In This Issue

A CORRECTION – BUT WHEN?

By Gordon Pape

The other night, I joined a group of friends for a glass of wine and a taco buffet at our golf club. During the course of the evening I must have been asked five times: “When is the correction coming?” All I could answer was: “I wish I knew”.

There’s going to be one, that’s certain. But it may not happen until the New Year. That’s when two events could rattle the markets: an indication from the Federal Reserve Board that it will start scaling back its quantitative easing (QE) program plus a renewed confrontation in Congress over the debt ceiling.

The bull market that we’ve been experiencing is unusual in several ways. It doesn’t seem to be following any of the conventional rules, which is what makes predicting the timing of a correction even more difficult.

For starters, we’re seeing the best gains in New York in a decade. As of the close of trading on Friday, the S&P 500 was up 26.5% for 2013 while the Dow had gained 22.6%. Even more significant was the fact both of those indexes broke through important psychological barriers during the week and held on to the gains. The Dow is now over 16,000 while the S&P 500 is through the 1,800 mark.

European markets have also been strong and the Nikkei 225 is up an astonishing 48% year-to-date. So the rally hasn’t been confined to New York; it’s a global event.

What’s more, when you look at the charts for the year, they go almost straight up. Oh sure, there are a few blips here and there but on the whole it’s been a pretty steady climb. October, which is often a rough month for markets, was uncharacteristically benign and the upward surge has continued through November. Now we’re coming up to the traditional time for the Santa Claus rally – except that this year there is nothing to rally back from. It’s all been good.

Some of the statistics are interesting. Since the Great Depression, the average length of bull markets has been 57 months. If you date this one back to March 2009, we’ve had a 56 month run, so by that standard the market should be close to exhaustion. But it’s not looking that way and some bull markets have gone on much longer. The Internet-fuelled rally of the 1990s lasted 113 months before it hit a wall in early 2000. So the precedent for a much longer run is there.

There is an active debate among market watchers as to whether we are experiencing a stock bubble that will soon burst. That’s typical when markets move into uncharted territory as both the Dow and the S&P 500 have.

On a price to projected earnings basis, the S&P 500 appears to be fairly priced – not cheap by any means, but not outrageously expensive either. But as the Associated Press pointed out last week, the adjusted p/e ratio based on a formula developed by Nobel Prize winner Robert Shiller indicates that stocks are trading well above historical averages and are due for a correction.

That brings us back to the original question – when? It could happen any time – one significant piece of bad news could trigger a sell-off. But absent that, my guess is that we won’t experience a major pull back of 10% or more until January. I think it will be sparked by an indication from the Federal Reserve Board that quantitative easing will finally begin to wind down. That will be good news for the economy but bad news for investors who have been relying on QE to keep interest rates low and fuel the stock market.

So what should you do now? Here are some suggestions.

Take some profits. Many of our recommendations have recorded good gains this year. In some cases we have advised taking part profits or even selling entire positions. But keep in mind, this is just guidance. Investors should take a close look at their personal situation and their tax position. Crystallizing profits outside a registered plan will trigger a taxable capital gain so take that into account in your planning. It may be appropriate to sell a losing position at the same time to partially offset the taxable gain.

Add new positions gradually. We believe markets will rise in 2014 after the correction. However, in most cases (e.g. the U.S., Japan, and Europe) we don’t expect the advances to match those of this year. Therefore, while we will continue to recommend securities that we believe offer upside potential, it is advisable to take a measured approach in your purchases. If you decide you want to own a particular stock, allocate the amount of money you are prepared to invest. Spend one-quarter to one-third of that now and then wait for a pullback. At that time, commit another portion of your capital. If the markets retreat even further, you may be able to acquire the rest at a bargain-basement price.

Hold some cash in reserve. If you decide to take some profits in the next few weeks, hold some of the cash in reserve. The markets will correct at some point – they always have. If you have money available, you’ll be able to buy some quality stocks at attractive prices.

Don’t panic. Some investors will inevitably hit the panic button when the market drops. Don’t be one of them. There is nothing to suggest that 2014 will bring us a repeat of 2008. Yes, there are still problems in the global economy, which the OECD again highlighted in a new report this month. In it, the OECD warned that uncertainty over U.S. fiscal and monetary policy poses a risk to the recovery and cut its growth projections for the Eurozone while warning that the risk of deflation has increased.

So we are not out of the woods yet by any means, which in itself is a good reason for stock markets to pull back from their current lofty positions. But the chances of a new recession appear very low. The coming year may bring slower growth than originally expected, but it will bring some growth with the promise of more to come. That’s why the markets will rally back after we hit the speed bump, and why you want to be there when they do.

Gordon Pape’s new book is titled RRSPs: The Ultimate Wealth Builder. It will be published by Penguin Canada in January but you can pre-order your copy now at a 28% discount to the suggested retail price by going to http://astore.amazon.ca/buildicaquizm-20

 

AIRLINE MERGER OFFERS OPPORTUNITY

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Contributing editor Glenn Rogers is here this week with his views on the one of the biggest airline mergers in U.S. history and what it means for investors. Glenn is a successful businessman and entrepreneur who has worked in both Canada and the U.S. over his career. He and his family now live in southern California. Here is his report.

Glenn Rogers writes:

If you’re like me you’ve seen a long, sad decline in the quality of the air travel experience over the last decade or so since the airlines were deregulated in the U.S. True, for a time prices did come down since there was a rush of cheap air carriers in the space. That caused many mainstream carriers to reduce their prices – and their services – to compete with the low-cost offerings.

During this era things we had taken for granted such as meals, pillows, blankets, free luggage check-in, etc. were steadily chipped away until we have gotten to the point where we have to pay extra for virtually everything. As this was going, on the airlines still lost gobs of money as they added more seats than the market could handle.

After years of this nonsense they began to figure out that they couldn’t outspend each other and gradually began to merge in search of efficiencies and route dominance.

Personally, have always avoided investing in airlines. They never seem to have any financial discipline, they require lots of capital, and were subject to the whims of union contracts and jet fuel prices. Airlines are one of the few sectors where Warren Buffett lost money and he swore he never would invest in one again. I felt the same way, but never say never because I’m about to recommend investing in airlines again.

Part of the reason is that I still believe in the travel industry in general over the next few years for reasons I’ve mentioned in previous columns. The Internet-related travel stocks we recommended have done extremely well and are now fully priced but I think there is room to grow in some of the still recovering airline stocks.

The result of all the reduction in services and the accompanying increase in fees, combined with a number of huge mergers, has made the space interesting again. This past week the U.S. Department of Justice agreed to let the $17 billion (figures in U.S. dollars) merger of US Airways Group (NYSE: LCC) with American Airlines (OTC: AAMRQ) go forward with very few concessions. Few analysts, including myself, believed they would get off so easily. But now that the terms of the deal have been set, it creates a very interesting opportunity to take advantage of the heavy travel period we are entering which, happily for the airlines, coincides with a recent steady drop in jet fuel prices.

This merger will create the world’s second largest airline (next to Delta). It enters into a market that has fewer competitors than at any time in the past 10 years. US Airways shareholders will get 20% of the new company’s equity while American Airlines creditors and shareholders will receive the remainder. US Airways management will for the most part run the company with Doug Parker, the highly respected US Airways CEO, taking over the combined business. Although US Airways management will run the show, the merged company will retain the American Airlines name.

The merged American will have to give up a number of landing slots in Washington and at New York’s LaGuardia Airport, along with reducing some exposure in Boston, Chicago, and Dallas. But it will still have 57% of the flights in and out of Dulles Airport in Washington and only 12 fewer flights from the normal 175 daily departures at LaGuardia. The company also expects to have over $1 billion in annual savings from the synergies it expects to benefit from post merger. There are other companies that will benefit from this merger, including Southwest Airlines (NYSE: LUV) and JetBlue Airways Corp. (NDQ: JBLU), which will be able to acquire a number of the gates that US Airways/American will have to let go.

Compared to the other large airlines, US Airways, which closed on Friday at $24.27, is quite cheap. The shares are trading at a discount to Delta Airlines (NYSE: DAL) which has a price-earnings multiple of 9 versus 6.6 (2014 estimated earnings) for the new American Airlines. If American just tracks to Delta Airlines multiples against its earnings forecast we could see the stock increase significantly over the next year and a half, perhaps to as much as $32 or better in 2015.

Certainly there could be some churn in the stock as the American Airlines and US Airways stakeholders decide how much they will continue to hold versus sell over the next few months but I would view every dip as a buying opportunity. The only thing that would significantly change my opinion is if jet fuel spikes to over three dollars a gallon for an extended period of time.

You don’t have to like airlines to like the investment opportunity that presents itself now. However, you need to understand a few complexities. US Airways stock continues to trade actively on the NYSE. However, American, which is technically still in bankruptcy, only trades as AMR Corp. on the U.S. over-the-counter market under the symbol AAMRQ. It closed on Friday at $12.06.

When the merger is completed and American emerges from bankruptcy protection, shares in the combined airline will be listed on Nasdaq under the symbol AAL. We don’t have an exact timetable for that but the whole process should be concluded some time in December.

For now, I advise buying US Airways on the New York Exchange. I expect the two stocks to track one another closely until the merger is complete. US Air closed on Friday at $24.27. I think the stock has the potential to reach $32 within 18 months.

Action now: Buy US Airways Corp. (LCC) at the current price.

 

GLENN ROGERS’S UPDATES

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The Boeing Company (NYSE: BA)

Originally recommended on Jan. 21/13 (#21303) at $88.89. Closed Friday at $135.07. (All figures in U.S. dollars.)

We recommended the stock last January when it was trading at $88.89. At that time we suggested that the concerns about the Dreamliner problems were likely overdone and that the dip represented a buying opportunity. This has turned out to be true and the stock closed Friday at $135.07 for a gain of 52% to this point. We have also received dividends of $1.94 per share.

Last weekend Boeing and Airbus announced at the Dubai Airshow that they had signed orders worth more than $100 billion as a number of Middle Eastern companies added to their fleets. This underscores again the continuing demand for aviation products with basically only two companies in the world able to supply the larger scale aircraft – Boeing and Airbus. Smaller manufacturers like Canada’s Bombardier (TSX: BBR.B) and Brazil’s Embraer (NYSE: ERJ) should also do well but the two big players will benefit the most.

True, Boeing may see reductions in some of its military divisions with the F-18 Super Hornet due to close out its assembly line in 2015. But given mankind’s proclivity to blow things up I wouldn’t bet against continued orders for the company’s warplanes. Ditto for Boeing’s strategic missile and defense systems.

But it is the passenger jet business that looks like it has a long way to run and the only thing that makes me hesitate at this point is that the stock is beginning to look a little expensive. With in mind I consider the shares to be a hold and would add to my position on any pullback.

Action now: Hold.

General Electric (NYSE: GE)

Originally recommended on May 18/09 (#2918) at $13.04. Closed Friday at $27.08. (All figures in U.S. dollars.)

One last airline related update brings us to General Electric, which was recommended back in May 2009 when it was trading at $13.04. I last updated it on April 15 at $23.46 at which time I rated it as a Buy.

Obviously, General Electric is not strictly an airline-related stock but it is a large supplier of jet engines to Boeing and received $26 billion in jet engine orders and service agreements during the Dubai Airshow last weekend.

Of course, GE has many other businesses and has gradually been returning to its roots as an industrial manufacturer, for example by divesting itself of NBC Universal. Earlier this month it announced plans to reduce its exposure to its finance arm by spinning off its credit card division.

This will still leave the company with significant stakes in energy, water treatment, and medical diagnostics. As well, it has a large business in transportation with a huge freight and passenger locomotives operation. The
stock yields 2.8% even after the steady run-up the shares have enjoyed since we first recommended them.

As with Boeing, I’m still a little concerned about valuation at the current price given GE’s long run. It’s also worth remembering that the market hasn’t had a good-sized correction for some time. So I would recommend holding the stock here and would add to my position on any pullback in the market.

Action now: Hold.

– end Glenn Rogers

FILTERING OUT THE RUBBISH

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Also with us this week is contributing editor Ryan Irvine, one of Canada’s leading experts in small-cap stocks and CEO of Keystone Financial (www.KeyStocks.com). Ryan lives and works in the Vancouver area. Here are his comments.

Ryan Irvine writes:

Historically speaking, with the S&P 500 trading at approximately 20 times trailing earnings, and with a Schiller p/e of over 25, U.S. stocks are not cheap.

In Canada, a terrible downturn in the metals and mining sector (one we have largely avoided with our picks over the past two years) has left the S&P/ TSX Composite Index with a poor record over the past 24 months compared to the S&P 500, which continues to hit all-time highs on an almost daily basis.

In recent weeks, we have increasingly heard several broad arguments as to why you should start buying equities, or continue to do so. These include:

No alternatives. With short- and long-term interest paying instruments such as GICs, bonds, T-bills, and savings accounts paying diddly squat, stocks are the only game in town.

All the “money on the sidelines” will flow into stocks. The argument here is that investors frightened by the 2008 crisis (for example) sold en masse and have yet to re-enter, but will soon, thus pushing markets higher.

These views are rubbish, in my opinion.

Let’s address the “money on the sidelines” myth. Two critical aspects are important when looking at this argument as a positive driver. First, money does not “enter” the market, it is swapped. For example, Investor A’s cash is used to buy shares from Investor B; after the transaction the roles are swapped with Investor B holding cash on the sidelines and Investor A holding shares. In other words, when shares are bought and sold on the stock market, money is simply going from “sideline” to “sideline” while stocks are being transferred from account to account. Since the total amount of money “on the sidelines” remains exactly the same, an abundance of money “on the sidelines” cannot be the cause of price increases. The inverse is true for money moving out of stocks and “onto the sidelines.” As a result, speculative discussions about the amount of cash “on the sidelines” are fairly meaningless.

Secondly, as stated by Morgan Stanley’s Gerard Minack, despite all the disclaimers retail flows assume that past performance is a good guide to future outcomes. Consequently money tends to flow to investments that have done well, rather than investments that will do well.

Having said all this, if we did step to an alternative universe where money flowed into stocks and was “absorbed” somehow with a net gain for stocks, would it be smart to follow that herd now? No. That’s like saying: “Buy when the dumb money arrives or buy what the smart money is selling!”

The theory goes that there exists a massive amount of dumb people out there (I like the theory if we stop here) that own huge quantities of bonds and/or have tons of idle cash lying around. The trick is to get into stocks now, right as all of this dumb money is about to “rotate” out of bonds and cash and start flooding into the stock market and cause a massive blow-off rally in equities.

So, we are being told that it is smart to do as the dumb money does, or is about to do. But before you do as you are told, Mr./Ms. Lemming, make sure to ask yourself this: who are the generous folks that will so graciously sell their stocks to the dumb money or to you? Interesting question, isn’t it?

Now let’s go back to argument number one – there are no alternatives. Seriously, that is an argument? This is like saying your goal is to move and your options are to stand still or jump off a bridge. On your tombstone it will read: “no alternative, had to jump.”

Of course there are alternatives – you can wait in cash or, more productively, choose not to invest all at once and abstain from the all-in or all-out short-term mentality the broader financial arena likes to sell to you.

Again, those who argue you should buy stocks based on simplistic ideas such as that there are no alternatives, that the money on the sidelines will eventually enter the market and push equities higher, or that you should buy because the markets are rising, are selling you shortcuts. These arguments make great headlines and easy quips but will likely just lose you money.

The only reason you should ever buy a stock is because the underlying business is sound, growing, and you can purchase a share of its current and future cash flows at a cheap or reasonable price. This will serve you well as an investor long-term.

Currently, with U.S. markets breaking new highs, we are proceeding with caution and find that in the current environment it is more challenging to uncover value than at any other time in the past five years. This is not to say we cannot find value, having issued two new Buy reports in the past month from our Small-Cap and Income Stock research. It is just more difficult to uncover.

RYAN IRVINE’S UPDATES

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High Arctic Energy Inc. (TSX: HWO, OTC: HGHAF)

Originally recommended on Sept. 3/13 (#21332) at C$2.85, US$2.55. Closed Friday at C$3.09. US$2.62 (Nov. 19).

We introduced High Arctic Energy Inc. to IWB readers in early September. Today we update the company in the light of its recently released third-quarter financial report.

HWO is an international oil and gas services company with operations in both Papua New Guinea (PNG) and Western Canada. The company’s substantial operation in Papua New Guinea is comprised of contract drilling, specialized well completion services, and a rentals business, which includes rig matting, camps, and drilling support equipment. HWO’s Canadian operation is focused on the provision of snubbing services and the supply of nitrogen to a large number of oil and natural gas exploration and production companies operating in Western Canada.

Revenues for the first nine months of 2013 increased by 6% to $114 million compared to $107.6 million in the same period of the prior year. The growth in revenue for the period was driven by increased activity in PNG with revenues of $85.9 million compared to $71.2 million for the first nine months of 2012. Third-quarter PNG revenues were $27.7 million, up from $22.6 million in the same period of 2012. The growth resulted from having a second active drilling rig and a larger fleet of rental equipment in 2013.

Revenues derived from PNG’s rental fleet contributed approximately $20.2 million for the first nine months of 2013, up from $14.5 million in the same period of 2012. Despite increased revenues, adjusted EBITDA decreased slightly to $29 million for the nine-month period from $29.6 million for the same period in 2012 due primarily to a reduction in the Canadian operating margin attributable to overall reduced industry activity levels.

Third-quarter revenue for Canada was $8.6 million, down from $13.2 million in the same period of 2012. For the first nine months of 2013, Canadian revenues decreased by $8.3 million or 23% from the same period in 2012 due to reduced revenue levels from both the core snubbing and nitrogen businesses which was consistent with the overall industry activity slowdown. The operating margins in Canada were adversely affected by the reduced revenue levels and by competitive pricing conditions primarily in the nitrogen operations.

Conclusion

While challenged once again in by lower year-over-year activity levels in its Canadian operations, solid performance from the company’s PNG operations produced another strong quarter of revenue growth, solid EBITDA, cash accumulation, and debt reduction from High Arctic.

The long-term outlook for activity in PNG continues to be strong and the recent signing of the three-year contract extension with Oil Search Limited (OSL, an Australian public company) provides some stability. OSL’s operations in PNG are less dependent on short-term fluctuations in oil and gas prices and instead are based on long-term decisions, particularly with its significant interest in a large-scale liquid natural gas (LNG) project currently under construction.

Having said this, the capital demands of that project should affect the capital available for drilling in the near term. High Arctic’s main customer in PNG will have only one rig active in the fourth quarter as it sets its budget. As such, we expect lower year-over-year revenues from this source. Offsetting this should be higher margin equipment and services revenue from the contract signed with a major Canadian global upstream oil and gas company.

While fourth-quarter aggregate revenues will likely be down from the previous year in total, EBITDA should come in at only slightly less or close to even from the prior year’s quarter as the mix should include higher margins work. The wild card here is in relation to the Canadian operations. If activity breaks early for the holidays then fourth-quarter EBITDA will likely be slightly lower. Conversely, if activity persists up until Christmas, fourth-quarter EBITDA has a chance to mirror levels seen in 2012.

From a fundamental perspective, High Arctic remains attractively valued. The company trades a low 5.61 times trailing earnings, a low 3.52 times trailing EBITDA, and at a very low Enterprise Value to EBITDA ratio of 2.95. High Arctic continues to boast a strong balance sheet with $21.9 million or $0.44 per share in cash net of debt.

The bottom line is that the stock remains cheap on a relative basis. However, there is no need to chase it, as we do not expect any near-term price increases given the near-term pullback in spending ahead of the PNG LNG project. The long-term potential in PNG remains very strong and High Arctic is well positioned to benefit from the growth as the project comes on stream.

Action now: We reiterate our Buy rating on High Arctic. In the near term, collect the strong 4.9% dividend and expect to hold for long-term growth catalysts over the next one to three years.

WiLAN Inc. (TSX: WIN, NDQ: WILN)

Originally recommended on Aug. 8/11 (#21128) at C$6.99, US$7.15. Closed Friday at C$3.38. US$3.20.

WiLAN Inc. has been volatile since we picked it, trending downward as higher litigation costs are currently being incurred in an effort to secure further long-term licensing deals.

To be blunt, we have been disappointed with the litigation results from WiLAN over the past year. While there have been some wins, the company has also experienced a couple of negative judgments where in the past there had been none. It appears the board of directors is in agreement (as has been the market) with this assessment and on Oct. 30 it was announced they had initiated a process to explore and evaluate a broad range of strategic alternatives for the company to enhance shareholder value.

The strategic alternatives to be considered include changes in reference to the current dividend policy, or other points of returning capital to shareholders. Of primary consideration is the disposition of assets, joint ventures, the sale of the company, alternative operating models, or continuing with the current business plan, among other potential alternatives.

It is important to point out that there can be no assurance that the strategic review process will result in the completion of any transaction or other alternative and no timetable has been set for the completion of this review. As is customary with a strategic review process, management does not intend to comment further regarding the process, until additional disclosures are appropriate or required by law.

The company’s recently reported third-quarter results were softer year-over-year, as expected. Revenues were lower at $20.7 million versus $21.2 million in 2012. Litigation expenses doubled to $14.4 million compared with $7.1 million a year earlier. Adjusted quarterly earnings amounted to a loss of $300,000 compared with adjusted earnings of $9.3 million, or $0.08 per share, in the same period last year.

The good news from the quarter was that with a large number of litigations resolved, it can be expected that legal expenses will be reduced in the fourth quarter. Management is expecting fourth-quarter revenues to be at least $28.4 million. This revenue guidance does not include the potential impact of any additional royalty reports to be received between now and the end of the quarter or any new agreements that may be signed.

Operating expenses for the fourth quarter are expected to be in the range of $13.5 million to $16.5 million, of which $6.3 million to $8 million is expected to be litigation expense. For the fourth quarter, and assuming no additional agreements are signed, adjusted earnings are expected to be in the range of $12.5 million to $15 million or a minimum of $0.10 per share. Having said this, the fourth-quarter guidance includes some one-time licensing agreements and should not be considered as predictive of a run-rate going forward into 2014.

WiLAN’s balance sheet remains solid as it completed the quarter with $142.3 million in cash, cash equivalents, and short-term investments worth approximately $1.18 per share. This represents a decrease of $34.6 million in the net cash position at last year-end, which is largely explained by more than $20 million being returned to shareholders through dividends and share buybacks and use of cash from operations, principally increased accounts receivable in this quarter of $11 million. The increase in the receivables position at quarter-end is due to the timing of the receipt of payment for fixed license fees, most of which has been collected subsequent to quarter-end.

Given the current strategic review, strong balance sheet, and positive near-term outlook for earnings, we continue to hold WiLAN. However, the company continues to face challenges to unlock the value of its patent portfolio and, with less visibility beyond the current quarter, we do not advise adding to positions at present.

Action now: Hold.

– end Ryan Irvine

A SECURITY TO WATCH

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Every so often a security comes to my attention that I feel has excellent potential. However, I am reluctant to recommend it to readers for one reason or another.

Here’s an example: the Cambria Shareholder Yield ETF (NYSE: SYLD), which surfaced on my radar screen when a reader asked if it was worth considering for his portfolio.

I think it is, and here’s why. This is an actively-managed ETF (most track a benchmark index) that focuses on companies that have demonstrated their ability to return free cash flow to shareholders. SYLD invests in about 100 stocks with market caps in excess of $200 million that rank among the best in terms of paying cash dividends, engaging in net share repurchases, and paying down debt.

In other words, fund managers Mebane Faber and Eric Richardson look beyond a company’s dividend history in deciding which stocks to choose. Using their proprietary quantitative algorithm, they identify companies that use all three methods to pass on free cash flow to investors.

It’s obvious to most people how dividends and share repurchases fit into this matrix. Cambria Investment Management, which is based in Los Angeles, notes that more U.S. companies have shifted their payout mix to include share buybacks and that research suggests that this strategy can actually result in a higher yield than simply paying dividends.

As for debt reduction, the argument is that by paying down balance sheet debt a company reduces interest costs, thereby freeing up more cash for shareholder distribution.

This all boils down to a value investing approach with a twist.

The portfolio offers a diversified blend of large cap (65%), mid cap (25%), and small cap (10%) stocks. The assets are spread over a range of sectors with consumer discretionary (19%), financials (18%), information technology (14%), industrials (13%), consumer staples (12%), and health care (11%) the largest groups. Some of the top names in the portfolio are Taser International, Boston Scientific, Gamestop, Manpower, Safeway, and Nu Skin Asia Pacific.

Performance so far has been quite good. As of Nov. 22, the ETF was up 15.3% since its launch in mid-May plus investors had received one quarterly distribution of $0.124 per unit (prices in U.S. currency). The MER is 0.59%, which is very reasonable for an actively managed fund.

So why not recommend it? The main problem is that we have no history to work with. The concept looks promising but there is no way of knowing whether the fund will outperform or underperform the market over time. Also, although the focus is on free cash flow, if the initial distribution is any indication income investors aren’t going to be happy with this ETF. If the $0.124 distribution were to hold for a year, the yield would only be 1.7% based on a recent price of $28.83.

It’s also worth noting that this is a relatively small ETF by U.S. standards with only $124 million in assets. Investors haven’t been exactly clamouring to get on board.

I’ll take another look at it in a few months to see how it’s doing but for now I’ll hold off making a buy recommendation. Of course, if you like the idea feel free to purchase a few shares. Just remember we won’t be tracking results unless and until it is added to our Recommended List. – G.P.

NEW BOOK

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For most Canadians, an RRSP is the only personal pension plan they will ever have. As employer-sponsored plans become increasingly rare outside the public sector, we must rely on our own savings and money management skills to ensure a comfortable lifestyle after retirement.

This comprehensive guide by best-selling financial author Gordon Pape provides the secrets to building a winning RRSP – everything from setting up the right kind of plan at the outset to proven strategies that will enable you to grow your RRSP over time to a value of several hundred thousand dollars. And all the while, you’ll be collecting sizeable tax refunds for every contribution you make.

This is a must-read book for everyone who cares about providing a comfortable future for themselves and their families.

Here are some of the key things you’ll learn:

• How to choose a plan that’s right for your needs.
• Tips for selecting the best RRSP investments
• Common RRSP mistakes and how to avoid them
• Little-known RRSP strategies
• How to build successful portfolios
• Deciding between an RRSP and a TFSA
• When to use the Home Buyers’ Plan
• Transitioning to a RRIF

 

Gordon Pape describes RRSPs as “one of the most powerful personal wealth-building opportunities in the world”. You owe it to yourself to take advantage of it.

You can pre-order your copy now from our on-line bookstore at only $13. That’s a saving of 28% from the suggested retail price.

Go to: http://astore.amazon.ca/buildicaquizm-20

 

That’s all for now. We’ll be back on Dec. 2.

Best regards,

Gordon Pape

In This Issue

A CORRECTION – BUT WHEN?

By Gordon Pape

The other night, I joined a group of friends for a glass of wine and a taco buffet at our golf club. During the course of the evening I must have been asked five times: “When is the correction coming?” All I could answer was: “I wish I knew”.

There’s going to be one, that’s certain. But it may not happen until the New Year. That’s when two events could rattle the markets: an indication from the Federal Reserve Board that it will start scaling back its quantitative easing (QE) program plus a renewed confrontation in Congress over the debt ceiling.

The bull market that we’ve been experiencing is unusual in several ways. It doesn’t seem to be following any of the conventional rules, which is what makes predicting the timing of a correction even more difficult.

For starters, we’re seeing the best gains in New York in a decade. As of the close of trading on Friday, the S&P 500 was up 26.5% for 2013 while the Dow had gained 22.6%. Even more significant was the fact both of those indexes broke through important psychological barriers during the week and held on to the gains. The Dow is now over 16,000 while the S&P 500 is through the 1,800 mark.

European markets have also been strong and the Nikkei 225 is up an astonishing 48% year-to-date. So the rally hasn’t been confined to New York; it’s a global event.

What’s more, when you look at the charts for the year, they go almost straight up. Oh sure, there are a few blips here and there but on the whole it’s been a pretty steady climb. October, which is often a rough month for markets, was uncharacteristically benign and the upward surge has continued through November. Now we’re coming up to the traditional time for the Santa Claus rally – except that this year there is nothing to rally back from. It’s all been good.

Some of the statistics are interesting. Since the Great Depression, the average length of bull markets has been 57 months. If you date this one back to March 2009, we’ve had a 56 month run, so by that standard the market should be close to exhaustion. But it’s not looking that way and some bull markets have gone on much longer. The Internet-fuelled rally of the 1990s lasted 113 months before it hit a wall in early 2000. So the precedent for a much longer run is there.

There is an active debate among market watchers as to whether we are experiencing a stock bubble that will soon burst. That’s typical when markets move into uncharted territory as both the Dow and the S&P 500 have.

On a price to projected earnings basis, the S&P 500 appears to be fairly priced – not cheap by any means, but not outrageously expensive either. But as the Associated Press pointed out last week, the adjusted p/e ratio based on a formula developed by Nobel Prize winner Robert Shiller indicates that stocks are trading well above historical averages and are due for a correction.

That brings us back to the original question – when? It could happen any time – one significant piece of bad news could trigger a sell-off. But absent that, my guess is that we won’t experience a major pull back of 10% or more until January. I think it will be sparked by an indication from the Federal Reserve Board that quantitative easing will finally begin to wind down. That will be good news for the economy but bad news for investors who have been relying on QE to keep interest rates low and fuel the stock market.

So what should you do now? Here are some suggestions.

Take some profits. Many of our recommendations have recorded good gains this year. In some cases we have advised taking part profits or even selling entire positions. But keep in mind, this is just guidance. Investors should take a close look at their personal situation and their tax position. Crystallizing profits outside a registered plan will trigger a taxable capital gain so take that into account in your planning. It may be appropriate to sell a losing position at the same time to partially offset the taxable gain.

Add new positions gradually. We believe markets will rise in 2014 after the correction. However, in most cases (e.g. the U.S., Japan, and Europe) we don’t expect the advances to match those of this year. Therefore, while we will continue to recommend securities that we believe offer upside potential, it is advisable to take a measured approach in your purchases. If you decide you want to own a particular stock, allocate the amount of money you are prepared to invest. Spend one-quarter to one-third of that now and then wait for a pullback. At that time, commit another portion of your capital. If the markets retreat even further, you may be able to acquire the rest at a bargain-basement price.

Hold some cash in reserve. If you decide to take some profits in the next few weeks, hold some of the cash in reserve. The markets will correct at some point – they always have. If you have money available, you’ll be able to buy some quality stocks at attractive prices.

Don’t panic. Some investors will inevitably hit the panic button when the market drops. Don’t be one of them. There is nothing to suggest that 2014 will bring us a repeat of 2008. Yes, there are still problems in the global economy, which the OECD again highlighted in a new report this month. In it, the OECD warned that uncertainty over U.S. fiscal and monetary policy poses a risk to the recovery and cut its growth projections for the Eurozone while warning that the risk of deflation has increased.

So we are not out of the woods yet by any means, which in itself is a good reason for stock markets to pull back from their current lofty positions. But the chances of a new recession appear very low. The coming year may bring slower growth than originally expected, but it will bring some growth with the promise of more to come. That’s why the markets will rally back after we hit the speed bump, and why you want to be there when they do.

Gordon Pape’s new book is titled RRSPs: The Ultimate Wealth Builder. It will be published by Penguin Canada in January but you can pre-order your copy now at a 28% discount to the suggested retail price by going to http://astore.amazon.ca/buildicaquizm-20

 

AIRLINE MERGER OFFERS OPPORTUNITY

Contributing editor Glenn Rogers is here this week with his views on the one of the biggest airline mergers in U.S. history and what it means for investors. Glenn is a successful businessman and entrepreneur who has worked in both Canada and the U.S. over his career. He and his family now live in southern California. Here is his report.

Glenn Rogers writes:

If you’re like me you’ve seen a long, sad decline in the quality of the air travel experience over the last decade or so since the airlines were deregulated in the U.S. True, for a time prices did come down since there was a rush of cheap air carriers in the space. That caused many mainstream carriers to reduce their prices – and their services – to compete with the low-cost offerings.

During this era things we had taken for granted such as meals, pillows, blankets, free luggage check-in, etc. were steadily chipped away until we have gotten to the point where we have to pay extra for virtually everything. As this was going, on the airlines still lost gobs of money as they added more seats than the market could handle.

After years of this nonsense they began to figure out that they couldn’t outspend each other and gradually began to merge in search of efficiencies and route dominance.

Personally, have always avoided investing in airlines. They never seem to have any financial discipline, they require lots of capital, and were subject to the whims of union contracts and jet fuel prices. Airlines are one of the few sectors where Warren Buffett lost money and he swore he never would invest in one again. I felt the same way, but never say never because I’m about to recommend investing in airlines again.

Part of the reason is that I still believe in the travel industry in general over the next few years for reasons I’ve mentioned in previous columns. The Internet-related travel stocks we recommended have done extremely well and are now fully priced but I think there is room to grow in some of the still recovering airline stocks.

The result of all the reduction in services and the accompanying increase in fees, combined with a number of huge mergers, has made the space interesting again. This past week the U.S. Department of Justice agreed to let the $17 billion (figures in U.S. dollars) merger of US Airways Group (NYSE: LCC) with American Airlines (OTC: AAMRQ) go forward with very few concessions. Few analysts, including myself, believed they would get off so easily. But now that the terms of the deal have been set, it creates a very interesting opportunity to take advantage of the heavy travel period we are entering which, happily for the airlines, coincides with a recent steady drop in jet fuel prices.

This merger will create the world’s second largest airline (next to Delta). It enters into a market that has fewer competitors than at any time in the past 10 years. US Airways shareholders will get 20% of the new company’s equity while American Airlines creditors and shareholders will receive the remainder. US Airways management will for the most part run the company with Doug Parker, the highly respected US Airways CEO, taking over the combined business. Although US Airways management will run the show, the merged company will retain the American Airlines name.

The merged American will have to give up a number of landing slots in Washington and at New York’s LaGuardia Airport, along with reducing some exposure in Boston, Chicago, and Dallas. But it will still have 57% of the flights in and out of Dulles Airport in Washington and only 12 fewer flights from the normal 175 daily departures at LaGuardia. The company also expects to have over $1 billion in annual savings from the synergies it expects to benefit from post merger. There are other companies that will benefit from this merger, including Southwest Airlines (NYSE: LUV) and JetBlue Airways Corp. (NDQ: JBLU), which will be able to acquire a number of the gates that US Airways/American will have to let go.

Compared to the other large airlines, US Airways, which closed on Friday at $24.27, is quite cheap. The shares are trading at a discount to Delta Airlines (NYSE: DAL) which has a price-earnings multiple of 9 versus 6.6 (2014 estimated earnings) for the new American Airlines. If American just tracks to Delta Airlines multiples against its earnings forecast we could see the stock increase significantly over the next year and a half, perhaps to as much as $32 or better in 2015.

Certainly there could be some churn in the stock as the American Airlines and US Airways stakeholders decide how much they will continue to hold versus sell over the next few months but I would view every dip as a buying opportunity. The only thing that would significantly change my opinion is if jet fuel spikes to over three dollars a gallon for an extended period of time.

You don’t have to like airlines to like the investment opportunity that presents itself now. However, you need to understand a few complexities. US Airways stock continues to trade actively on the NYSE. However, American, which is technically still in bankruptcy, only trades as AMR Corp. on the U.S. over-the-counter market under the symbol AAMRQ. It closed on Friday at $12.06.

When the merger is completed and American emerges from bankruptcy protection, shares in the combined airline will be listed on Nasdaq under the symbol AAL. We don’t have an exact timetable for that but the whole process should be concluded some time in December.

For now, I advise buying US Airways on the New York Exchange. I expect the two stocks to track one another closely until the merger is complete. US Air closed on Friday at $24.27. I think the stock has the potential to reach $32 within 18 months.

Action now: Buy US Airways Corp. (LCC) at the current price.

 

GLENN ROGERS’S UPDATES

The Boeing Company (NYSE: BA)

Originally recommended on Jan. 21/13 (#21303) at $88.89. Closed Friday at $135.07. (All figures in U.S. dollars.)

We recommended the stock last January when it was trading at $88.89. At that time we suggested that the concerns about the Dreamliner problems were likely overdone and that the dip represented a buying opportunity. This has turned out to be true and the stock closed Friday at $135.07 for a gain of 52% to this point. We have also received dividends of $1.94 per share.

Last weekend Boeing and Airbus announced at the Dubai Airshow that they had signed orders worth more than $100 billion as a number of Middle Eastern companies added to their fleets. This underscores again the continuing demand for aviation products with basically only two companies in the world able to supply the larger scale aircraft – Boeing and Airbus. Smaller manufacturers like Canada’s Bombardier (TSX: BBR.B) and Brazil’s Embraer (NYSE: ERJ) should also do well but the two big players will benefit the most.

True, Boeing may see reductions in some of its military divisions with the F-18 Super Hornet due to close out its assembly line in 2015. But given mankind’s proclivity to blow things up I wouldn’t bet against continued orders for the company’s warplanes. Ditto for Boeing’s strategic missile and defense systems.

But it is the passenger jet business that looks like it has a long way to run and the only thing that makes me hesitate at this point is that the stock is beginning to look a little expensive. With in mind I consider the shares to be a hold and would add to my position on any pullback.

Action now: Hold.

General Electric (NYSE: GE)

Originally recommended on May 18/09 (#2918) at $13.04. Closed Friday at $27.08. (All figures in U.S. dollars.)

One last airline related update brings us to General Electric, which was recommended back in May 2009 when it was trading at $13.04. I last updated it on April 15 at $23.46 at which time I rated it as a Buy.

Obviously, General Electric is not strictly an airline-related stock but it is a large supplier of jet engines to Boeing and received $26 billion in jet engine orders and service agreements during the Dubai Airshow last weekend.

Of course, GE has many other businesses and has gradually been returning to its roots as an industrial manufacturer, for example by divesting itself of NBC Universal. Earlier this month it announced plans to reduce its exposure to its finance arm by spinning off its credit card division.

This will still leave the company with significant stakes in energy, water treatment, and medical diagnostics. As well, it has a large business in transportation with a huge freight and passenger locomotives operation. The
stock yields 2.8% even after the steady run-up the shares have enjoyed since we first recommended them.

As with Boeing, I’m still a little concerned about valuation at the current price given GE’s long run. It’s also worth remembering that the market hasn’t had a good-sized correction for some time. So I would recommend holding the stock here and would add to my position on any pullback in the market.

Action now: Hold.

– end Glenn Rogers

FILTERING OUT THE RUBBISH

Also with us this week is contributing editor Ryan Irvine, one of Canada’s leading experts in small-cap stocks and CEO of Keystone Financial (www.KeyStocks.com). Ryan lives and works in the Vancouver area. Here are his comments.

Ryan Irvine writes:

Historically speaking, with the S&P 500 trading at approximately 20 times trailing earnings, and with a Schiller p/e of over 25, U.S. stocks are not cheap.

In Canada, a terrible downturn in the metals and mining sector (one we have largely avoided with our picks over the past two years) has left the S&P/ TSX Composite Index with a poor record over the past 24 months compared to the S&P 500, which continues to hit all-time highs on an almost daily basis.

In recent weeks, we have increasingly heard several broad arguments as to why you should start buying equities, or continue to do so. These include:

No alternatives. With short- and long-term interest paying instruments such as GICs, bonds, T-bills, and savings accounts paying diddly squat, stocks are the only game in town.

All the “money on the sidelines” will flow into stocks. The argument here is that investors frightened by the 2008 crisis (for example) sold en masse and have yet to re-enter, but will soon, thus pushing markets higher.

These views are rubbish, in my opinion.

Let’s address the “money on the sidelines” myth. Two critical aspects are important when looking at this argument as a positive driver. First, money does not “enter” the market, it is swapped. For example, Investor A’s cash is used to buy shares from Investor B; after the transaction the roles are swapped with Investor B holding cash on the sidelines and Investor A holding shares. In other words, when shares are bought and sold on the stock market, money is simply going from “sideline” to “sideline” while stocks are being transferred from account to account. Since the total amount of money “on the sidelines” remains exactly the same, an abundance of money “on the sidelines” cannot be the cause of price increases. The inverse is true for money moving out of stocks and “onto the sidelines.” As a result, speculative discussions about the amount of cash “on the sidelines” are fairly meaningless.

Secondly, as stated by Morgan Stanley’s Gerard Minack, despite all the disclaimers retail flows assume that past performance is a good guide to future outcomes. Consequently money tends to flow to investments that have done well, rather than investments that will do well.

Having said all this, if we did step to an alternative universe where money flowed into stocks and was “absorbed” somehow with a net gain for stocks, would it be smart to follow that herd now? No. That’s like saying: “Buy when the dumb money arrives or buy what the smart money is selling!”

The theory goes that there exists a massive amount of dumb people out there (I like the theory if we stop here) that own huge quantities of bonds and/or have tons of idle cash lying around. The trick is to get into stocks now, right as all of this dumb money is about to “rotate” out of bonds and cash and start flooding into the stock market and cause a massive blow-off rally in equities.

So, we are being told that it is smart to do as the dumb money does, or is about to do. But before you do as you are told, Mr./Ms. Lemming, make sure to ask yourself this: who are the generous folks that will so graciously sell their stocks to the dumb money or to you? Interesting question, isn’t it?

Now let’s go back to argument number one – there are no alternatives. Seriously, that is an argument? This is like saying your goal is to move and your options are to stand still or jump off a bridge. On your tombstone it will read: “no alternative, had to jump.”

Of course there are alternatives – you can wait in cash or, more productively, choose not to invest all at once and abstain from the all-in or all-out short-term mentality the broader financial arena likes to sell to you.

Again, those who argue you should buy stocks based on simplistic ideas such as that there are no alternatives, that the money on the sidelines will eventually enter the market and push equities higher, or that you should buy because the markets are rising, are selling you shortcuts. These arguments make great headlines and easy quips but will likely just lose you money.

The only reason you should ever buy a stock is because the underlying business is sound, growing, and you can purchase a share of its current and future cash flows at a cheap or reasonable price. This will serve you well as an investor long-term.

Currently, with U.S. markets breaking new highs, we are proceeding with caution and find that in the current environment it is more challenging to uncover value than at any other time in the past five years. This is not to say we cannot find value, having issued two new Buy reports in the past month from our Small-Cap and Income Stock research. It is just more difficult to uncover.

RYAN IRVINE’S UPDATES

High Arctic Energy Inc. (TSX: HWO, OTC: HGHAF)

Originally recommended on Sept. 3/13 (#21332) at C$2.85, US$2.55. Closed Friday at C$3.09. US$2.62 (Nov. 19).

We introduced High Arctic Energy Inc. to IWB readers in early September. Today we update the company in the light of its recently released third-quarter financial report.

HWO is an international oil and gas services company with operations in both Papua New Guinea (PNG) and Western Canada. The company’s substantial operation in Papua New Guinea is comprised of contract drilling, specialized well completion services, and a rentals business, which includes rig matting, camps, and drilling support equipment. HWO’s Canadian operation is focused on the provision of snubbing services and the supply of nitrogen to a large number of oil and natural gas exploration and production companies operating in Western Canada.

Revenues for the first nine months of 2013 increased by 6% to $114 million compared to $107.6 million in the same period of the prior year. The growth in revenue for the period was driven by increased activity in PNG with revenues of $85.9 million compared to $71.2 million for the first nine months of 2012. Third-quarter PNG revenues were $27.7 million, up from $22.6 million in the same period of 2012. The growth resulted from having a second active drilling rig and a larger fleet of rental equipment in 2013.

Revenues derived from PNG’s rental fleet contributed approximately $20.2 million for the first nine months of 2013, up from $14.5 million in the same period of 2012. Despite increased revenues, adjusted EBITDA decreased slightly to $29 million for the nine-month period from $29.6 million for the same period in 2012 due primarily to a reduction in the Canadian operating margin attributable to overall reduced industry activity levels.

Third-quarter revenue for Canada was $8.6 million, down from $13.2 million in the same period of 2012. For the first nine months of 2013, Canadian revenues decreased by $8.3 million or 23% from the same period in 2012 due to reduced revenue levels from both the core snubbing and nitrogen businesses which was consistent with the overall industry activity slowdown. The operating margins in Canada were adversely affected by the reduced revenue levels and by competitive pricing conditions primarily in the nitrogen operations.

Conclusion

While challenged once again in by lower year-over-year activity levels in its Canadian operations, solid performance from the company’s PNG operations produced another strong quarter of revenue growth, solid EBITDA, cash accumulation, and debt reduction from High Arctic.

The long-term outlook for activity in PNG continues to be strong and the recent signing of the three-year contract extension with Oil Search Limited (OSL, an Australian public company) provides some stability. OSL’s operations in PNG are less dependent on short-term fluctuations in oil and gas prices and instead are based on long-term decisions, particularly with its significant interest in a large-scale liquid natural gas (LNG) project currently under construction.

Having said this, the capital demands of that project should affect the capital available for drilling in the near term. High Arctic’s main customer in PNG will have only one rig active in the fourth quarter as it sets its budget. As such, we expect lower year-over-year revenues from this source. Offsetting this should be higher margin equipment and services revenue from the contract signed with a major Canadian global upstream oil and gas company.

While fourth-quarter aggregate revenues will likely be down from the previous year in total, EBITDA should come in at only slightly less or close to even from the prior year’s quarter as the mix should include higher margins work. The wild card here is in relation to the Canadian operations. If activity breaks early for the holidays then fourth-quarter EBITDA will likely be slightly lower. Conversely, if activity persists up until Christmas, fourth-quarter EBITDA has a chance to mirror levels seen in 2012.

From a fundamental perspective, High Arctic remains attractively valued. The company trades a low 5.61 times trailing earnings, a low 3.52 times trailing EBITDA, and at a very low Enterprise Value to EBITDA ratio of 2.95. High Arctic continues to boast a strong balance sheet with $21.9 million or $0.44 per share in cash net of debt.

The bottom line is that the stock remains cheap on a relative basis. However, there is no need to chase it, as we do not expect any near-term price increases given the near-term pullback in spending ahead of the PNG LNG project. The long-term potential in PNG remains very strong and High Arctic is well positioned to benefit from the growth as the project comes on stream.

Action now: We reiterate our Buy rating on High Arctic. In the near term, collect the strong 4.9% dividend and expect to hold for long-term growth catalysts over the next one to three years.

WiLAN Inc. (TSX: WIN, NDQ: WILN)

Originally recommended on Aug. 8/11 (#21128) at C$6.99, US$7.15. Closed Friday at C$3.38. US$3.20.

WiLAN Inc. has been volatile since we picked it, trending downward as higher litigation costs are currently being incurred in an effort to secure further long-term licensing deals.

To be blunt, we have been disappointed with the litigation results from WiLAN over the past year. While there have been some wins, the company has also experienced a couple of negative judgments where in the past there had been none. It appears the board of directors is in agreement (as has been the market) with this assessment and on Oct. 30 it was announced they had initiated a process to explore and evaluate a broad range of strategic alternatives for the company to enhance shareholder value.

The strategic alternatives to be considered include changes in reference to the current dividend policy, or other points of returning capital to shareholders. Of primary consideration is the disposition of assets, joint ventures, the sale of the company, alternative operating models, or continuing with the current business plan, among other potential alternatives.

It is important to point out that there can be no assurance that the strategic review process will result in the completion of any transaction or other alternative and no timetable has been set for the completion of this review. As is customary with a strategic review process, management does not intend to comment further regarding the process, until additional disclosures are appropriate or required by law.

The company’s recently reported third-quarter results were softer year-over-year, as expected. Revenues were lower at $20.7 million versus $21.2 million in 2012. Litigation expenses doubled to $14.4 million compared with $7.1 million a year earlier. Adjusted quarterly earnings amounted to a loss of $300,000 compared with adjusted earnings of $9.3 million, or $0.08 per share, in the same period last year.

The good news from the quarter was that with a large number of litigations resolved, it can be expected that legal expenses will be reduced in the fourth quarter. Management is expecting fourth-quarter revenues to be at least $28.4 million. This revenue guidance does not include the potential impact of any additional royalty reports to be received between now and the end of the quarter or any new agreements that may be signed.

Operating expenses for the fourth quarter are expected to be in the range of $13.5 million to $16.5 million, of which $6.3 million to $8 million is expected to be litigation expense. For the fourth quarter, and assuming no additional agreements are signed, adjusted earnings are expected to be in the range of $12.5 million to $15 million or a minimum of $0.10 per share. Having said this, the fourth-quarter guidance includes some one-time licensing agreements and should not be considered as predictive of a run-rate going forward into 2014.

WiLAN’s balance sheet remains solid as it completed the quarter with $142.3 million in cash, cash equivalents, and short-term investments worth approximately $1.18 per share. This represents a decrease of $34.6 million in the net cash position at last year-end, which is largely explained by more than $20 million being returned to shareholders through dividends and share buybacks and use of cash from operations, principally increased accounts receivable in this quarter of $11 million. The increase in the receivables position at quarter-end is due to the timing of the receipt of payment for fixed license fees, most of which has been collected subsequent to quarter-end.

Given the current strategic review, strong balance sheet, and positive near-term outlook for earnings, we continue to hold WiLAN. However, the company continues to face challenges to unlock the value of its patent portfolio and, with less visibility beyond the current quarter, we do not advise adding to positions at present.

Action now: Hold.

– end Ryan Irvine

A SECURITY TO WATCH

Every so often a security comes to my attention that I feel has excellent potential. However, I am reluctant to recommend it to readers for one reason or another.

Here’s an example: the Cambria Shareholder Yield ETF (NYSE: SYLD), which surfaced on my radar screen when a reader asked if it was worth considering for his portfolio.

I think it is, and here’s why. This is an actively-managed ETF (most track a benchmark index) that focuses on companies that have demonstrated their ability to return free cash flow to shareholders. SYLD invests in about 100 stocks with market caps in excess of $200 million that rank among the best in terms of paying cash dividends, engaging in net share repurchases, and paying down debt.

In other words, fund managers Mebane Faber and Eric Richardson look beyond a company’s dividend history in deciding which stocks to choose. Using their proprietary quantitative algorithm, they identify companies that use all three methods to pass on free cash flow to investors.

It’s obvious to most people how dividends and share repurchases fit into this matrix. Cambria Investment Management, which is based in Los Angeles, notes that more U.S. companies have shifted their payout mix to include share buybacks and that research suggests that this strategy can actually result in a higher yield than simply paying dividends.

As for debt reduction, the argument is that by paying down balance sheet debt a company reduces interest costs, thereby freeing up more cash for shareholder distribution.

This all boils down to a value investing approach with a twist.

The portfolio offers a diversified blend of large cap (65%), mid cap (25%), and small cap (10%) stocks. The assets are spread over a range of sectors with consumer discretionary (19%), financials (18%), information technology (14%), industrials (13%), consumer staples (12%), and health care (11%) the largest groups. Some of the top names in the portfolio are Taser International, Boston Scientific, Gamestop, Manpower, Safeway, and Nu Skin Asia Pacific.

Performance so far has been quite good. As of Nov. 22, the ETF was up 15.3% since its launch in mid-May plus investors had received one quarterly distribution of $0.124 per unit (prices in U.S. currency). The MER is 0.59%, which is very reasonable for an actively managed fund.

So why not recommend it? The main problem is that we have no history to work with. The concept looks promising but there is no way of knowing whether the fund will outperform or underperform the market over time. Also, although the focus is on free cash flow, if the initial distribution is any indication income investors aren’t going to be happy with this ETF. If the $0.124 distribution were to hold for a year, the yield would only be 1.7% based on a recent price of $28.83.

It’s also worth noting that this is a relatively small ETF by U.S. standards with only $124 million in assets. Investors haven’t been exactly clamouring to get on board.

I’ll take another look at it in a few months to see how it’s doing but for now I’ll hold off making a buy recommendation. Of course, if you like the idea feel free to purchase a few shares. Just remember we won’t be tracking results unless and until it is added to our Recommended List. – G.P.

NEW BOOK

For most Canadians, an RRSP is the only personal pension plan they will ever have. As employer-sponsored plans become increasingly rare outside the public sector, we must rely on our own savings and money management skills to ensure a comfortable lifestyle after retirement.

This comprehensive guide by best-selling financial author Gordon Pape provides the secrets to building a winning RRSP – everything from setting up the right kind of plan at the outset to proven strategies that will enable you to grow your RRSP over time to a value of several hundred thousand dollars. And all the while, you’ll be collecting sizeable tax refunds for every contribution you make.

This is a must-read book for everyone who cares about providing a comfortable future for themselves and their families.

Here are some of the key things you’ll learn:

• How to choose a plan that’s right for your needs.
• Tips for selecting the best RRSP investments
• Common RRSP mistakes and how to avoid them
• Little-known RRSP strategies
• How to build successful portfolios
• Deciding between an RRSP and a TFSA
• When to use the Home Buyers’ Plan
• Transitioning to a RRIF

 

Gordon Pape describes RRSPs as “one of the most powerful personal wealth-building opportunities in the world”. You owe it to yourself to take advantage of it.

You can pre-order your copy now from our on-line bookstore at only $13. That’s a saving of 28% from the suggested retail price.

Go to: http://astore.amazon.ca/buildicaquizm-20

 

That’s all for now. We’ll be back on Dec. 2.

Best regards,

Gordon Pape