The year was 2015, and it was a simpler time. Donald Trump was only pondering a run for President, content in knowing he would never emerge victorious from such a quest. 96% of today’s stupid memes didn’t exist. The Chicago Cubs were still hapless losers.
And your trusted author was buying up Pizza Pizza (TSX:PZA) shares.
There were a number of things I liked about the stock. The company had big plans to expand into other provinces — particularly Quebec and Manitoba — building on its dominant market share in Ontario. Alberta’s economy was expected to recover, which would provide a nice boost to the company’s Pizza 73 chain there. The valuation was decent (I paid around 15x earnings) and the stock sported a succulent 6% dividend yield.
There’s a lot to like about the royalty trust business, too. Essentially, public investors own about 20% of Pizza Pizza, but in a separate company. The parent deals with all the expenses, the advertising, and so on. The royalty trust has virtually zero expenses (other than interest, taxes, and the ongoing cost of being a publicly-traded company), as well as a dependable source of revenue (a portion of top-line sales). This leads to terrific profit margins, dependable growth, and the ability to pay generous dividends.
So I loaded up, buying aggressively in the $13.50 range. The position eventually became about 10% of my portfolio.
At first, this looked like a terrific investment. Shares would eventually peak at $18 each in mid-2017 before falling. As I type this, Pizza Pizza shares trade hands for $14.25 each. Including dividends, this is a return of about 7% a year over 2.5 years. The TSX Composite Index rose about 4% a year during that time.
Although the result hasn’t been a disaster, I thought I’d revisit the decision. And I decided I’d do things a little differently. Here’s what I’d do.
Spread your bets, yo
Choosing between a diverse portfolio filled with many different stocks or having big positions in a few securities comes with a number of trade-offs.
Taking a big position in a stock works out if the thesis is correct. And what’s the point in researching if you’re not going to have confidence in your results?
But at the same time, diversification has obvious benefits, especially if you’re a bit of a wuss. If you happen to be wrong, you’ll protect more of your net worth. And if you’re buying a stock like Pizza Pizza primarily for the dividend income, then it’s easy to argue for diversification. More sources of income will protect you from a dividend cut.
Let’s look at how Pizza Pizza has performed versus some of its peers. This chart shows the share price performance of Pizza Pizza, A&W, Boston Pizza, and the Keg, since mid-2015 until today.
The correlation is interesting, but probably not that surprising. After all, these royalty trusts basically follow one of two factors — interest rates and same store sales. A&W had stellar results in 2016 and early 2017, which lead to it’s outsized performance. Results returned to normal lately, which is why the stock has fallen so much.
If I would have split my Pizza Pizza investment into four different stocks I would have given myself a comparable income stream while hedging my bets away from one company. I would have been free to sell A&W during its outperformance, or I could have just let it ride. But diversification would have given me more options.
The bottom line
I don’t regret my Pizza Pizza decision, and I’m happy to hold the stock. The company has upped its payout three times since I bought it, bringing my yield on cost up to close to 7%. I know yield on cost isn’t the best metric, but dividend growth is always nice.
But in the future, I’ll be hedging my bets by putting some money to work in Canada’s other royalty trusts. These are good businesses, companies I plan to hold for a very long time. They have the potential to be the bedrock of a good income portfolio, something which appeals to me more and more as I get older.