While working on last week’s post on margin, I stumbled upon an old experiment some of you might remember. No, I’m not talking about that those experiments we all did in college. I’m talking about how I made a dividend portfolio to see whether the borrow to invest concept works.

The borrow to invest portfolio was a simple one. It was $75,000 in total, with $37,500 coming from the borrower’s own sources and $37,500 from margin. The interest rate for the margin was set at Prime, which was 3% at the time. That’s gone down since, so hooray for us.

When we last left the portfolio, it was doing pretty well. The TSX Composite Index was down 3.47% since I started, and my portfolio was only down 2.27%. A victory! Of sorts, anyway.

That was back in June, and a lot has happened since then. The TSX Composite crashed pretty hard back in January, bottoming out just below 12,000. It has since recovered, closing May 11th at 13,788. That’s still a return of -5.9% since the last update and is down 6.5% from when the contest began.

Enough small talk. Here’s how the borrow to invest portfolio is doing, as of the close of trading on Wednesday, May 11th.

Fu borrow to invest

Hey, that’s not bad. Big winners included Extendicare, Calloway REIT, Saputo, Rogers Sugar, and Manitoba Telecom. Results were dragged down by Cenovus, TransCanada, TransAlta, and Power Financial.

The value of the portfolio has increased ever so slightly, from $75,000 to $76,906.84. If $75,000 would have been invested in the TSX Composite when the exercise began, it would have been worth $70,125. That’s a nice outperformance. Nelson, go ahead and take the rest of the day off.

Here’s where the outperformance really shines. Including dividends, my total is $81,682. A similar amount invested in the TSX Composite (via the XIC.TO ETF) would be worth a little less than what we started with including dividends, coming in at $74,378. Now, admittedly, this isn’t exactly an apples-to-apples comparison, since my portfolio does include some U.S. stocks and the index doesn’t.

Most importantly, the dividend income was easily enough to easily cover the interest. The borrow to invest portfolio generated enough to pay off the interest and $3,300 in additional income that could be put towards paying down the debt.

The best part of these results is it shows how I can swing and miss on a few picks and still have the results end up okay. Both TransAlta and Cenovus have cut their dividend, which means they’re out of the fund. Let’s go ahead and replace them.

The replacements

Copyright: Nelson's brain and definitely not stolen from a major Hollywood movie.

Copyright: Nelson’s brain and definitely not stolen from a major Hollywood movie.

The first replacement stock is going to be Artis REIT (TSX:AX.UN). Even though the portfolio already has REIT exposure via Calloway (which has been renamed Smart REIT), I like Artis here for a crapton of reasons.

First of all, it’s cheap. Shares trade for something like 35% under book value. Most of that discount is because of exposure to Calgary, which is apparently in worse shape than Kabul. But the company only trades at some 10 times funds from operations (which is earnings in the world of REITs), and has a payout ratio in the neighborhood of 70%. The yield is 8%, and the share price as I write this is $13.47 each.

If we sell the TransAlta shares, we can use the proceeds to pick up a nice round number of 259 Artis shares. Good thing it’s all computer trading now or some trader would be plotting ways to kill me in my sleep.

The replacement for Cenovus is going to be something loosely energy related, the misleadingly-named Information Services Corporation (TSX:ISV). It operates the land and corporate registry for the province of Saskatchewan, scoring a contract to do so exclusively until 2033.

Like Artis, it’s cheap, trading at just a little over 11 times what I think 2016’s free cash flow will be. It has succulent net margins, the ability to make small bolt-on acquisitions to grow the business, and it’s shown it can handle a year where property sales are a little slow. It also easily earns enough to cover the $0.20 dividend each quarter (a yield of 5%) and has $36.5 million in the bank, which is enough to pay 2.5 years of dividends.

I’m a little upset having to pay $16.07 per share for it, but hey. I don’t want to let this one get away.

The Cenovus stake is currently worth $3,800, which means we can buy 236 shares of ISV. That represents potential income of $189 per year, while Artis is projected to add $279 each year to the portfolio.

Manitoba Telecom should probably be replaced soon, since it looks pretty likely the takeover offer from BCE is going to go through. But it’ll keep paying dividends in the meantime, so we’ll let it stay for now. YOUR DAYS ARE NUMBERED, MANITOBA. I mean, uh, Manitoba Telecom.¬†You people from Manitoba can live. For now.

Final word

Ooh, that’s much classier than saying conclusion. FINALLY, FINANCIAL UPROAR DOES THE CLASSY THING.

A lot of people like to crap on borrowing to invest. But as long as you don’t overextend yourself, it can be an effective way to jumpstart the whole building wealth thing. Think of it like driving. As long as you’re smart about it, the chances of somebody getting hurt is pretty slim. Doing dumb stuff like putting the whole portfolio into one stock is the equivalent of getting behind the wheel after a dozen long island iced teas.

Even though I’ve had three stocks cut their dividends so far, my borrow to invest portfolio is still generating enough cash to easily pay the interest while outperforming the market. I guess time will tell whether I can keep up this performance, but it sure looks like the concept can work.

Tell everyone, yo!