Investoid

I’m off to Miami to watch the last half of the Sony Ericsson Open tennis tournament. As a result, I won’t be posting until I return next Tuesday.

I’ve been fortunate to travel a lot in the past 12 months, and my wife and I are already looking forward to whereever we decide to go next. There’s a good discussion that’s been going on at Million Dollar Journey on living life now versus later, which I encourage you to read. Enjoy and see you in a week.

Despite my tech background, I currently don’t have any tech stocks or index funds in my portfolio. I think part of the reason for that is that Canada’s tech index is so heavily weighted on RIM, but also because there is a dearth of up and coming public tech companies, relative to the U.S. I plan on looking at more Nasdaq-based companies in the future, but in the meantime I have been looking at Systems Xcellence (SXC – TSX / SXCI – Nasdaq), which is a company that has a dual listing.

Company Analysis

• SXC is a pharmaceutical software provider. Their business focuses on managing the prescription drug supply chain.
• Two primary market customers:
• Payor customers such as Blue Cross/Blue Shield and Governments
• Provider customers such as chain and independent pharmacies
• Currently the payor market represents approximately 70% of revenue, providers the remainder.
• Revenue is concentrated in the U.S. (over 95%).
• The company had a U.S. IPO on Nasdaq in the past six months, which has raised its profile in the U.S.

Market Analysis

• Total market size for payors and providers: $4.5B.
• Growth potential:
• The number of prescriptions being filled is increasing as North American population ages.
• In addition, number of prescriptions per individual is increasing.
• Payor customers are looking to increase operational efficiencies to reduce administration costs.
• Pharmacies require effective solutions to manage increasing volume.

Financial Analysis

Stock Analysis

• Since dropping to $12 (Canadian) in June, the company’s stock has increased dramatically. It reached a high of over $25, but has since pulled back to the $21.50 range.
• The stock is more volatile than the Canadian IT index (as represented by XIT), but is strongly correlated to it.
• According to the company, 12 analysts cover the stock on both sides of the border. According to GlobeInvestor, the consensus recommendation on the stock is a strong buy.

Opinion

Overall, I think this company is in a solid growth sector and has demonstrated strong organic growth over the years. I like the space they’re in and the fact that they are part of the solution to manage overall costs in the health care system, rather than being a cost driver.

Using my valuation models, I have arrived at fair value prices pretty close to SXC’s current price. I think that the stock is fairly valued at this point given future expectations, but if the stock continues to fall to $19 or so I think it becomes a good value and I will be looking to accumulate some for my portfolio.

If you invest in individual stocks, you need something to be able to cut down the universe of possible investments. There are simply too many possible stocks out there to analyze even a tiny fraction of them effectively, especially when you’re a time constrained do-it-yourself person.

While some people follow the major trends in the marketplace (whether by sector or by specific companies that are in the news), I think it’s important to have a systematic way to look for companies. Stock screening tools allow you to use quantifiable criteria to identify companies with traits you deem attractive.

There are quite a few free online stock screening tools available, among the most notable:

• GlobeInvestor’s stock filter
• MSN’s moneycentral filter
• Zacks stock screening software

All of these tools offer basic screening capabilities. However, none of them are that comprehensive. The main drawbacks for me are:

• Limited fundamental criteria: Most of the basics (EPS, revenue growth, etc.) are there, but there are so many more factors that I believe are important that all the basic tools are useless for me.
• Relative rankings: I want to be able to rank companies in order based on some criteria (for instance, highest return on equity) rather than inputting in less than/greater than values which removes them from the result set. I don’t necessarily want to eliminate stocks from the universe based on one poor value from my selection criteria.
• Cannot weight variables: I would like to be able to weight certain variables more than others to create aggregate relative weightings. This is what a lot of value-based investment shops do to get a look at undervalued companies.
• Limited output abilities: usually the online screens will list the companies that match the screen criteria but not their values on which you screened, so it’s difficult to overcome any of the above drawbacks by manually ranking companies after the fact.

When I was in school and part of a real-money investment management program, we used CPMS, which was pretty good. Its only major drawback was that backtesting required us to send the company our model, which they would then run on for us and send back the results. But at $2,000+/month, it’s not a tool I can get for myself. Thus I am in the market for a good stock screening tool.

I’ve taken a look at ChartSmart, and it seems to have some of the features I want (but not all). I’m going to run its 30 day demo and see if it’s worth the money.

If anyone else knows about good screening software that’s affordable, please let me know. Depending on the features, I’d be willing to spend up to $700-800 a year on such software.

Since I wrote about covered calls yesterday, I’ve come across some information on US-based ETFs that specialize in covered call strategies. As this TheStreet.com article states, diversification when attempting a covered call strategy is relatively important if you’re not merely speculating. These types of funds get around the main issues I had with do-it-yourself covered call writing.

Beware of the Net Asset Value premium on these stocks, as is being discussed on this Financial Webring forum post. Nonetheless, these ETFs may be a good choice if you are slightly bearish or neutral on the US market right now.

I’ve posted quite a few opinions on various stocks over the past month, so I think it’s appropriate to update their status once in awhile to keep me accountable. So, let’s take a look at how each stock has fared since my analysis.

DivestCo (DVT): DivestCo is essentially flat (down 0.1%) since the close of February 26. They had strong quarterly numbers and announced another acquisition, leaving their trailing P/E at a low 6.6. I still see this as a good value.

iShares Financial Index (XFN), Bank of Nova Scotia (BNS), National Bank (NA): On March 3rd, I said that these financials had been oversold as a result of the China market correction, and now was a good time to pick them up on the cheap. Since the close of the next trading day (March 5), XFN is up 4%, BNS is up 8.9%, and NA is down 1.2%. I would hold off on picking up more XFN and BNS, as they have really rebounded off their lows (particularly BNS off its strong earnings report), while I see NA as a great value here. There is still uncertainty around NA as the new CEO takes over, so the next few quarters will be critical to its long term performance.

Since March 5, RIM’s up about 0.5%. I think this stock will tread water until the iPhone comes out and we get figures on its penetration. I’ve listened to some analysts who think RIM won’t be devastated by all its competition since it is also an e-mail delivery provider, not just a handset provider. While that is true, their high PE reflects an expectation of all divisions growing quite strongly, something I don’t see happening in the future. The options backdating issue also reflects poorly on the company.

In a couple short weeks, Score Media (SCR) is up 14.7%, largely due to a 4 million share transaction that occurred late this week. This has supported the speculation that SCR is indeed being bought by CanWest Global. While I’m not a fan of the company on a standalone basis, I can see why they’re attractive to larger media companies. There may be further upside if a takeover is imminent, but I wouldn’t want to speculate on that.

I’ll sporadically update how stocks I’ve looked at are doing. If you want me to analyze a specific company, or update an analysis on one I’ve already covered, feel free to contact me.

I came across this great piece by Martin Sosnoff, who runs a $6 billion investment management firm.

Basically, Sosnoff is saying that with so much wealth in the world, that eventually the scarcity of profitable investments will cause deals to go south, inflation to rise, interest rates to go up, and all the market booms will come crashing down.

He uses several analogies from past booms and busts and points out that several of the signs are here today that could lead to a crash (flat yield curve, high liquidity, lots of people using leverage for real estate and other alternative investments, etc.).

It has definitely been awhile since we’ve seen a widespread global slowdown (I’d say the early nineties was the last major recession for most of the world). Since then we’ve seen corrections in various markets, from Asia and Russia in 1998 to North America in 2001-3, but nothing has really brought down the growth from around the world for a long time. We are at a high point of global interconnectivity economically and financially, which definitely is a precursor for a widespread collapse.

I am not sure whether there will be a precipitous decline around the world or not, but I think it’s wise to diversify your holdings accordingly. As I’ve said before, long term and high risk bonds are one of the worst things to be in, since their yields can’t go much lower before they bump into short term Treasury rates. I don’t think it’s time to put all your money into consumer staples and the like, but I would definitely take money off the table from your high risk investments like China/emerging markets, energy, etc.

As the markets have see-sawed in the first quarter this year, I have been thinking about writing call options on my RRSP investments (this is known as a covered call strategy). Basically you are betting that your investments are not going to go up greatly in value in the near term - thus you give someone the option of purchasing your stocks at a price near the current one (depending on what you want to do, this could be below, at, or above the current price). If the markets go down or otherwise stay below your strike price, you get the pocket the option premium while keeping the underlying stock. Is this a feasible strategy for investors with their RRSP savings?

First, you need to determine whether you can write covered calls. Most RRSP accounts allow for covered call writing (as well as purchasing of calls and puts), so this isn’t usually an issue, but one you still need to verify. I was looking to write covered calls for my XFN and XIC holdings, and perhaps for XIN as well, so I needed to find out where the options are traded. All Canadian equities options are routed through the Montreal Exchange.

The first hurdle - if the MX doesn’t have options on the shares you wish to write covered calls, you’re out of luck. Turns out they don’t trade options for XIN or XIC (but they do for XIU), so already two out of three of my investments were nixed. For regular stocks, they have a good listing of the major large cap companies and popular sectors in Canada, but I find they are heavily focused on energy, materials, and financials (the complete listing is found here).

The next hurdle is trading fees - is it worth your while? 1 options contract is for 100 shares, so you need to multiply the bid/ask prices you see by 100 to get the total price you will receive for a call option. If I wanted to write a call option for XFN with an expiry of May at a price of 57, I could get $50 per contract at the last bid price. That’s not so bad on a percentage basis (about a 0.8% return on the share value + another 1.7% upside if they are sold at the strike price), except when you take commissions into account. Here is a sample of commission prices from Canadian brokerages:

• CIBC Investor’s Edge: $28 + up to $2.80 per contract
• TD Waterhouse: $29 + $1.75 per contract
• BMO Investorline: $35 + up to $3.50 per contract
• E-Trade (not active trader): $19.99 + $1.75 per contract
• TradeFreedom: $9.95 + $1.25 per contract + exchange fees

Note that this does not take into account the transaction fees you will incur if you option is exercised. As you can see, these fees make it relatively cost-prohibitive if you are trying to write a small number of contracts (which is likely if your portfolio is just getting started or if the holdings you wish to write options are are small). With a bank brokerage, any premium under $150-200 is almost completely eaten up by fees.

The last hurdle (and for me this was the biggest issue) - the liquidity and spread. The XFN volume on call options today was a big 0. That’s right, nothing, for any strike price or call date. While there are bid and ask prices for each option, the spread ranged between 10 and 30 cents. This can be over 20% of the option price. This makes the valuation of the options very volatile. You would really need to be satisfied with the price you are receiving for your calls and expect to give up your shares if the stock rises, rather than purchasing a cancelling call option on the open market later on.

Overall, I’ve decided against using a covered call strategy for now, based on my specific holdings. However, for people with more volatile holdings (such as XEG, individual oil or uranium companies and the like) who want to hold these assets long term but are not sold on their short term prospects, then covered call writing could be a good way to generate short term returns while waiting for the long term upside. With the right stock, covered calls can be like creating a monthly dividend on your equity.

I’ve been asked here and elsewhere what my thoughts on technical investing are. To be brief, I think that the simple mathematical formulae espoused by traditional technical traders is mostly smoke and mirrors. However, a lot of solid mathematical development has occurred in the past two decades to advance quantitative investing as a real science.

I was reading VentureBeat yesterday and came across an interesting company called FatKat. They just raised a Series C round of $2.4 million (venture capitalist speak for the third round of financing from heavy duty sources) to continue development on their proprietary trading algorithms. On their site they have a good overview of the development of quantitative investing strategies, which I think is worth a read for all investors.

I think it’s important for do-it-yourself investors to be aware of the fact that a sizable portion of trading today is done by algorithms, not humans. This can materially affect how the market swings in both directions, as algorithms are intent on capturing as much statistical market-independent returns (otherwise known as alpha) as possible. These algorithms can be quite complex and require some major computing power to work, but the potential payoff is huge.

While it may seem daunting to be up against legions of Math Ph.D’s and their computers, it’s important to note that most of these strategies are focused on generating short-term, market independent gains. This can lead to more volatility and sizable short-term shocks. The upshot is that if you are a value style investor such shocks lead individual stocks and even whole markets to be oversold quite quickly, thus leading to good buying opportunities.

Quantitative investing has taken out the human element for many of the world’s largest investing institutions on at least a portion of their assets. Meanwhile, casual investors are by and large left to their own devices and the talents of mutual fund managers. Don’t fret though - academics have postulated that there is only so much alpha to go around, and all these quant shops are chasing the same scarce resource. As a result they have to spend more and more energy (both brainpower and literal) each year just to maintain their share of the pie.

To me, this means that an equilibrium will be reached whereby quantitative investment methods will always have to continuously adjusted to be of any value, and thus there will be no net growth in their share of the market. As a result, I think that the long term dynamics of markets will maintain their current and historical statistical properties, meaning regular investors will still have opportunities to have solid returns.

The Middlefield group closed a $195 million IPO for the Uranium Focused Energy Fund. This fund is listed on the TSX under the symbol UF.UN.

If you’re looking to be part of the uranium bull run, this could be the investment vehicle for you, although it won’t be a pure uranium play. According to the company’s prospectus, they will initially invest 70-80% of the fund into large cap uranium stocks, with the remainder going into other energy companies (read: oil & gas producers). The goal is to provide regular quarterly distributions, and they have set the initial distribution at 50 cents. The MER is 1.1%, with an additional 0.4% being taken off for trailer fees for advisors, and an additional $300K for management expenses. The fund will wrap up operations in 2013 and return the NAV of the units to investors at that time.

With uranium over 200% in the past two years, many people are discussing the possibility of a bubble. I wholeheartedly agree there is a quite a bit of speculation in this market (like any other one that has risen so high so fast), but there is also a fundamental supply and demand reason for the price to be increasing, since demand is outstripping supply based on current use, much less the expected rise in demand from new power plants.

It is also interesting to note that the IPO was for $195 million, but the maximum offering was for $400 million. This could be a sign of investor sentiment on future price increases in uranium, meaning that there is an expectation of less upside in the future.

I expect the price will probably continue to rise, until some expected nuclear power plant construction doesn’t go through. If or when that occurs, there will probably be a rather large shock in the price along with the corresponding producer and explorer companies.

Note: I don’t follow this sector in any real depth, but I thought that this type of publicly traded investment vehicle is an interesting way for diversification within this sector.

Now that the federal budget has been unveiled, the rumors have been dispelled and the actual policy is front and centre. The Canadian Capitalist has already written a good summary article, so I will suggest you read that article and I’ll try not to venture on its subject matter too much.

Here are a couple of important aspects of the budget:

• The government has begun a policy of enabling people to work later on in life without sacrificing benefits. By increasing the maximum RRSP contribution age to 71, the government is acknowledging that people are living longer and should be able to work longer without penalty (if they so wish). Furthermore, the government is making allowances for part-time work, by allowing workers to draw partially on existing benefits while accruing additional benefits with part-time work. I think this is a step in the right direction and fits right in with my ‘never retire’ ideas.
• Oil sands companies lose, while manufacturers win: The accelerated 100% CCA allowance given to Oil Sands development will be phased out between 2011 and 2015, which is admittedly a long way off. In the meantime, manufacturers will get a 2 year straight line depreciation schedule for large equipment purchases made between now and the end of 2008. It will be interesting to see how the markets react to this news: I expect manufacturers will get a slight positive bump while Oil Sands will remain more or less neutral.
• Small business capital gains lifetime exemption has increased by 50%, with no other capital gains changes. While this is a decent measure for small business owners, it does nothing for the public markets. Also, this exemption has never been a great boon, since you must hold the shares for at least two years before selling. So if you have a very successful company and sell a portion or all of your stake in it before two years from the share issuance date, then you can’t use the exemption. Once again the government penalizes success.
• As far as I can tell, the income trust legislation was not part of the budget. If anyone can confirm or deny this, please comment and let me know.

Overall it was a relatively uneventful budget, with the government trying to please a large mass of voters for the next election. A little bit for everyone, but not much for anyone. Expect more of the same as long as we have a minority government.

Update: Thanks to Canadian Dream, I was able to find out that the trust legislation was in fact part of the budget. Take a look at the official budget website (scroll to the bottom).