canadian National Railway (CNR): After getting on the Dividend Express in October I again added to my position in CP and further lowered my ACB in CNR at $42. While both are economically sensitive the price of energy has decreased recently adding to their profitability. Bulk commodities and products will continue to be moved across the continent in large quantities by the only cost-effective method as rail offers producers a fast and efficient method of transporting inventory across borders and to ports. My exposure to these industrial companies is adequate for the moment and I expect them to be successful investments over the long-term with strong dividend growth.

Manulife Financial (MFC): After publishing Confessions of a Value Investor II, I found myself staring at Manulife with the option of topping up my weighting in the company to 5%. After reviewing my analysis on the company and considering the current risks I added to my position at $21.50.

Power Financial (PWF & PWF.PR.H): PWF is a unique stock as it owns controlling interests in Great-West Life GWO) and IGM Financial (IGM) as well as some attractive European industrial assets through Pargesa Holding S.A. I was looking to add to my position to balance my position in IGM and after purchasing more common shares in PWF I looked through my watchlist of preferred shares and suddenly noticed an issue trading at a YTW (yield-to-worst) of 9.58% (13.4% pre-tax equivalent). While I normally would avoid purchasing a preferred in the same company I hold common equity of the investor willing to part with their shares at the price I paid was a difficult investment to ignore.

Westcoast Energy (W.PR.J): this preferred gem comes with a tax-advantaged yield of nearly 9.5% and has cumulative dividends to boot. This is another non-financial perpetual preferred that I've added to my portfolio for additional income. In 2002 US based Duke Energy bought Westcoast Energy and left their preferred share issues (H & J series) in the open market and remain rated at Pfd-2 (low) by DBRS.


RSP:

SPDR Technology ETF (XLK): This is an ETF I’ve been waiting to initiate a position in for quite some time during this market decline. Technology is a sector I want exposure to over the long-term and rather than buying individual positions in large-cap software and hardware companies I get very cheap exposure to some of the best technology companies out there. XLK’s top 10 holdings can be found here.

Berkshire Hathaway (BRK.B): Although I only purchased a single share of this company you would have to go back to 2003 to get a better price under $2600. The holding company guided by Warren Buffett and Charlie Munger has recently come under pressure as its derivatives come into question. Although I hold many of the same equities in my RSP (KO, JNJ, KFT, PG, SNY, WMT & WFC) Buffett is an investor able to take advantage of opportunities not offered to other investors such as his recent GE, GS and USG investments. Despite concerns over succession of the company when either Buffett or Munger step down I believe that there are enough competent managers running the businesses under the umbrella of BRK to provide meaningful value in the future. The market tends to discount Buffett on numerous occasions and as a student of his investing method I trust the old man still knows a lot more than me about value.

Becton Dickinson (BDX): This medical device, supply and systems company was removed from my Healthcare portfolio when it closed shop in 2007 and was something I eyed very closely in the recent market tumble. At $60 I couldn’t resist adding it into my RSP to compliment my holdings in BAX and JNJ. With the recent increase in the dividend of 15.8% and authorization for additional share repurchases (a rare move in recent months) the company is poised to grow over the long-term. I work directly with this company’s products daily and management in a top-down format are eager to receive constructive criticism on product development to improve patient care.

Whirlpool (WHR): I provided a stock analysis of WHR earlier in 2008 and nothing fundamentally has changed with this company as global growth slows. The company is well positioned in multiple markets to take advantage of an emerging middle class. They are focused on cost reductions, have a high level of goodwill, but an otherwise strong balance sheet. Paying over a 5% dividend and under 10x forward earnings when I purchased my second round of shares WHR offers excellent value for a company I intend to hold for the long-term.

Seaspan (SSW): This company has been completely trashed along with other global shipping stocks as credit concerns, shipping rates and the BDI (Baltic Dry Index) has plummeted. SSW is a company that owns and charters containerships through long-term fixed-rate leases to shipping companies. The company has secured financing on all current assets in development and has adequate protection from losses through contractual abilities. The current dividend yield on the company is stunning and through my analysis of the company has no material evidence of being cut. I have recognized the potential for a cut in my valuation, but have added to my position under $5 as I view this as a conservative long-term investment on emerging markets and globalization.


Stocks Sold:

Reitmans (RET.A): I will be discussing this in further detail with Confessions of a Value Investor III shortly.


December is Interview Month at TMWTFS
Tune in each Monday for the first three weeks in December for interviews with two dividend investors and Sramana Mitra, author of Entrepreneur Journeys (Volume One)


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DIY Investing Q&A:

One recent theme of TMWTFS has revolved around stock analysis and what an investor needs to consider and evaluate once they’re interested in taking action of their own finances and begin the process of investing on their own. I understand, having gone through the process myself, that there are a number of questions individuals have asked themselves or others as they question where to start this process. Here are a few good questions to start with and I encourage readers with any others to respond privately or publicly so I can address them in a follow-up post.


Is Do-It-Yourself investing for me?

It’s a difficult question to answer and like most it will depend on the individual situation, expectations and needs of the individual investor. Those who don’t have the time or desire to invest should seek professional advice, but there are a growing number of investors who want to take charge of their own financial future and have difficulty knowing where to start.

When friends ask about investing on their own I frequently get questions about strategies, specific stocks, ideas, companies in the news or about a single mutual fund/fund company. An investing strategy needs to fit your needs and capabilities and should never seem overwhelming, complex in practice or confusing when you start out.

When investing I make a priority to identify the importance of taking more control of my finances and understanding the important aspects of my intended investing approach. Money isn’t everything, but it can sure make life a lot easier if you let money and debt work for you instead of against you. Individuals often struggle to save because they spend more than they make or don’t structure their debt and investments in a way to maximize the most benefit.

Here is a good resource to start


Do I have the Confidence?

Investing is a progression and confidence is never automatic; it takes time. There’s no trick or simple “Get Rich” approach that will make you money overnight. You can learn an abundance of information from books or academic literature, but I’ve learnt more about investing from just a few mentors and direct experience than I ever did in any business or finance class during university. Those classes built a foundation for examining the numbers of a business, but the qualitative tools that I learnt to apply to my investing activities often rely on common sense. There’s no replacement for common sense and rational decisions in any investing approach.
Do I have the time?

Successful investing is not something that can be done overnight or in the blink of an eye despite the attempts of many authors and “supposed” experts attempting to convince the public. Promises of instant wealth will be irrational and time is likely your best opportunity to create meaningful wealth. There will always be successful individuals who roll the dice and come out lucky, but the majority of us who give it a try are just as likely to fail 9 out of 10 times. Eventually the market catches up with investors who take on too much risk and the market resets the delicate balance that exists between risk & reward.


Do I know the risks?

Investing should never be a gamble and in my own activities I attempt to have every action planned, considered, evaluated and then calculated more than once before I ever make a purchase. An old carpentry phrase of “Measure Twice, Cut Once” is something I often apply to a situation where I know more patience is needed.


Do I have the knowledge?

While most investors hate paying fees they are inherently part of the process. Whether it’s a MER, commission, taxes or other if you don’t have the knowledge to investor initially by all means seeks professional help through an accredited advisor or professional. You will pay more due to fees over the short-term, but you’ll likely be diversified against risk and have a relationship with a professional as you begin your education. Managed products are at times a better solution than investing blindly into a strategy you don’t completely understand how to conduct in an effective manner.


Do I have a strategy?

Strategy is something many investors talk about at length, but rarely can define in any concrete method. It’s easy to simple start investing, but can you put your strategy on paper? Can you define it or explain it? Is it complex or simple, easy to duplicate or difficult? Has it been successful in the past and for what reasons? What made it successful and is the investing environment the same to accomplish those objectives? Is it fundamentally sound or permanently flawed?


Can I commit to a strategy?

When I talk about discipline this is what I directly mean or allude to. You need to not only talk the talk, but walk the walk and see something through if you believe it to be the best fundamentally sound process for investing for your situation. Far too many new investors switch strategies multiple times that lead to inevitable short-term failures instead of allowing time and compound interest to work in their favour. Micromanaging a portfolio is likely detrimental to long-term returns and commitment, as in life, has many long-term benefits.


Can I anticipate my reaction to the market?

Twelve months ago could you have imagined the market volatility, significant equity losses and bankruptcies of the past year? If your portfolio had suffered double digit losses how would you react? If the market goes down 10% in a single day what will you do: buy, sell or hold? Can you handle the upside of the market as well as the downside? Will you be greedy, fearful or rational in your decisions? Those are all questions you can’t truthfully answer until you place your own money at risk with your decisions. A good rule to follow is that what you initially determine to be your risk tolerance will inevitably be half during extreme market turmoil.


Am I comfortable with my abilities?

Confidence is a wonderful trait, but arrogance can kill your portfolio. One key for any individual investor as they begin to invest on their own is to stay grounded and stick to doing what you do best. There’s nothing wrong with learning as you go, but you have to have a basic understanding of what you’re investing in to protect yourself reasonably from unforeseen risks. If you know honestly that you aren’t prepared to invest in a certain asset class or investing strategy than you owe it to yourself to wait until you feel you’re properly prepared. When you finally decide to begin you may still have some anxieties but you’ll know that you have the tools needed for success.


How will I evaluate my performance?

This might seem like a redundant question to ask yourself, but it really makes a difference on how an investor measures results and expectations. You can choose to evaluate your performance on absolute returns, an increase in tax-efficient cashflow or risk-adjusted versus other assets but the importance is to match how you’ve performed with some tangible measure that makes sense to you.

Another great resource you can use to answer these questions and more is the New Investor Index located along the top of this site.


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Taking Stock in IGM, Review:

In August I published a four-part series on IGM Financial (IGM) where I took readers through the process of conducting an in-depth fundamental analysis of the qualitative and quantitative factors I use in my stock analyses.

In this series I focused on how to conduct a situational analysis, collecting numbers, definition & interpretation of numbers & determining a valuation for a stock using a DCF format.

With the increase in comments and emails from new investors I thought it might be a good time to review a few of the central themes and ideas from this series to help simplify the process and create a "check list" of items you want to remember when you're working through the learning phase of conducting a stock analysis.

Here are a few helpful tips to keep in mind when going through the process of a stock analysis:

• Pick a stock and business model you can easily understand
• Don’t get discouraged if you encounter barriers in your research
• Be adaptive & resourceful
• Be creative – think outside of the box whether right or wrong this can often lead to important insights
• Focus on the Situational Analysis first
• Be specific in your research
• Keep things simple
• Take the time needed to read over financial statements or learn
• Understand the numbers
• Consider taking an introductory accounting/business course at your community college or read an introductory accounting textbook at your library
• Focus on understanding the specific elements of your analysis and then worry about putting them together into the bigger picture
• Take the time to develop your confidence
• Know yourself and your limitations
• If at first you don’t succeed…try, try again!

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The DIY Journey:

There are a lot of investors looking to get into the DIY (do-it-yourself) game of late and that’s likely for a number of important factors.

Many investors that I’ve talked to in recent weeks are tired of over-paying for under-performance and watching their hard earned money decline in the market despite trusting a professional to manage their money. When they share concerns about moving funds, utilizing a different strategy or expressing themselves with the need for more involvement in their investment decisions they are discouraged to do so and stick it out. Financial advisors can’t take all the blame as each individual investor now realizes that their risk tolerance was likely much lower, but clearly there is a need to put people first when it comes to managing their money.

The financial services industry is dominated by massive firms selling financial products that’s sole benefit is not to increase returns for investors but rather charge increasing fees for the management that is provided. They make more money when you, as an investor, do well but that’s not their sole motivation or core value principle. This is no secret to individuals in the profession and very few stand out against the goliaths by carving out their own distinct niche of business that focuses on client needs rather than advisor needs. Advisors need to be paid; that’s how they earn their money. But even with the growth of index funds and exchange-traded funds that offer low-cost investment vehicles to DIY investors active management continues to dominate the focus of the industry.

I’ve said this many times and I continue to believe it to be true: No one will ever manage your money like you can.

While you might trust your advisor, have a good relationship and a mutual understanding of your expectations an advisor will never take the same type of diligent care that you would with your own money. Any DIY investor realizes this the very first time they consider pressing the “buy” order through their discount brokerage. You start to second guess yourself or wonder if you can get the stock cheaper. You realize immediately that you are the sole individual responsible for the investment decision and it is both a very powerful and humbling experience.

I understand the difficulty in this journey because I myself, only four short years ago, took the important step of buying my first stock. I understand the barriers to education that exist, the abundant bias of advice and difficulty in determining how you approach stock analysis & conducting due diligence. It’s insanely frustrating and in the beginning you find very little help to guide you on your way. Through all of my frustrations of making mistakes and losing money I learnt how to adapt my investing approach to better recognize risk as my primary focus. I’ve adopted an approach that doesn’t focus on numbers entirely but instead on making sense of the difference between a good business and great investment.

A wise investor told me recently, “The subject of dividend based investing is heavily covered these days so what I have to add is minimal. I do believe that most dividend investors & blogs focus way too much on the data and way too little on understanding the business & the business model.”

He’s right.

While I respect my peers there is a clear absence in the frequent analysis that we conduct on value, dividend or alternative investments. If there is anything we can learn from the unravelling of the markets these past few years it is that numbers never quite give you the complete picture and that one of the most important factors of a sustainable business is how it is structured. The business models of many great investments have deteriorated incredibly by losing focus on what makes a business successful. Whether its leverage, over-diversification or management losing focus the business model has suffered and shareholders are now paying the price.

Growth in dividends, earnings and revenues mean little moving forward if the business isn’t sustainable. If there’s no demand for a product or service and a company can’t be competitive, proactive and innovative than they’re going to fall by the way side and we’re seeing that now in a number of industries. The world moves fast and to be competitive you have to know not only where you want to go but how to get there.

Those are all elements of what I talk with small business owners about when I’m consulting, but these also apply directly to investors. As a shareholder you are part owner in the business and need to learn to evaluate the business with that mentality. You need to critically examine what the company does, how it does it and what changes it is making to maintain its market share and become more competitive.

My Value Rules aren’t just about identifying good investments; they’re about identifying good businesses. They are fundamental rules that I believe a business should strive to achieve or apply that lead to a great investment. An investor might lose money over the short-term but investing is partly about learning how to lose in order to gain at another time. We all lose money and that is inevitable. The goal as an investor is to minimize your losses while maximizing your gains. How you decide to do that is dependent on each individual.

I’ve grown a lot as an investor over the last eight years and recognize the uphill battle that many new investors face when attempting to follow in the footsteps of those of us who have endured the journey to where we are today. I’ve never forgotten those struggles and frustrations and this site carries the focus of giving back to those who want to learn but don’t know where or how to start.

My focus has always been on quality rather than quantity and I encourage readers to engage me in what they want to learn, read and need guidance with. Whether you participate publicly in the comments section of my posts with questions or privately via email I want to know what you’re having difficulty with and what information you’re seeking to learn about. They can be suggestions for a stock analysis, what my analyses are lacking, how my situational analysis can be broken down on a more basic level or more focus on a specific fundamental.

I won’t have all the answers, but I’ll try my best to point you in the right direction.

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Taking Stock in MFC:

“I believe I had my first Coca-Cola in either 1935 or 1936. Of a certainty, it was in 1936 that I started buying Cokes at the rate of six for 25 cents from Buffett & Son, the family grocery store, to sell around the neighborhood for 5 cents each. In this excursion into high-margin retailing, I duly observed the extraordinary consumer attractiveness and commercial possibilities of the product. I continued to note these qualities for the next 52 years as Coke blanketed the world. During this period, however, I carefully avoided buying even a single share, instead allocating major portions of my net worth to street railway companies, windmill manufacturers, anthracite producers, textile businesses, trading-stamp issuers, and the like. (If you think I'm making this up, I can supply the names.) Only in the summer of 1988 did my brain finally establish contact with my eyes.” -- Warren Buffett (1989).

There are a great number of investors who quote Warren Buffett, follow his investment activities and attempt to walk in his footsteps in the hope of achieving success. I was taught some time ago that investors all too often neglect stocks with a reasonable valuation and dominant fundamentals in favour of buying companies with discounted valuations and less dominant fundamentals. I’ve learnt this by taking the time to study the best, the brightest and the most fallible of investors in my pursuit of understanding their behaviour, motivation and investing process.

What Buffett is talking about in reference to his eventual investment in Coca-Cola (KO) after staring it in the face for over half a century is the concept of Enduring Value. The label of Enduring Value is often easy to recognize after a corporations decades of solid performance and successful global achievements, but difficult to identify in the early phases of a company’s history.

I was reminded of this quote by Buffett the very first time I read through the 2004 Annual Report of Manulife Financial (MFC). At the time I was just beginning my mentorship under a great investor and looking to apply the early lessons I had crafted on stock analysis. Beyond the numbers, financial statements and discussions on investments stood a business that was superbly managed and growing. Manulife had only been a publicly traded corporation since 1999 but almost immediately I gained insight into not just where the company had been but where it was going. The presentation of the company was clear, the expectations from management were evident, a strong financial base sustained and a wonderful track record of accretive acquisitions implemented effectively.

The Manufacturers Life Insurance Company (Manulife) dates back to 1887 when Sir John A. Macdonald, Canada’s first prime minister, was elected president of the company. Manufactures Life was then one of the first companies to offer women life insurance on the same basis as men – a highly controversial and innovative decision at that time.

In 1893 Manulife sold its first insurance policy outside of Canada beginning what would later become a tradition of expanding operations internationally. By 1897 Manulife had expanded into Asia and from 1900-1950 had operations to the Philippines, Indonesia, The United States and United Kingdom. By 1980 Manulife was operating joint ventures in Singapore, acquiring US & Canadian insurance operations and in 1996 opened China’s first joint venture life insurance company. The company currently has global operations in Canada, The United States, Asia & Japan selling a diverse portfolio of insurance and investment products.



In 1994 Manulife announced the appointment of Dominic D'Alessandro to Chief Executive Officer and who later led Manulife on its acquisition path that in 2004 purchased Boston based John Hancock Financial Services for $10.4B.

I have always believed that great business is conducted by great people and that integrity, values and discipline are the hallmark of any great leader. Manulife not only has had a great leader, but a collection of great people running operations of their business around the world. In a top-down approach the values of the company are prominently demonstrated by its leaders. Through his executive track record, charity and attitudes towards the business he expects his company to conduct Dominic D’Alessandro will be a substantial loss for the company when he steps down in May of 2009. His replacement will be Donald Guloien, currently Chief Investment Officer of Manulife. Donald has been employed with Manulife since 1981 and was responsible for integrating the investment operations of Manulife with John Hancock during its 2004 acquisition of the company.

One of the first things that I always notice whenever I read the annual reports on Manulife is the clear and concise definition of corporate culture. The company’s values are described publicly through the acronym PRIDE which stands for Professionalism, Real value to our customers, Integrity, Demonstrated financial strength and Employer of choice.

Investors should realize that values, corporate culture or a mission statement can mean little if not executed or demonstrated in a top-down approach. Management should demonstrate not on a “do as I say” but a “do as I do” modelling of how a company conducts itself both internally and externally. In any public statement, interview or speech provided by the senior management of Manulife is the clear expectation that this is how the company expects to do business now and moving forward.

During the past two years there has been an intent focus on credit quality, available corporate liquidity and risk. Risk management has been the new corporate buzz word on Wall Street and Bay Street with corporations and business schools making public acknowledgements that risk management is a top priority of their corporate culture or curriculum. As an investor and businessman I know there is a significant difference between saying and doing and when management says one thing I expect them to walk instep with their public and private commitments.

Manulife has a strict risk management culture that included oversight governance from a Product Oversight Committee, Credit Committee & Global Asset Liability Committee. Since going public as a corporation Manulife has clearly presented to investors the risk management policy, expectations, identification & monitoring, measurement, controls and mitigation activities they have in place. In their 2007 Annual Report they clearly define their strategic risk, market risk, foreign currency risk, credit risk, insurance risk, liquidity risk, operational risk, derivatives risk, interest rate risk and risk from variable products & managed assets.



If I can add a perspective:
There are ten pages or 8% of the 2007 annual report devoted to strictly conveying risk that the company is exposed to in its various operations in detail for shareholders. These aren’t hidden in the notes of financial statements or written in fine print as legal disclaimers at the end of the report. In each annual report Manulife commits an entire section to the explanation of risk and this isn’t a recent event in light of the credit crisis. As a percentage of the annual report risk management was:
- 8% in 2006
- 6% in 2005
- 7% in 2004
- 11% in 2003
As you go through those reports Manulife’s risk profile has changed little over that period.

Financial strength of the company and credit ratings, in light of recent events, remain strong.




One difficulty in evaluating any insurance company is gaining an appropriate assessment of their bond and investment portfolios. With the Lehman Brothers and large financial failures in 2007 and throughout 2008 we’ve seen many companies take large write-downs on losses through direct or indirect credit exposure. Manulife stated in September that less than 1% of their $164B in assets has exposure to Lehman Brothers, AIG or Washington Mutual and that their par value investments in each respectively was $395M, $374M and $41M.

The company has stated that $96B of their bond portfolio is rated at investment grade or better (BBB or higher). In my research the lowest component of their bond and private placements has a rating of 80% investment grade and comprises only 4% of the portfolio in the category of basic materials. 27% of the portfolio is Government and agency bonds with 22% in financials.

Their investment division holds 45% bonds, 7% of stock, 16% mortgages and 13% private placements. Mortgages are comprised of 55% Canadian and 45% US with 74% of total mortgages as commercial and 21% of the total portfolio as government insured. The remainder of the non-commercial mortgages are Canadian residential and agricultural.

Since 45% of Manulife’s investment portfolio is comprised of bonds some future losses are likely to materialize. Greater transparency of the bond portfolio would be helpful in any assessment, but likely due to the size and scale of the portfolio very few investors would have the time to perform a comparative risk assessment based on any number of factors.

Segregated funds have been a major concern of the equity markets in recent weeks and put Manulife and other insurers in the spot light. Segregated fund products in recent years have been very attractive to insurance companies and aggressively sold to investors seeking capital preservation of their investments with the potential benefit of upside as markets appreciate. As equity markets have declined significantly in recent months questions have been raised about these products and whether additional capital needs to be raised in order for companies to meet these longer-term obligations. In my situational analysis one significant internal threat for my investments in insurance companies has been the increased affinity for these products. While they offer lucrative fees and an incentive from the issuing company’s perspective the explosive growth of these products has been concerning and likely something that will be appropriately managed in future years.

One benefit is that although segregated products have been sold by Manulife in all their major markets many of these products do not require repayment for another 7-30 years and the potential costs of these products are within the stated resources of the company. Manulife continues to operate above any regulatory minimum for their capital ratios and have not yet taken significant losses attributed to these products.
Presentation
Fact Sheet

So now I have to try and answer some difficult questions:

• Do I trust management?
• Do I approve of the plan for CEO succession?
• Is the business model and business operations sustainable?
• Will the company continue to be profitable?
• Is there an element of Enduring Value?
• Have any competitive disadvantages emerged?
• Do strong fundamentals of the business, markets and customers remain?
• What am I willing to pay for the risks that have been highlighted?

At this point in my analysis I want to go back to the numbers to see how the company has performed by putting their business model into perspective. I know from following the company that earnings have not benefited or been inflated from the business being over leveraged as we saw in recent years with many large financial instituions. The company does not have material exposure to derivatives or subprime mortgages and the company has never been investigated or performed questionable accounting.

Going back to 1995 I have the following historical data on the company:

ROE: 14.8%
Div Yield: 1.75%
Payout: 25.9%
P/E: 15.4x
P/B: 2.32
Div Growth: 22.3%
BV Growth: 12.2%

Current Data:
Dividend: $1.04
BVPS: $15.80
EPS (ttm): $2.70
Yield: 4.20%
Payout: 38.5%
P/B: 1.58x

If I apply my dividend discount model to determine a FMV for Manulife as previously shown I have a few issues first to resolve.

(For investors looking to gain insight into my rationale of the next section please review parts III and IV of my fundamental analysis series).

As a value investor I need to recognize a few potential outcomes of any investment in this environment. I know that earnings, over the interim, are likely to either compress due to market weakness or stagnate under continued growth pressures. There’s also potential that an investment will experience dilution from issuance of additional common shares in the event the company needs to raise capital (assume 10% dilution). Despite my confidence in strong operating fundamentals of the company I need to provide a realistic valuation to best protect myself from risk.

I have a few options:

• I can stay consistent with my traditional valuation method
• Increase my discount rate beyond 25% to 50% to account for the greater equity risk
• Discount my expectations of full EPS for the full year 2009
• Take into consideration a worst case scenario of a 50% drop in EPS & 40% cut to the dividend

Growth Rate = [Historical ROE / Current P/B] + Historical BV Growth)



As you can see this gives me a wide range of potential valuations depending on how risky I view the investment to be. When I summarize my situational analysis, including all potential outcomes for risk, I’m confident in selecting #3 as the most appropriate valuation at this time disclosing to readers that #1 is my original FMV through which I bought the shares in May of 2007.

My reasoning for choosing #3:

The company has a targeted dividend payout of 25-35% and the payout currently sits at 38.5% which is only slightly above the historical high side for the company. The dividend in my view is safe as the company’s revenues and earnings are diversified in a number of markets and financial products. The company has adequate financial resources to sustain the dividend and earnings, as of right now, have not shown any substantial weakness that would indicate otherwise. Capital ratios for the company remain above regulatory thresholds and investments are diversified by risk in a number of asset classes and groups.

I do expect earnings to drop slightly as write-downs and loss provisions are taken to better position the company for an eventual acquisition. What I don’t anticipate is a drop of greater than 20% to full EPS for 2009 from their current level.

At current prices Manulife is likely undervalued by approximately 15% or more. At its recent 52-week low of under $22 my analysis indicates that the market perceived a drop of 50% in EPS for 2009 and a dividend cut of 40% or was looking for an adequate margin of safety nearing 50%. While I cannot rule out the possibility of a serious earnings decline or dividend cut my experience, analysis and confidence in management indicate to me that the outcome for a dividend cut and sustained drop in earnings is remote.

If the company were to issue common shares to the effect of a 10% dilution I would take the opportunity to add to my position as I view that move as prudent given the current market environment and potential for accretive acquisitions. The company is a long-term investment for my portfolio and has been wonderfully managed before this crisis to position itself in a conservative financial position and I don’t see signs of that changing now. Management was not motivated to take extreme risks in their financial products and the investment portfolio is well diversified in terms of risk. While I can’t promise that losses from certain investments won’t have an impact on earnings I do have confidence in the ability of current management to position Manulife for growth moving forward.

(Disclosure: I own common shares in MFC)

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See Also:
- Dividends4Life Stock Analysis: Manulife Financial Corp (MFC)
- TMWTFS Stock Analyses
- See it on Seeking Alpha


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Manulife Stock Analysis:

At the encouragement of Value Geek last week I am currently preparing a written stock analysis on Manulife Financial (MFC) drawing information from my situational analysis of the company.

The analysis, titled Taking Stock in MFC, will include both a qualitative and quantitative analysis of the company including my insight of their fundamentals, asset exposure and a fair market valuation (FMV) for the company.

The post will be published on Wednesday, November 5th at 2:00pm EST.

Since my analysis and valuation model takes into account past performance and future assumptions on earnings growth I feel that providing the stock analysis 24 hrs prior to the release of Manulife's third quarter results is fair.

-Taking Stock in MFC


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Inside My Dividend Dream:

In my previous post I introduced my Dividend Dream and gave better insight into the topic of Enduring Value that I’ve adapted to create a long-term investing approach focused on value and dividends. This post will look inside my decision criteria for this group of stocks, what companies comprise the DivG portfolio and what decisions I made on how to construct and organize the portfolio.

To review the current organization of my portfolios:

• Short-term Cash/Savings comprise 17.5% of my invested assets and is held in a high interest savings account.
• RSP includes only Canadian bonds, international ETF’s, US equities and ADR’s of international companies. This maximizes the efficiency of taxes on foreign income (dividends) and interest bearing investments. My RSP comprises 25% of my invested assets.
• Dividend Growth is my non-registered dividend growth portfolio that comprises 57.5% of my invested assets and concentrates on Canadian dividend/income paying equities that are eligible for the Canadian dividend tax credit.

Remember that the intent for my Dividend Dream portfolio in the future will be where money provide me with flexibility to do the things I want, give me the ability to make decisions independent of finances and allow time to create that wealth for myself and my family.

When I initially decided to create a dividend growth portfolio I had a number of decisions to make that included how many stocks to hold, what stocks to target & buy, what sectors to include and how to increase efficiencies as best as possible.

I started out with a fairly simple list of requirements as a guideline for how the portfolio would be constructed.
These included:

• A cap of 25 total common equities held within the portfolio
• Each individual stock would represent only 3-5% of the overall portfolio to mitigate risk
• Targeted portfolio pre-tax yield of 50-100bp above the Government of Canada 10-year bond
• Stock selection method requiring Enduring Value
  Targeted dividend growth rate of 5-8% (per annum)
• Targeted CAGR of 8-10% (including re-invested dividends)
• Maximize tax efficiency and create a growing tax-efficient cashflow that outpaces inflation

Stock Selection:

This is one of the most difficult phases for any investor attempting to construct an equity portfolio. While ETF’s give you exposure to an entire market, sector or group of stocks there are advantages to owning individual equities. While an ETF (such as XIU or XDV) gives you broad exposure to a large number of stocks cost effectively you gain exposure to both the good/ bad and under/over-valued within that specific group.

As a value oriented investor I have a preference of owning stocks based on a collection of my own individual criteria. In an ETF the good stocks that are under-valued can be disproportionately represented to the bad stocks that are over-valued. This leads to some obvious problems for a portfolio of Canadian dividend paying equities that isn’t nearly as diverse as a US or International group.

Another issue presents itself if I were to target owning only the bluest of dividend payers; specifically all five major banks (BMO, BNS, CM, TD & RY), all the major insurers (GWO, MFC & SLF) and all the utilities/pipelines (ACO.X, CU, EMA, ENB, FTS, TA & TRP). If I took this approach I would already be over half way to my limit of 25 common stocks before I even started to look at anything else for the sake of diversification. What about consumer stocks, the railways, the grocers, telecoms or wealth management companies? Suddenly XDV doesn’t appear to be such a bad compromise, but you don’t gain equal exposure to the entire group. My decision was to use some simple logic.

I knew I wanted to apply Enduring Value to this portfolio and I wasn’t motivated to beat the market for ego, fame or fortune. There also isn’t a financial product that cost effectively allows me to do what I want to do. What I realized through my research was that each individual company has different competencies that emerge once I began to conduct a situational analysis on them and compare within a group. Some companies have strengths in one area and weaknesses in another. Was it possible to compliment one with the addition of another without creating excessive or repetitive overlap?

I first turned my attention to the five largest banks: Bank of Montreal (BMO, Bank of Nova Scotia (BNS), CIBC (CM), TD Bank (TD) and Royal Bank (RY). I wanted a balance of exposure to a number of different banking operations and through my SA’s I determined that I wanted exposure to investment banking, retail banking and a growing presence to international banking outside the North American markets. RY fit well for its strength in investment banking, TD for its dominant retail presence and BNS for its unparalleled expansion into international banking operations. CM & BMO didn’t offer significant diversification away from the main three aside from yield and additional risk. I decided that exposure to RY, BNS and TD was sufficient for the bank section of the portfolio.

Next I turned to the insurers: Great-West Life (GWO), Sunlife (SLF) and Manulife (MFC). Each company does certain things well and has exposure to different domestic and international markets. Owning all three made sense to me for the long-term, but with GWO as part of the Power family (POW & PWF) I could easily gain exposure to Great-West indirectly through either of the two parents. I knew I wanted exposure to IGM Financial (IGM), a large wealth management company under the umbrella of the Power group, to gain a higher exposure to asset management outside of the banks I could invest into a lesser weighting of (IGM). To determine the exact ratio of how to balance IGM and a Power component initially proved to be difficult, so I bought MFC, SLF and a small position in IGM. Later I bought a heavy weighting of PWF for exposure to GWO and additionally to IGM. The decision between Power Financial (PWF) and Power Corp (POW) was simple: I didn’t have any desire to gain exposure to media assets which POW held and PWF was the better fit for more direct exposure to the key European and energy assets of the company.

For industrial exposure I chose exposure in Canadian National Railway (CNR), Canadian Pacific Railway (CP) and Russel Metals (RUS). I chose both railways companies for the distinct differences in their operations since CNR is largely a North-South operator and CP an East-West. CNR is a much more efficient railway and better managed than CP and I hold CNR in a higher relative weighting in the portfolio. RUS is a diversified metals distribution and processing company with a heavy-weight dividend. The company supplies steel infrastructure to the oil & gas industry in Western Canada and has operations in metal services and steel distribution throughout North America.

For telecom exposure I chose both Shaw Communications (SJR.B) for its western Canada exposure and more recently Rogers Communications (RCI.B) for its competitive advantages and dominant positions over national industry rivals. Both stocks hold the highest prospects for growth in my analysis and their increasing cashflow makes them attractive investments over the long-term in a capital intensive industry. While RCI.B currently holds a competitive advantage in their 3G network that will be eroded slowly over time, their competition face high costs and a changing technological environment that allows RCI.B to continue offering premier products that operate solely on their network.

For consumer stocks I chose to invest in North American cheese maker Saputo (SAP), pharmacy retailer Shoppers Drug Mart (SC) & Canadian woman’s retailer Reitmans (RET.A). As a compliment to a more predictable aspect of consumer demand I invested in Metro (MRU.A) and Empire (EMP.A) for their grocery operations across Canada. Each consumer company adds a different element of growth to the portfolio and exposure to discretionary or consumer staples in various areas of the country.

Choosing stocks for my energy exposure proved difficult. I often say that a value investor expresses humility in their actions and understanding the various elements of the energy industry is not more forte. I’ve gone with simplicity and infrastructure as the main themes for my exposure to this sector. I chose to invest in Husky Energy (HSE) for its upstream, midstream and downstream operations and a commitment to increasing its dividend. After careful study I added a complimentary natural gas & energy infrastructure company by the name of Alta Gas (ALA.UN).

Utilities and pipelines have presented one of the significant challenges to the construction of the portfolio. As with the banks I wanted to gain exposure to a number of various operations and long-term fundamentals of the specific industries. With the weakness in markets throughout 2008 valuations finally seemed more tolerable and I initiated positions in utilities Fortis (FTS) and Atco (ACO.X). Both companies have international exposure and service different regions of Canada with their operations. ACO.X has a controlling interest in Canadian Utilities (CU) and although I continue to want exposure to Enbridge (ENB) for its strong pipeline operations the valuation continues to be too expensive.

As a hedge against inflation over the long-term I decided that a prudent objective would be to invest in real estate assets away from the railway stocks and utilities. Real estate investment trusts (REITs) were the most cost effective method of investing directly in real estate and I chose two companies: Calloway REIT (CWT.UN) and Cominar REIT (CUF.UN). CWT.UN provides my portfolio with exposure to commercial shopping real estate and indirectly to Walmart who is their largest tenant. CUF.UN, a Quebec based REIT, provides exposure to commercial business real estate with large office holdings in Montreal and Quebec City.

One element of diversification that I’ve included in this portfolio is gaining exposure to preferred shares. Now these aren’t usually exciting, but with high volatility in credit markets throughout this year many preferred shares are trading on a tax-advantaged basis well above their respective commons. Since my original intention was to hold 25 common stocks I felt that exposure to an additional five preferreds would decrease the overall risk in my portfolio from common equities and decrease the long-term volatility of the portfolio when compared to the overall market. Each preferred gives me additional exposure to a sector that I felt was lacking in my portfolio. Specifically BAM.PR.J for real estate, CU.PR.B for utilities, LBS.PR.A & NA.PR.L for financials and ENB.PR.A for my desired exposure to pipelines.

For exposure to supplementary business services and business infrastructure I hold shares in Thomson-Reuters (TRI).


Dividend Growth:

For any investor starting out a portfolio of dividend stocks there is the eternal debate of whether an investor is better to own a stock of high yield and low dividend growth or a stock of low yield and high dividend growth. Throughout my stock selection process I was very keen to attempt to create a balance between both.

Stocks in the portfolio such as EMP.A, MRU.A, RCI.B, SAP or SC have always had low dividend yields, but grow those dividends in the double digits annually well above the blue chip banks or insurance companies. An investor may state that it takes a stock such as SC years to reach a cost-based yield of what a bank offers today, but for an investor with a long-term investing horizon concentrating on low yield and high growth stocks offers a very attractive method of growing my annual income at an expedited rate. It will entirely depend on the individual investors priorities, but I think a rational investor constructing a portfolio of stocks benefits from the accelerating cashflow provided by higher growing dividends over the long-term than concentrating exclusively on stocks that yield over a minimal requirement (>2%). An investor would still hold a large portion of their portfolio in 3-4% yielding equities, but yield growing stocks add a nice element of diversification for cashflow purposes that help to provide cash to fuel continued purchasing.


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Rogers’ Loss of Leadership:

Investors this weekend who owns shares in Canadian public company Rogers Communications (RCI.B) likely have heard the news that Ted Rogers has given up his duties as CEO to Alan Horn, chairman of the board of directors for the company, on an interim basis.

While current reports are that Mr. Rogers is receiving treatment for an existing cardiac condition, this no doubt will weigh heavy on the stock on Monday morning as equity markets are never comfortable with uncertainty. The hospitalization of the 75 year old media icon who founded the business bearing his name shouldn’t come as a surprise to shareholders as Ted Rogers has had a number of health issues over the years including a quadruple bypass in 1992.

While few business leaders can have the strategic vision and determination Ted Rogers possessed over the past fifty years the company is well positioned for this change in leadership. The company has been wonderfully managed for years and within the ranks of the Rogers management are a number of individuals who are more than capable of taking over the reins of the company.

My expectation is that Nadir Mohamed will continue to have a pivotal role in the operational guidance of the company from his current position of CEO of the Rogers wireless division and the most likely successor to the interim CEO Alan Horn.

Ted Rogers has expressed a keen interest in keeping control of the company in the hands of the Rogers family with both his son and daughter (Edward & Melinda) occupying executive positions in the company in cable and strategy & development. While Edward may appear to be the likely successor to the position due to his designation of controlling shareholder of the corporate family trust holding control of the A class shares, the board is likely to give the CEO position to Nadir as he possesses both the better track record of corporate responsibility, strategic vision of where the company will go with its wireless division and ability to execute effectively over the long-term.

Despite the loss of any single leader my situational analysis had listed as a significant internal weakness the possibility of Mr. Rogers stepping down. Further analysis prior to buying the stock showed that RCI.B continues to have an extensive resource of highly competent managers to draw upon to fill any gaps in their strategic focus and execution.

The company stands in a strong capital position with a competitive advantage in its wireless operations for the next 2-3 years. It has a balance of revenues from three core operating divisions and its recent third quarter numbers were very impressive. The company has positioned itself well to continue growing revenue streams with tight controls on cost and a clear focus on the business and public consumer for its products and services.

The downside to this situation is the short-term volatility that may exist when the markets factor in the uncertainty of who leads this company forward. If the shares drop substantially on Monday below $30 I will not hesitate to add to my position as I view this company as a high quality long-term investment within my portfolio.

(Disclosure: I hold common shares in RCI.B)

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