I’ve mentioned a few times in past posts the importance of identifying unsustainable trends in the economy and business cycles of companies. Every investor needs to be proactive in his or her investing activities to identify risk because far too often each of us are solely reactive to developments in the market and this leads to significant losses of our capital and opportunity for gains. Trees never grow to the sky, and when a stock chart or market goes parabolic, gravity has a sickening effect on the scale and speed of its inevitable descent.

I practice diversification by investing outside of Canada, and this directly exposes me to varying degrees of currency risk each time I purchase a foreign stock, bond, mutual fund or ETF. As a long-term investor I recognize that volatility in FOREX (foreign exchange) comes with the territory of being diversified globally and that over the long-term currency fluctuations tend to even out. But as an investor in the accumulation phase of his portfolio construction, I’m concerned about the short-term effect of currency volatility because it can impact the price I pay for an investment and any gains (income, capital gains, interest) I subsequently receive. While I view currency exchange as a cost of investing, I want to always minimize my exposure to costs as much as possible because costs directly impact my ability to achieve short-term gains and compound long-term results.

Background

A corporate bond is a bond issued by a corporation to investors in order to raise money for activities of operating, expanding or conducting business. The bond will mature (maturity) at some specific date in the future (term) and pays a coupon (interest) on the principal amount over that time. A bond is sold initially at par and its value will move up or down in response to various criteria and events.

Debt investing and equity investing have very different styles both in the method and criteria that an investor will approach a company with. As an equity investor you may be interested in the long-term capital appreciation, earnings growth, dividends or future takeover prospects of a company and this determines how you analyze your prospective investment. As a debt investor your sole objective and focus is on receiving income and ensuring the security of the capital you’ve invested.

A vital long-term objective in my investing discipline is to concentrate on the cashflows of the businesses I own and to maximize the cashflow I receive in my core portfolios. Cashflow is important for a number of reasons and one of the most important for a conservative investor is that you can’t always count on making investment gains exclusively from the price appreciation of the investments you own. There will be times in an economic cycle where the real return (return after inflation) is 0-2% providing minimal returns. Cashflow provides a necessary flexibility that each investor should concentrate on, if they don’t already, because of the additional benefits cash provides to returns over the long-term.

One of my objectives last year in 2008 was to expand my investing knowledge beyond common shares and move up the hierarchy of capital towards preferred shares, bonds and debentures. I began by pulling out old notes from business school and asking various investors for information on classifications of securities taking detailed notes for future reference. After a few months I felt confident enough that I had accumulated an adequate amount of knowledge to understand the basics and constructed a watchlist of various securities trading in North America to observe their trading activity. I constructed a list of reading material and began watching for commentary and opinions from various investors well versed in the debt markets and individual fixed income products.

Company:

Pfizer is a global research based pharmaceutical company with a long corporate history dating back to 1849. The company strives to demonstrate that their products effectively prevent and treat targeted diseases, improve symptoms and suffering and that the company helps to form the basis for improvements in the healthcare system.

Photo courtesy of Canadian National Railway.

As valuations of equities continued their uninterrupted slide this week The Dividend Express kept chugging along. Despite being down 8.87% YTD Canadian National Railway (CNI) made an announcement on Wednesday that quietly flew under the radar of investors and the broader market. When cashflow is king and the cost of capital becomes prohibitive companies who are able to secure cheap financing benefit from an important competitive advantage that places them in a position to continue operating without impairment through any economic crisis.

An anonymous reader asked the following question in a comment:

Since you're in health care what do you think of Stryker…not a dividend monster by any means but maybe some upside soon?

When one first examines Coca-Cola (KO), there is an immediate emotional response many individuals have for their product(s). Love it or hate it; the products of this company are consumed on a daily basis globally to the tune of nearly 1.5 billion times. To put this in some perspective, that’s the equivalent of 25% of the global population consuming a minimum of one product sold by the Coca-Cola Company each and every day.

This is the brand power on a massive scale with a strong domestic history in North America dating back to 1886. Globally, Coca-Cola products are sold in over 200 countries and the company is the “largest manufacturer, distributor and marketer of non-alcoholic beverage concentrates and syrups in the world.” The company sells four of the top five carbonated brands around the world (Coca-Cola, Diet Coke, Sprite and Fanta), owns or licenses an additional 450 brands and possesses the largest beverage distribution system on the planet.

I'm not the brightest investor on the street, but I know enough that something isn't quite right when I've fielded two dozen questions in recent days about the investing prospects of the Bank of Montreal (BMO) from peers who are intently focused on the stunning 9%+ dividend yield of its common shares.

I first want to lay out in this post the cost of capital that banks have currently experienced when going to the market for equity to shore up their balance sheets.

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

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

In a previous post I presented as part of my short-term investing strategy a long held Value Rule that a company should never compete on price.

In the comments of the post the moneygardener asked the following question:

I took the opportunity of further declines in the markets today to strengthen my position in Canadian Pacific Railway (CP). After buying a full position in Canadian National Railway (CNI) on Friday I was looking to rebalance my railway holdings into my original targeted ratio.

I view CNI as the better business and hold a higher weighting in my Canadian dividend portfolio of it (DivG) and I consider CNR the best North American rail company, but CP isn't far behind.

The market reaction to Research In Motion (RIMM) Friday wasn't pretty, following their earnings release Thursday evening after the market close. Concerns over margins were raised as gross margins fell. RIM is an interesting stock for a number of reasons, beyond the fact that the fundamentals of its business model are very strong and growing. [click to enlarge image]

Despite significant competition in the consumer market, job losses and cuts in spending by financial institutions on the corporate side of business, RIM continues to meet both revenue forecasts and new subscriber targets in each successive quarter. The premium on this growth stock has recently dropped dramatically as a number of investors consider the short-term effects of various risks.

But RIM makes a superior business product, has a dominant software infrastructure and their market share outside of North America is still low and growing. The company has proven that it can continue to innovate and meet the demands & expectations of its customers with new products and has diversified itself away from just one product line.

At a conservative target of $3.55 EPS for 2009, RIM currently trades around 21x forward earnings which does seem high at first glance. But there's been no tangible decrease in demand, costs continue to meet management's targets and the company's products continue to penetrate the consumer market. As consumers begin using features of a blackberry that they've never had access to before, early adoption is leading to more usage of their products.

While I continue to see RIM as over-valued, I will likely take some time this weekend to examine the company more closely. They have various products in development at the company and the upcoming product pipeline has both depth and diversity for its target markets.

This is a wonderfully managed company with strong relationships with its target market and although many investors view this as a one-stock-show (Apple (AAPL) vs. RIM), I continue to see strength in the operations of both.

The consumer market is difficult to predict on frequent occasions, but RIM does a good job of always leaving consumers wanting just a little more in the next updated Blackberry. They have the unique ability to capture a market and then keep them using their products for sustained periods of time. Competition is healthy for any company and RIM certainly has lots, but at less than 20x 2009 EPS, this value investor might begin to raise an eyebrow towards RIM as a prospective investment for 2009.

I don't know if I've told readers this before....(ok maybe almost a hundred times)....but I love dividends. 

In a market such as this, where volatility rules the day, dividends are the solstice in my investing activities that reminds me why I enjoy being paid to wait. Even if the market drops 20%, I'm not nearly as exposed to losses as indexed investors when my portfolio yields a hefty 4% of tax efficient dividends. Not only that but my tax-efficient cashflow is growing anywhere between 5-8% per year at a minimum and in depressed markets I'm simply adding to already undervalued shares with the prospects of a stress-free retirement with unlimited possibilities to keep me occupied.

On May 13^th UPS issued a press release to announce their purchase of 200 hybrid electric vehicles [HEVs] to compliment their already existing order for 300 compressed natural gas [CNG] vehicles for their US fleet.

While this purchase has been spun as a positive marketing tool for UPS to improve the perception among consumers and their clients of the environmental initiatives they undertake, the true motives of these purchases still revolves around profitability for the company and a focus on decreasing costs.

One of the lessons I learnt as a young value pupil was to take note of my surroundings and learn to view investing with a slightly different perspective. One lesson taught to me by Charles was an insight that investors are often “far too eager to discuss their investing successes than they ever will be in talking about their failures” and this should serve as an important lesson for where my investing education should build its foundation. For all the individual successes I’ve studied of various investors, I’ve examined a greater amount which have failed. It’s easy to label Warren Buffett as the most successful investor of all time, but very few ever consider or study his mistakes and what we can learn from them.

My Value Rules serve as a reminder of all the successes and failures that I’ve studied, learnt from and experienced in business. While they don’t guarantee success, they serve as a template and instructional tool for evaluating an investment from a number of different perspectives.

Recession proof…what is it?

There’s been abundant discussion of late in the business media, among investors and in economic circles about the probability/inevitability of a US recession, its global effects and how to best position an investment portfolio against those risks.

As a value investor, I confess to swallowing a tough pill as I sold out of my entire position in Norbord (NBDFF.PK) [TSE:NBD] last week, after exactly 24 months of holding these shares.

When I originally bought Norbord, I was a fairly green value investor and consumed at that time with reading everything I could get my hands on about other value investors, their holdings, philosophies and disciplines. Norbord at that time was a value favorite of Irwin Michael of ABC Funds, and one through my own research that I felt offered decent value at its then valuation of $8.50 per share. The stock was a low-cost producer of OSB and had been hit hard in sympathy with lower sales linked to the declining housing market in the US despite a strong European presence.