Economist Gary Becker - RIP

The following is a repost of an article offered by First Trust Advisors FTA on the passing of Mr. Gary Becker.  I have been a reader of FTA's articles and market commentary as they have been very straightforward, insightful, and informative.  I fully agree with the statement in the last paragraph:  "The world would be a better place if lawmakers of both political parties were more familiar with his work."  Enjoy.

"The economic world lost a leading thinker this weekend with the passing away of Gary Becker, who, since the death of Milton Friedman in 2006, was the most influential, and important, living economist.

Becker, who won the Nobel Prize in 1992, led an invasion of classical economic thought into previously sloppy and hidebound areas of study such as sociology, demography, and crime. He studied human capital. Think of it this way: Without Becker, bestselling books like Freakonomics wouldn’t even be possible.

Prior to Becker, the academic study of these topics was dominated by social determinists in general and Marxists in particular. So, for example, conventional wisdom held that people commit crime because of discrimination, overly strict fathers, capitalist oppression, or the exploitation of the working class.

Becker shoved all these simplistic (and unscientific) answers aside, applying the free-market principle that people have an incentive to pursue their self-interest not only as producers and earners but also outside the workplace.

To Becker, people commit crimes more often when they perceive that the benefits outweigh the costs. So, better policing to apprehend criminals and harsher sentences would result in less crime because they raise the potential costs of crime. To Becker, becoming a predator was a choice, like becoming an engineer, or a bus driver, or a politician (known as predators in some circles).

Becker was instrumental in developing the economic analysis of the family, fertility and marriage. He also focused on drug addiction and education. Decades ago, he analyzed education as an investment choice, with time as a key cost of investment. Becker is largely responsible for this now being the mainstream view.

One of his early path-breaking findings was that employment discrimination can hurt not only workers who are discriminated against but also the firms that discriminate, particularly in more competitive business sectors. And so, firms in competitive sectors have an incentive to hire the best workers regardless of race, ethnicity, religion, or sex.

It’s also fair to say that he didn’t think highly of the direction of economic policy in the US over the last several years. Becker noticed that the largeness of some corporations could undermine effective decision-making, but thought the problem much worse with the federal government because it was involved in so many endeavors and faced no competition at all.

Becker opposed further increases in the minimum wage, opposed Dodd-Frank, supported lower taxes on Corporate America, and argued that a larger more-intrusive government cuts economic growth.

In recent years some economists have argued that we are in an era of “secular stagnation,” where we simply have to accept slow economic growth. Becker said the theory was just another version of a similar theory that had popped up in the past, and would likely be proven untrue with time. Innovations in energy and health care could push the economy back toward a faster growth path and government policy should focus more on economic growth and less on redistribution.

The world would be a better place if lawmakers of both political parties were more familiar with his work. We’re not holding our breath waiting for that to happen. But long term shifts in public thinking sometimes start in the academic world, which Gary Becker changed for the better by challenging and enlightening, making many see the world with clearer vision than they had before".

I appreciate your time and interest in Guiding Mast Investments, George Fisher

What to do With Foreign Dividends

Besides fixed income, one asset allocation that is often overlooked is foreign dividend paying stocks.  While some may think there is not much difference between foreign dividend payers and their US counterparts, the reality is there are several important aspects to consider.

The first is the impact of foreign exchange fluctuations between the payer’s currency and the US dollar.  Even with ADRs, (American Deposit Receipts) that trade on US exchanges, dividends are paid in the currency of the country the company is domiciled in.  For example, HSBC Holdings (HSBC), the parent company of giant international HSBC Bank and formerly known as Hong Kong Shanghai Bank is headquartered in London after moving from Hong Kong in 1999.  While the stock has dual listings on both the Hong Kong and London exchanges, the company reports its results and pays its dividends in Great Britain Pounds (GBP). 

One HSBC ADR traded on the NYSE represent five London traded shares and ADR investors in America acquire five times the dividend per London shares because of this ratio.  Therefore, if the London shares announced a USD $0.10 per share dividend, ADR investors would receive $0.50 per ADR.  However, dividends are declared and paid in GBP, not USD.   For example, over the past nine years, the list below are the annual dividend paid by HSBC.

Year;  Pound dividend declared;  USD : Pound exchange rate;  USD dividend paid per London Share;  Total dividend paid per ADR

2013 - 0.3016 - 1 : 1.62 - $0.49 x 5 = $2.45

2012 - 0.2816 - 1 : 1.74 - $0.49 x 5 = $2.45

2011 - 0.2597 - 1 : 1.57 - $0.41 x 5 = $2.05

2010 - 0.2273 - 1 : 1.58 - $0.36 x 5 = $1.80

2009 - 0.2179 - 1 : 1.59 - $0.34 x 5 = $1.70

2008 - 0.3826 - 1 : 1.67 - $0.64 x 5 = $3.20

2007 - 0.4593 - 1 : 1.99 - $0.90 x 5 = $4.50

2006 - 0.4193 - 1 : 1.93 - $0.81 x 5 = $4.05

2005 - 0.4033 - 1 : 1.81 - $0.73 x 5 = $3.65

The impact of the exchange rate fluctuations becomes quite clear using the above long-term table.  As the USD strengthens and the GBP declines, the USD dividend paid goes down, and the opposite is true.  For example, the highest exchange rate is in 2007 at 1:1.99 and the lowest is in 2011 at 1:1.57.  This represents a 21% differential.  All else being equal, the same declared dividend by HSBC in GBP could fluctuate by as much as 21% for US investors, based on exchange rates.

American investors buying foreign stocks will receive a higher relative USD dividend when the USD is weaker than when it is stronger – regardless of the amount declared and paid in the foreign currency.  If you believe the USD is in a cyclical or structural decline versus other currencies, then investing in foreign dividend paying stocks could provide a improved return than dividend growth alone.

Below is one of several online currency exchange rate graphing sites.  This one is easy to use and allows for 5-year graphs.  It is important for investors to appreciate the impact of currency exchange fluctuations on the income received.

http://www.oanda.com/currency/historical-rates/

Another aspect is the taxation of foreign dividends and the impact on total stock returns. The discussion below should not be construed as tax advice and a qualified tax advisor should answer all questions.   In the US, most dividends are separated into “qualified” and “non-qualified”, with different income taxes for each category.  Unless specified, for US residents, the IRS does not withhold taxes from each dividend payment and all taxes are due annually.   However, this is not the case with foreign governments.

Each country either has or has not a tax treaty with the US. Usually, if the country has a tax treaty with the US, the issue of withholding taxes is addressed and amounts of withholding are set via the treaty.   Some countries exempt all dividends from withholdings while others limit the exemption to IRA-type account only.  Others have no exemption regardless of where the investment is held. 

For most investors with less than $300 deducted in tax withholding from dividends from investments held in non-tax advantaged accounts, it is pretty simple to reclaim this withholding.  There is a line on your personal Form 1040 for foreign dividend taxes paid, and it is a credit again total tax due.   

However, the amount withheld may not be a one-for-one offset.  From the IRS Publication 514: “The amount of foreign tax that qualifies as a credit is not necessarily the amount of tax withheld by the foreign country. If you are entitled to a reduced rate of foreign tax based on an income tax treaty between the U.S. and a foreign country, only that reduced tax qualifies for the credit.”

 For example, Switzerland has a 35% withholding rate, even though the US Tax Treaty stipulates a 15% tax due. Since the Swiss government does not which country the investor is located, they withhold the same 35% for every investor.  In this case, taxpayers can deduct only 20% of the 35% withheld by the Swiss government.  

Investors should not shy away from investing in foreign dividend paying stock just because of these tax issues.  The final impact should be figured into the anticipated return to determine the desirability of the specific investment.

For instance, Pargesa (PGRAF) is a Swiss-based investment holding company that owns 50% of Groupe Bruxelles Lambert (GBLBF).  GBLBF is headquartered in Brussels.  PGRAF is subject to 35% Swiss withholding while GBLBF is subject to 25% Belgium withholding – even though the dividend is originally paid by GBLBF.  The investment thesis for holding the higher-taxed PGRAF is the possibility that the Frere Family may purchase all shares sometime in the future, which could be at a premium to the added taxes paid over time.

Canadian companies usually do not withhold tax for investments held in IRA-type accounts, but will for accounts with no tax advantages.

It is important for investors to determine their exposure to foreign withholding dividend tax, and the ability to recoup the tax, prior to investing in the shares. 

More information can be found at the IRS website here:

http://www.irs.gov/pub/irs-pdf/p514.pdf

http://www.irs.gov/Individuals/International-Taxpayers/Foreign-Tax-Credit-Compliance-Tips

Below is a list of tax withholdings by country:

No withholding tax will be credited from the following countries:

Cuba, Iran, Libya, North Korea, Sudan, Syria

The table below lists the countries that have no withholding taxes on dividends paid to U.S. residents:

http://www.djindexes.com/mdsidx/downloads/withholding_tax.pdf

Countries with No Tax Withholding Rate for Dividends:

Argentina 0.00%, Bahrain 0.00%, China - Red Chips 0.00%, Colombia 0.00%, Croatia 0.00%, Cyprus 0.00%, Egypt 0.00%, Estonia 0.00%, Hong Kong - Local Shares  0.00%, India 0.00%, Jordan 0.00%, Mauritius 0.00%, Oman 0.00%, Qatar 0.00%, Singapore 0.00%, Slovakia 0.00%, South Africa 0.00%, Tunisia 0.00%, United Kingdom 0.00%, UAE 0.00%, Vietnam 0.00%

The following table below shows the withholding tax rates by country on dividends paid to U.S. residents:

Country Withholding Tax Rate for Dividends

Australia 30.0%, Austria 25.0%, Bangladesh 15.0%, Belgium 25.0%, Bosnia 5.0%, Brazil 15.0%, Bulgaria 15.0%, Canada 15.0%, Chile 35.0%, China - A Shares* 10.0%, China - B Shares**, 10.0%, China - C Shares*** 10.0%, Czech Republic 15.0%, Denmark 28.0%, Finland 28.0%, France 25.0%, Germany 26.4%, Greece 10.0%, Hungary 10.0%, Iceland 15.0%, Indonesia 20.0%, Ireland 20.0%, Israel 20.0%, Italy 27.0%, Japan 10.0%, Kazakhstan 15.0%, Kenya 10.0%, Kuwait 15.0%, Latvia 10.0%, Lebanon 10.0%, Lithuania 15.0%, Luxembourg 15.0%, Macedonia 10.0%, Malaysia 25.0%, Malta 35.0%, Mexico 10.0%, Morocco 10.0%, The Netherlands 15.0%, New Zealand 30.0%, Nigeria 10.0%, Norway 25.0%, Pakistan 10.0%, Peru 4.1%, Philippines 30.0%, Poland 19.0%, Portugal 20.0%, Romania 16.0%, Russia 15.0%, Saudi Arabia 5.0%, Serbia 20.0%, Slovenia 20.0%, South Korea 27.5%, Spain 19.0%, Sri Lanka 10.0%, Sweden 30.0%, Switzerland 35.0%, Taiwan 20.0%, Thailand 10.0%, Turkey 15.0%, UK - REITS only 20.0%, Ukraine 15.0%

Disclosure:  I am long HSBC, PRGAF, GBLBF.  HSBC is followed by Guiding Mast Investments newsletter

I appreciate your time and interest in Guiding Mast Investments,  George Fisher

Are Non-Traded REIT Right for You?

What are “Non-Traded REITS”?  These are real estate investment trusts very similar to their publicly traded counterparts.  Non-traded REITs are not available to all investors and are usually sold by financial advisors and broker-dealers. Non-traded REITs have some basic differences from listed REITs in their commissions and sales fees ranging from about 7% to 15% and in their average yield of 6.7% vs a listed average of 3.3%. 

From a 2012 Forbes article, “Non-Listed REITS continue to be an excellent source of hard-asset investing for suitable investors,” says Investment Program Association (IPA) CEO and President Kevin Hogan. “Meant to be held for the long term, these products provide significant benefits, including true portfolio diversification, to the retail investor who typically would not have access to such options.” Hogan adds, “the structure and lifecycle of these products allow you and I the unique opportunity to invest in office buildings, medical facilities or retail malls, managed by world class real estate firms. This design is a significant value proposition of these products. There is no better time for investors to consider adding these products to their portfolios than now.”

Collectively, non-traded REITs represent about $100 billion in investor assets vs. its traded brethren with about $500 billion in investor assets. 

There are 63 non-traded and private REITs listed on NARIET website as Association members (with links to each home page) and the list is found here:  http://www.reit.com/investing/investing-tools/reit-directory/public-non-listed-private-real-estate-companies

FINRA offers an article on the pitfalls of non-traded REITS and it can be found here: http://www.finra.org/investors/protectyourself/investoralerts/reits/p124232

Below is a list of the difference between non-traded REITs (NTR) and exchange traded REITs (ETR) from this article:

Listing Status

NTR - Shares do not list on a national securities exchange.

ETR - Shares trade on a national securities exchange.

Secondary Market

NTR - Very limited. While a portion of total shares outstanding may be redeemable each year, subject to limitations, redemption offers may be priced below the purchase price or current price.

ETR - Exchange traded. Generally easy for investors to buy and sell.

Front-End Fees

NTR - Front-end fees that can be as much as 15% of the per share price. Those fees include selling compensation and expenses, which cannot exceed 10%, and additional offering and organizational costs.

ETR - Front-end underwriting fees in the form of a discount may be 7% or more of the offering proceeds. Investors who buy shares in the open market pay a brokerage commission.

Anticipated Source of Return

NTR - Investors typically seek income from distributions over a period of years. Upon liquidation, return of capital may be more or less than the original investment depending on the value of assets.

ETR - Investors typically seek capital appreciation based on prices at which REITs’ shares trade on an exchange. REITs also may pay distributions to shareholders.

Also from the FINRA article, “Private REITs - There is another type of REIT—a private REIT, or private-placement REIT—that also does not trade on an exchange. Private REITS carry significant risk to investors. Not only are they unlisted, making them hard to value and trade, but they also generally are exempt from Securities Act registration. As such, private REITs are not subject to the same disclosure requirements as public non-traded REITs. The lack of disclosure documents makes it extremely difficult for investors to make an informed decision about the investment. Private REITS generally can be sold only to accredited investors, for instance those with a net worth in excess of $1 million. As with any private investment, it is a good idea to have the investment reviewed by an investment professional who understands the product and can offer impartial advice.”

For most investors, sticking with the diversity of publically traded REITs would be recommended.  Non-traded and private REITs are fraught with investment pitfalls that can be avoided by utilizing their more transparent brethren.

Disclosure: No positions

I appreciate your time and interest in Guiding Mast Investments, George Fisher

Canadian Power Companies Will Add Power to Your Portfolio

Power Financial (PWF.TO) and Power Corporation (POW.TO) are powerhouse Canadian financial companies connected at the hip.  Founded by the Demarais family, these two companies are usually overlooked by US investors.  However, they offer stable exposure to Canadian financial consumers and to European equity markets.  Investors seeking greater exposure to Canadian financial markets should review both companies.

Power companies reach 12 million Canadians and serve about 1 in every 3 Canadian citizens.   The Power companies  proved their investment value during the financial crisis of 2007 to 2009 by actually earning their dividends.  However, like much of the rest of the financial sector, Power company stocks slid by about 50% before rebounding in 2010.

Power Corp is a holding company whose largest investment is a 68% ownership of Power Financial.  As the organizational chart describes, POW also owns a communications and media firm along with various investments.   The investments include private equity positions in companies in Europe, the US, China and the Pacific Rim. 

Power Financial Corp is a financial services company involved in insurance, money wealth management, and European equity investments.  PWF offers some well-known financial services brands, such as Canada Life, Great-West Life and Putnam Investments.   ICM Financial offers wealth management services along with commercial employee benefit packages.  PWF, through its interest in Pargessa (PRGAF), owns about 13.9% of Groupe Bruxelles Lambert (GBLBF), itself a holding company with concentrated equity investments in major European companies.    For example, GBL owns a 3.6% interest in the French oil-giant Total (TOT) and represents about 20% of GBL’s book value. 

I strongly suggest reviewing the Organizational Chart on their website here:  https://www.powercorporation.com/en/about/organization-chart/

Both pay a dividend which was pretty stable during the recent financial crisis.  However, both POW and PWF have not raised their dividend since 2009.  POW pays a dividend of CAD$1.16 while PWF pays CAD$1.40 per share.  At a current price of $31 for POW and $35 for PWF, the current yield would be 3.8% and 4.0%, respectively. 

Comparing the value fundamentals, both POW and PWF are about equal with PE’s of 14.7 and 13.5, and both carry the same consensus buy recommendations at a lukewarm 2.4.

The biggest fundamental difference is price to book value valuation where POW is trading at 1.2x book value while PWF is trading at a premium of 1.8x book value.   One reason for this discrepancy is the better 10-yr average return on invested capital ROIC of PWF at 8.7% vs a 10-yr average ROIC for POW at 5.9%.

If consensus price targets of $35 for POW and $39 for PWF are reached over the next two years, POW would generate a 13.2% total annual return while PWF would generate a 9.7% total annual return. 

Power Corp has a higher Navigator Rating by virtue of its lower current valuation and is in a buy range while Power Financial is a neutral Rating, mainly due to its premium to book value.

POW’s other assets above its ownership of PWF provide some interesting diversification.  However, the bulk of POW’s  cash earnings, and hence dividends, comes from PWF.  For the year 2013, total-operating earnings for POW was $1.035 billion, with PWF accounting for $1.124 billion and the balance generating a loss of $89 million.   

Power Corp owns the controlling interest in PWF.  In addition, POW’s exposure to the other assets offering a potential turnaround makes POW the preference between the two.   With the dividend payout ratio fluctuating between 52% and 64%, earnings growth from here should create the opportunity for increasing the dividend to match earnings growth.    

We are adding Power Corp POW.TO to our list of followed companies. 

More information on POW can be found on its website: https://www.powercorporation.com/en/

We have a long positions in POW.TO.  It is followed by Guiding Mast Investments monthly newsletter.

I appreciate your time and interest in Guiding Mast Investments, George Fisher

Wisdom of Crowds: Crowdsourced Stock Opinions Beat Analysts

We do not all have the same opinion concerning the fortunes-to-be of the US and international economy, and we hold very diverse opinions of the fortunes of specific companies.  However, within the confines of these various views lies a very powerful force – what is known as “crowdsourcing”. 

From Wikipedia:  

"Crowdsourcing is the practice of obtaining needed services, ideas, or content by soliciting contributions from a large group of people, and especially from an online community, rather than from traditional employees or supplier.  This process is often used to subdivide tedious work or to fund-raise startup companies and charities, and can also occur offline.  It combines the efforts of numerous self-identified volunteers or part-time workers, where each contributor of their own initiative adds a small portion to the greater result. The term "crowdsourcing" is a portmanteau of "crowd" and "outsourcing"; it is distinguished from outsourcing in that the work comes from an undefined public rather than being commissioned from a specific, named group."

It now seems there is economic value in crowdsourcing stock market information and the consensus of the future for specific companies along with their stock.  This week, Wall Street Journal’s publication Venture Capital Dispatch posted an article titled “Study: Crowdsourcing Stock Opinions Beat Analysts”.  A link to the article is found here:

http://blogs.wsj.com/venturecapital/2014/03/19/study-crowdsourced-stock-opinions-beat-analysts-news/

From the site estimize.com, Estimize Research, a description of the study:

"The study published by researchers from the City University of Hong Kong, Purdue University, and Georgia Institute of Technology found that bloggers on SeekingAlpha in aggregate were better able to predict earnings surprises and stock returns than Wall Street’s sell side pros and traditional financial news outlets."

From the WSJ article:

"SeekingAlpha.com, run by venture-backed Seeking Alpha Ltd., based in Ra’Anana, Israel, is a forum for investors who write opinion pieces about stocks for the site. An editorial board vets the quality of the blogs and posts up to 250 articles every day.

Researchers analyzed about 100,000 Seeking Alpha articles and commentary published between 2005 and 2012 for the paper “Wisdom of Crowds: The Value of Stock Opinions Transmitted Through Social Media,” which is forthcoming in the Review of Financial Studies."

The study used SeekingAlpha as its platform due to its broad base of contributors.  With its active and open comment section, the ability of interaction between author and reader will many times bring in new information that expands the discussions of the specific investment opportunity.  There are over one million readers registered on the site.  SeekingAplha has become one of the leading financial websites for original analysis of a wide variety of investment concepts. 

I have been a contributor on SeekingAlpha since February 2010, and have published almost 300 articles on their website.  My emphasis has been on specific companies that provide investors with relative fundamental value and that most likely pay a dividend, with a focus tilted to the utility sector.  I whole heartily support SeekingAlpha as an excellent resource for investment research and am pleased to have been associated with them.  For a time, I used the pen name Jon Parepoynt.  Below are links to a list of articles authored by George Fisher and Jon Parepoynt:

http://seekingalpha.com/author/jon-parepoynt/articles

http://seekingalpha.com/author/george-fisher/articles

Author’s note:  Wondering Aloud - How many of these 100,000 articles were mine?

I appreciate your time and interest in Guiding Mast Investments, George Fisher

Barron's 2014 Asset Allocations of the Big Boys

Barron’s offers a yearly breakdown of asset allocations for the leading 40 private wealth managers.  While not necessarily advisable for all investors to follow, comparing your portfolio construction to these money mangers’ portfolio asset allocations may provide a few interesting personal assessments.

Some thought-provoking changes to the average allocation of these money managers over the past three years have been the decline in fixed income’s allocation from 33% to 26%.  The major backdrop for this movement is the current low interest yield and subsequent higher current risk levels to rising interest rates.   This restructuring represents a 21% reduction in fixed income allocations over the past 24 months. 

Where is that money going?  It would seem to be landing in higher allocations for foreign stocks in developed countries along with higher alternative hedge funds and private equity allocations.  Below is a table of Penta's annual asset-allocation survey, as published by Barron’s, for 40 leading wealth management firms.  The table reviews the average asset allocations as reported for the past three years. 

Asset Classifications               2014      2013       2012

Stocks Total                             51.1%      48.0%     44.7%

Stocks US                                 31.0%      30.0%     30.7%

Stocks Developed                    14.0%      10.0%       8.4%

Stocks Emerging                       6.0%        7.0%        5.6%

Income Total                            25.8%     29.0%     33.2%

Income US                                23.0%     25.0%      29.4%

Income US High Grade            19.0%      21.0%       23.8%

Income US High Yield                4.0%        4.0%          5.1%

Income Developed                      1.0%         1.0%          1.8%

Income Emerging                         1.8%         2.5%          2.1%

Alternative Total                        20.4%      20.0%        17.7%

Alternative Real Estate                  3.1%        3.0%          2.8%

Alternative Commodities               1.9%        3.0%          3.4%

Alternative Hedge Fund, PE,

    Other                                          14.1%       13.5%          11.7%

Cash                                                2.8%        2.6%          3.9%

Source: Barron’s and GuidingMastInvestments.com

Stocks, in general, increased in allocation by 13% with US and emerging markets allocations remaining relatively flat.  Developed country equities exposure almost doubled, from 8.4% to 14.0%. 

As one measure of diversification, this table should provide some additional insight into your own portfolio construction.  To duplicate this table using your own investment is pretty easy.  List all your holdings and their value by position.  Then, list next to them the appropriate broad category from the table above.  Sort by the categories, sub-total each, and generate a percentage of the whole portfolio.  Mutual funds are easy to identify by their name and a quick review of their top 10 holdings. 

While each investor should know their own personal risk profile and a “one size fits all” approach to investing might be unrealistic, comparing various portfolio designs should create for some self-reflection.  Ask yourself, “Do I have exposure to all these asset classes, regardless of allocation percentage? And if not, why not?”

It is important for investors to appreciate the interconnectability of their individual investment selections to the whole portfolio construction.  This simple table is one additional tool investors can use to better analyze their holdings and to hopefully better match individual risk profiles with investment selections.  

The entire Barron’s article can be found here:

http://online.barrons.com/article/SB50001424053111903713804579391420179385190.html#articleTabs_article%3D0

The 2014 survey allocation table can be found here:

http://barrons.wsj.net/public/resources/documents/BARRONS_PRIVATE_EQUITY_ALLOCATIONS_2014.pdf

Disclosure: No positions

I appreciate your time and interest in Guiding Mast Investments,  George Fisher

Equity Quality Ratings and Why It's Significant for Investors

 

Standard and Poor’s Capital IQ stock reports offers an intriguing insight into a company’s history of creating shareholder value over the longer term. Known as the “Quality Rating” S&P rates companies on a very important matrix – earnings and dividend growth over the previous ten years. Long-term investors rely on these two fundamentals to drive share prices higher over time.

RIA firm QVM Group offers a good recap of the criteria on their website:

“The starting point in the ranking process is a computerized scoring system based on per-share earnings and dividend records over the most recent 10-year period, a time period sufficient to measure a company’s performance under varying economic conditions. The system measures growth, stability within the trend line, and cyclicality. From these, scores for earnings and dividends are determined. The system makes allowances for company size, since large companies have certain inherent advantages over smaller ones.

Once computed, a final score is measured against a scoring matrix. The results are reviewed and sometimes modified, because no mechanical system can evaluate the many special considerations that could affect a company’s earnings and dividend record.

The Standard and Poor’s Earnings and Dividend Ranking System have seven grades:

A+, A, and A- are above average;

B+ is average;

B, B-, and C are below average;

An NR designation (no ranking) is given to common stocks with insufficient historical data or because the stock is not amenable to the ranking process. As a matter of policy, Standard & Poor’s does not rank the stock of foreign companies, investment companies, or certain finance-oriented companies;

D signifies a company in reorganization.”

S&P Capital IQ reports should be a staple of most brokers’ research offerings.  Investors should be reviewing their on-line broker’s research offerings and utilizing them for specific due diligence information.  As investors develop overall criteria for stock selection, the Quality Rating should be included as a basic rating to review. A+ is the highest ranking offered.  S&P Capital IQ follows about 1500 companies and there are only 47 companies included in the A+ category. 

Some broker's stock search criteria include Equity Ratings as a screening tool.  Fidelity allows clients to use this criteria as one of the fundamental screening options.  It is then possible to develop a complete listing of all companies that fall within a specific equity rating.  For example, this screen could generate a list of all companies rated A+ and A, only.

Of these 47 highest rating companies, My Investment Navigator closely follows 15.

The sectors with A+ ratings are not equally distributed, with the majority falling into industrial and consumer sectors.  Combined, these two sectors comprises about 45% of companies rated A- and higher.  Technology, Energy and Financials comprise 4.8%, 3.3% and 5.8%, respectively.   

Another easy method of finding stocks rated as A- and better is to review the holdings of the PowerShares High Quality ETF (SPHQ).  This ETF follows the S&P 500 High Quality Rating Index The Index information can be found here:

http://us.spindices.com/indices/strategy/sp-500-high-quality-rankings-index

The index include companies that are rated A- and higher and who are included in the S&P 500 Index. Of the 500 companies in the Index, about 130 qualify for this rating.  To be included in this index, the major characteristics would be to be a larger cap firm in the S&P 500 and to generated above average high earnings and dividend growth from 2003 to 2013. 

This time period include the Great Recession.  Reviewing ratings prior to mid-decade and comparing them to the current ratings would find the biggest change would be in the financial sector.  Both earnings and dividends were hard hit and reflect the majority of financial sector ratings in the B range, B- to B+. 

S&P Quality Ratings should be reviewed as a basic research tool. For example, conservative, long-term investors may want to include mainly higher rated companies in their portfolio selections.   

I appreciate your time and interest in Guiding Mast Investments, George Fisher

Why ROIC Comparisons are Important for Investors

Return on invested capital (ROIC) is one of the most important and overlooked matrix for management evaluation. Within a specific sector, many investors compare earnings, earnings growth, dividend, and yield. Some will scribble these numbers on the back of a napkin, others using spreadsheets. However, they may be missing an interesting fundamental comparison tool, especially in the capital intensive, low growth, and usually regulated environment of utilities.

The majority of investors should be familiar with return on equity (ROE) and this ratio is available as a standard analytic tool. Most financial reports and stock summaries will, as a minimum, list the trailing twelve month ROE.

However, if two similar companies generate the same return on equity, but one utilizes twice the debt capital, management should not be viewed as generating equivalent shareholder value.

ROIC evaluates company earnings to its total capital investment by combining both shareholder equity and total debt. The ability of management to produce profits from the available capital created through equity and through debt issuance gives a clearer picture of management effectiveness, especially in capital-intensive businesses. In general, some believe management should grow long-term earnings about in line with its multi-year ROIC achievements.

According to the Public Utilities Fortnightly, a utilities industry trade magazine, discipline in capital expenditures is the key to improving ROIC. Due to the combination of high capital expenditure needs and debt funding, better managers will utilize their available leverage to increase returns. According to the article, which focused on the top 40 public utilities, ROIC had a much higher correlation to 3-year total stock returns than either dividend yields or gross margins.

The problem with consistently using ROIC as a comparison tool is the complexity of the formulas and the lack of easily accessible presentations. Most company reports and stock summaries do not specifically offer a ROIC management effectiveness assessment. Rather than just looking up a number on a stock summary, ROIC evaluations sometimes have to self-calculated. Listed below is one of the most basic formulas:

Net profit (also called net earnings) divided by total investment (total debt plus total equity), then multiplying by 100 to arrive at a percentage.

All of the components of the formula can be found on the company’s income and balance sheets. There is also a more complex ROIC formula called the DuPont Formula that incorporates deployment of assets and cost controls. Further evaluating ROIC with management’s weighted average cost of capital (WACC), also known as the ROIC Spread, probably gives the truest picture of management’s financial performance.

Again, the problem is being user friendly. While the raw data is readily accessible, most investors overlook the need to actually do the calculations. It is also critical to have consistency in acquiring the data; such as does the net profit calculation include taxes and is it before or after special charges.

Years ago, I read an article that discussed an easier return on invested capital comparison using a formula that incorporates readily accessible ratios. While I am not a math whiz or an accountant (and I expect to hear a lot from them), the formula is easy to calculate and remember:

ROIC = Return on equity divided by (1 + total debt to equity)

While not as exacting as the actual ROIC formula, the modified version incorporates the amount of debt management utilizes. By using the same source for the basic raw data, consistency becomes less of an issue. For instance, the ratios used in the modified formula are available on Yahoo.Finance.

Morningstar.com offers their ROIC calculations equities they follow and is available in the “Key Ratios” tab of their stock summary report.  Fastgraph.com offers interesting graphics of historical ROIC ratios by company through their premium service.  Reuters.com offers trailing twelve month and 5-yr average ROIC on its “Financial” tab from its stock summary report page.

For example, AES Corp (AES) has generated a trailing twelve month ROE of 9.53% and is pretty close to American Electric Power (AEP) 9.48% ROE. However, AES carries a current debt to equity ratio of 2.73 compared to AEP’s 1.22. The return on invested capital ratio for AES would calculate to 2.55% compared to AEP’s 4.27%. Over the past 12 months, AEP’s management has generated a substantially higher return for shareholders based on all the capital at its disposal than AEP.

Applying the return on invested capital formula to the Dow Jones Utility Average stocks would produce the following table (Return on Equity - Total Debt to Equity Ratio - and Return on Invested Capital):

Dominion Resources (D)       16.67%     1.10     7.94%

Centerpoint Energy (CNP)     12.46%     1.93    4.25%

NextEra Energy (NEE)            10.10%      1.32    4.35%

AES Corp. (AES)                       9.53%     2.73    2.55%

American Electric Power (AEP)     9.48%     1.22     4.27%

Consolidated Edison (ED)         8.80%     1.10       4.19%

NiSource Inc. (NI)                       8.58%     1.50      3.43%

Southern Co. (SO)                      8.40%     1.16       3.89%

Exelon Corp. (EXC)                     7.70%    0.73     4.45%

Edison International (EIX)           7.70%    0.97      3.91%

Duke Energy (DUK)                     6.45%   0.99      3.24%

PG & E Corp. (PCG)                     5.43%    1.01       2.70%

FirstEnergy Corp. (FE)                  2.91%   1.62         1.11%

Reviewing the same type of information for large-cap oil and gas exploration stocks would generate the ROIC comparison table below (Return on Equity - Total Debt to Equity Ratio - and Return on Invested Capital):

BP (BP)                  19.00%     0.36      13.97%

Chevron (CVX)      14.98%     0.13      13.26%

Total SA (TOT)       11.62%      0.44      8.07%

Suncor (SU)             9.53%     0.27      7.50%

ExxonMobil (EXC)    7.70%     0.87      4.12%

Apache (APA)           6.86%    0.27      5.40%

Source: Finance.Yahoo

There are many short-term factors that might constrain or exaggerate ROE figures and these types of ratios are best reviewed over time. Taking into consideration reduced demand in some economic sectors due to sluggish economic activity, returns for some companies over the past year have been lower than their historic average and should improve going forward. Keep in mind this is only a snapshot of management’s effectiveness today.

Adding a return on invested capital ratio to basic stock research may assist in identifying better quality management that could provide better shareholder returns. The more tools incorporated in research, the more prepared an investor becomes in making market-beating stock selections. The addition of one more column to the scribbling on the back of your napkin may prove to be enlightening.

Disclosure:  I am long AEP, SO, EXC, APA, SU.  These companies are followed by Guiding Maast Investments  monthly newsletter.

I appreciate your time and interest in Guiding Mast Investments, George Fisher

Nine Overlooked Equities for 2014

It seems to be the season for financial writers to offer their ideas of potential investments opportunities that could be considered during an investor’s annual review of current portfolio performance.  Below is my offering.

I maintain a research list of about 130 companies (mainly dividend payers) that evaluates various fundaments of each.  These include:

• changes in 2014 (soon to be 2015) earnings estimates,
• 5-yr estimated eps growth rates,
• 2014 PEG ratio,
• current dividend yield,
• broker timeliness consensus,
• price target consensus (while most targets are offered for forward 12 months periods,  I look at these as potentially 24 month goals),
• S&P Quality Equity Ranking for 10-yr consistency in earnings and dividend growth. 

 In addition, I calculate anticipated annual 2-yr total returns for each.  From the top thirty companies, the following are some equities worthy of further research.

Och-Ziff (OZM): Target price of $17, distribution yield of 9.8%, anticipated 2-yr return of 12.3% annually, 2014 PEG ratio 0.55. I prefer to buy money managers than to buy the products they sell.  While OZM has had a great run in 2013, it is still underfollowed and under owned.  The corporate structure creates tax-advantaged distributions and the current yield is above average.  The largest distribution payment is in February and is based on the income from annual incentive fees.  World markets need to grow by 6% and OZM needs to continue to gain market share in its assets under management for this stock to continue to perform well.  Investors also need to appreciate hedge fund managers use their shares as a part of employee compensation.   

Macquarie Infrastructure (MIC): Price target of $68, dividend yield of 6.6%, anticipated 2-yr return 20.8% annually, 2014 PEG ratio 1.63.  Another high dividend yield stock, MIC offers an interesting diversification into private jet airport services at 62 airports, 12 port bulk liquid storage terminals for  petroleum products and other liquids, gas distribution in Hawaii and central heating/cooling.  The airports and bulk storage generate about 80% of profits.  The firm is structured as an LLC,  much like OZM, and management has targeted an 80% to 90% payout. The Australian investment bank Macquarie Group (MQBKY) is the manager.  While the firm has been paying down debt and now stands at a debt to equity ratio of 0.95, the heavy debt load almost sunk the company in 2009.  While MIC is an interesting prospect, I personally have a hard time adding more shares as I bought some at $20, $1.59 and $2.69 back before and during the crash of both MIC and the overall market in 2009.  If I did not already own it, MIC would be on my list of buys.  

Halliburton (HAL): Target price $65, dividend yield 1.2%, anticipated 2-yr return 15.5% annually, 2014 PEG ratio 0.57.  The oil services business will continue to flourish both in the US and abroad.  HAL offers a bit better value than its peers offer and is a good portfolio diversifier of positions in large cap integrated oil companies.    HAL lives off the capital expenditure budgets of oil companies.  As long as cap ex stays strong, and is driven by higher oil prices, HAL should continue to prosper.

Dorchester Minerals (DMLP): Price target $32, distribution yield 7.4%, anticipated 2-yr return 22.1% annually, 2014 PEG ratio 1.91.  Over the past few years, DMLP has added oil production royalties to its core natural gas royalty business.   About 50% of income is now generated from oil royalties.  DMLP is structured as an MLP and, by design, offers no UBIT exposure.  As natural gas pricing rebounds, DMLP’s unhedged positions will benefit, as will its unit holders.  DMLP has assets in most of the nameplate energy plays in the US, and only about 30% of its land has been developed.  Compared to many oil/gas trusts, DMLP’s reserve decline has been minimal over the years, with much of the upward revisions coming from organic growth. 

Glencore Xstrata plc (GLCNF.PK):  Price target $8, dividend yield 3.0%, anticipated 2-yr return 33% annually, 2014 PEG ratio 1.07.  GLCNF is the world’s largest commodity trader and owns industrial mineral mining assets of coal, copper, zinc and iron ore. As the global economy continues to improve, the demand for industrial commodities will follow suit.   Glencore Xstrata has strategically expanded into the agricultural commodities through the purchase of the grain handling assets of Canadian and Australian-based Vittera this year.   An position in GLCNF offers diverse exposure to various commodities.  However, the dividend in paid in Swiss Franc and the international withholding tax is 35%.  The tax is recouped when filing personal taxes as “foreign taxes paid”.  The unsponsored ADR trades lightly with an average daily volume of 35,000 shares. 

Suncor (SU): Target price $45, dividend yield 2.2%, anticipated 2-yr return 18.3% annually, 2014 PEG ratio 1.65.  One of the premiere oil sands producers, SU has interests in offshore assets, marketing and refining as well as substantial natural gas reserves.  While there is still uncertainty as to the development of the Keystone pipeline to increase demand for oil sands, a western pipeline to the Pacific coast and the Chinese markets continues to move ahead.  Either way, through the US or to the Pacific, the necessary pipelines/transportation will be built to allow for expansion of oil sands production.  SU will be a direct recipient of higher demand. 

HSBC Holdings plc (HSBC): Target price $65, dividend yield 3.6%, anticipated 2-yr return 12.5% annually, 2014 PEG ratio 0.97.  HSBC is an international bank with strong exposure to the Asian markets.  As global interest rates increase, so will bank and insurance company profits.  The company operates a network of 6,600 offices in 81 countries in Europe, Asia, Hong Kong, the Middle East, North Africa, North American and Latin America.  HSBC offers exposure to both emerging markets and to developed countries.  Unlike its US counterparts, the bank has lower exposure to the potentially costly regulations of the US Congress and the Fed.  The firm is headquartered in England, the dividends are paid in British Pounds,  and there is no dividend withholding tax.  

GATX (GMT): Target price $59, dividend yield 2.4%, anticipated 2-yr return 9.5% annually, 2014 PEG ratio 0.95,  Formerly known as Great American Transportation, GMT offers financial exposure to the rail car and marine transport sectors.   With a history dating back 115 years, GMT operates one of the largest global fleets of railcars.  Specializing in tank railcar leasing and repair services has been the company’s niche since 1889.   Railcar count at the end of 3rd qtr. was 132,000 of which 109,000 was in North America and the balance in Europe.  Utilization rates were reported at 98.5% in North America and 96.3% in Europe.   GMT manages a fleet of 18 ships, mainly dry bulk commodity such as iron ore and coal.  As the US and global economies continue to expand, GMT is well positioned to expand its asset base and expertise. 

Investors seeking more European exposure may want to research investment firms Pargesa (PRGAF.PK, PARG.SW) or Groupe Bruxelles Lambert (GBLBF.PK, GBLB.BR).  The investment firm holds a concentrated position in oil company Total (25.8% of assets), cement maker Lafarge (23.0% of assets), industrial minerals processor Imerys (16.0 % of assets), natural gas and electric utility GDF Suez (12.9% of assets), sprits maker Pernod Ricard (14.2% of assets), and water company Suez Environmental (2.6% of assets).  Trading at a 25% to 28% discount the value of its publically traded holdings in some of Europe’s best-known international companies, Pargesa or Groupe Bruxelles Lambert offer an actively managed diversified portfolio approach to investing in Europe.   These two firms are controlled by the Albert Frere family of Brussels and Power Financial Corp of Canada.  GBL is one of the largest ten companies in Belgium and is a component of the Belgium Stock Index BEL20.  Pargesa is headquartered in Switzerland and reports in Swiss Franc while GBL is headquartered in Brussels and reports in Euros.  Both subject US investors to dividend withholding tax, with the Swiss taking a bit larger bite than Belgium does.  An alternative is Swedish-based investment firm Investors AB (IVSBF.PK, INVEB.ST) managed by the Wallenberg family.  More information on Investors AB and GBL can be found in this SA article.

http://seekingalpha.com/article/1416281-european-holding-companies-at-a-discount-over-european-etfs

Only HSBC and SU offer a margin of safety as calculated by the original Graham formula.   SU is rated “A” high by the S& Quality Equity ranking; HSBC, GMT, HAL are ranked “B+” average; the balance are NR not rated.   The list consists of two financials (OZM, HSBC), three energy (HAL, DMLP, SU), two industrial (MIC, GMT), one commodity (GLCNF) and one European investment firm (PRGAF, GBLBF, or INVSB).  If the global economy continues to expand, these firms should continue to excel. 

While readers may not appreciate these names or the respective investment profiles may not fit their goals, investors should continue to look past the usual equity candidates during portfolio rebalancing.   Beyond the normal, in-the-news large-cap firms lies a host of opportunities that are mostly overlooked by investors.   

Disclosure:I am long all the above except Investors AB.  All of the above except Pargesa, GBL, and Investors AB are followed by Guiding Mast Investments

I appreciate your time and interest in Guiding Mast Investments, George C. Fisher