Joel writes in with an interesting question.
I’ve noticed you’re not a fan of Home Capital Group (TSX:HCG) and from your comments it makes sense to me. On the other hand though, you’ve written about First National Financial (TSX:FN) and their juicy yield. Any reason why you like FN over HCG?
Good question Joel. Unlike all those other questions I get, which are pure dog crap.
Who are you?
What are you doing here?
Why are you taking off your pants?
I DON’T HAVE TIME FOR ANY OF THOSE BAD QUESTIONS, TAYLOR SWIFT. WHY CAN’T YOU JUST SHUT UP AND ACCEPT MY CREEPY STALKING?
First National and Home Capital have a lot in common. They both heavily securitize their mortgages, which means they package them together and sell them to investors. The difference is one packages up (mostly) CMHC insured loans, while the other packages up some CMHC-backed loans and some non-CMHC loans.
Home Capital has just under $26 billion worth of loans outstanding. Here’s how they break down:
Now the way the mortgage market works is Home Capital has traditionally been able to buy bulk mortgage insurance on at least some of its uninsured loans (I explained more about the bulk insurance practice here). But certainly not all of these loans are protected by insurance. There’s also close to $1 billion in credit card loans, lines of credit, and “other consumer retail loans.”
In other words, I’m not a huge fan of the portfolio. There’s too much crap I think gets impaired in a big way when the Toronto housing bubble pops.
Compare that to First National. This is from March, 2016 but is still accurate. Note the last line:
About 80% of First National’s mortgages are backed by a mortgage default insurer. The next 15% are conventional mortgages with more than 20% down. These aren’t much of a risk because First National has focused on AAA customers. That leaves us with just 5% of the portfolio in multi-unit, commercial loans or bridge financing.
Basically, I like First National’s portfolio much more than Home Capital’s. First National deals with prime borrowers. Home Capital doesn’t.
The mortgage servicing business
Both Home Capital and First National heavily securitize their mortgages. The loan is sold off to whoever while the company gets paid to service it. The servicing business is fantastic.
In 2016, First National did $1.05 billion in revenue and made $196 million after tax. This gives it post-tax margins of just under 20%. That is a succulent business.
First National also makes a little money when it sells the loans to investors and also makes money doing bridge loans.
Growth in the broker market
I also like First National as a way to play growth in the mortgage broker market.
The internet has democratized the mortgage process. All it takes is four seconds on Google to see if you’ve gotten a good rate or not. People with good credit will insist on getting the lowest rates possible.
This is good for the mortgage broker market. They’re done a decent job marketing themselves as the low rate leaders. First National is one of the biggest mortgage broker lenders with consistently low rates. It’ll benefit as this trend continues.
I think First National is a somewhat decent value stock, although I don’t own any myself. It trades at less than 9x trailing earnings; it’s obvious the market thinks earnings go down next year, most likely thanks to the new mortgage rules making it tougher to qualify.
Even if earnings do fall, I still think the dividend is relatively safe. The annual payout is $1.95 per share while the company made $3.28 in 2016. That represents a 7% yield.
Disclosure: No position in any stock listed and no plans to buy, either.
I’m back, bitches. See? I told you guys I wouldn’t abandon you completely.
(Goes for cigarettes, never comes back)
Let’s talk a little about an interesting special situation I came upon. The Swiss Helvetia Fund (NYSE:SWZ) is a closed-end fund that has been around since 1987. As of December 31st, 2016, it held 38 stocks, six direct private equity investments, and one participation in a private equity limited partnership. The fund’s largest positions include Novartis, Nestle, UBS Group, and something called Roche Holding. These top four positions account for about 42% of assets.
There’s really nothing special about the fund. It has a 1.19% (in 2016) management expense ratio, which is pretty expensive. It’s not hard to get exposure to a basket of Switzerland-listed equities in 2017. It really just exists to generate fees for Schroder Asset Management, who manages the fund.
Bulldog Investors have been forcing these shitty closed-end funds into action for years now.
Their schitck is more predictable than my laziness. They establish a position in a closed-end fund without a lot of insider ownership (i.e. 99% of them). They amass about 10% of the outstanding shares and then start stirring the pot. As the largest shareholder, they usually get exactly what they want.
Bulldog has set its sights on the Swiss Helvetia Fund. The main guys involved with Bulldog have amassed 2.1 million shares, or about 7.5% of the 28.2 million shares outstanding. Karpus Investment Management owns 1.4 million shares, and 1607 Capital Partners owns 3.2 million shares. Lazard Capital Management also owns 2.4 million shares.
All four of these companies have a history of being activist investors who are willing to rattle a few chains. Together, they own about one third of the fund’s shares.
Bulldog recently wrote a letter to the fund’s management, saying it intended to nominate “one or more” of their partners to the fund’s board of directors. They also plan to ask the current shareholders to vote on whether they support continuation of a bylaw specifying director qualifications.
In short, Bulldog wants to take over the Swiss Helvetia Fund’s board of directors, and it likely has the votes to do so.
There’s more. In the last two weeks, both the Fund’s Treasurer and Chief Legal Officer have resigned. And most importantly for us, the Fund has announced it will buy back up to 10% of its shares on April 24th.
As I type this, Swiss Helvetia Fund shares currently trade hands at $11.59 each. They have a net asset value of $12.76 per share. Thus, shares trade at a 9.2% discount to their current value.
The tender offer has been made at 98% of net asset value, meaning the bid will come in at $12.51 per share. This will change over the next month, of course, since the Fund tracks a basket of publicly-traded stocks.
Say you buy 500 shares today at $11.59. Assuming $7 in commission, your total cost comes in at $11.60. The sale would be at $12.51 (remember, brokerages don’t charge a commission to tender shares), giving us a profit of $0.89 per share, or 7.8% in a little less than a month.
There are two major risks. The first is underlying asset risk. If the Swiss Franc gains ground against the U.S. Dollar in the next month, that would depress the price of the Fund. The smart move would be to simultaneously short an equal amount of shares, thus locking in the spread.
The far bigger risk is not getting enough of the deal to make it worthwhile. The Fund will only tender up to 10% of outstanding shares. Logic would dictate some of the major shareholders would try to tender at least a portion of their shares. Remember, they own a third of the company.
Here are a few scenarios.
*The profit column assumes the spread stays the same as today.
There’s no way we can tell how many shares will be tendered. But we can use a similar tender offer to guess how many shares will be tendered.
Each year, the Canoe EIT Income Fund (TSX:EIT.UN) does a similar tender offer. It limits the annual redemption to 10% of total units at 95% of net asset value. 42.8% of shareholders tendered their shares in 2016.
If a similar percentage tendered their Swiss Helvetia Fund shares, our profit would be about 2%, barring any crazy moves.
You might not think that’s very exciting, but keep in mind that you’ll make 2% in just 26 days. That works out to a 28.1% annual return. Not bad. And that’s pretty much a worst case scenario outcome. If the big shareholders decide to hang on, the profit could be much larger.
Disclosure: Nelson does not own any shares listed, but will likely buy Swiss Helvetia Fund shares in the next few days.
As you kids have probably figured out by now, I’m a big fan of contrarian stocks nobody likes.
Other value investors will try to tell you the best opportunities are in stocks that are truly great businesses. That way you can buy and hold for a very long time, collecting some sweet profits.
But the world isn’t quite that simple. There are a lot of overpriced stocks today people think are great businesses. When stocks go down, they’ll get hit and get hit hard. And besides, there are a lot of business that look good during boom times.
It’s also hard to envision the average stock trading at 20x earnings doubling over any reasonable period of time. This would either mean valuations would have to get much higher (which has a snowball’s chance in hell of happening) or earnings would have to double. I don’t like either of those odds.
There aren’t many true value stocks available today, but I’ve found one that could very well be the cheapest stock I’ve ever seen.
- It trades at less than 3x free cash flow
- It trades at just 7x earnings
- The company is also cheap on a book value and price-to-sales perspective
- And it’s down 70% from its recent peak
I have confidence this stock could double. Or even more. If management figures out the turnaround, I think a triple is even possible. My target price is 2.5 times higher than Thursday’s close.
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The Snap Inc. (NYSE:SNAP) IPO happened last week, giving millennials yet another reason to prove to older generations that they will forever doom our planet to a premature death, probably from explosion. They delivered, snatching up shares with all the gusto of me buying up North Korean currency.
What? You gotta admit that country only has one direction to go. Nukes!
The issue was supposed to debut at $17 per share, but strong interest before the open shot shares up to $24 before the first trade was made official. It went all the way up to $29.24 during trading the next day before falling faster than my chances to make friends with the rest of the PF blog-o-net. Shares trade hands for $22.71 as a write this, a major bummer for anyone who bought during those first couple of days.
Snap’s IPO wasn’t the only one to go nuts over the first little while and then fall below their issue price. The Facebook IPO popped during the first few hours of trading before retreating quickly.
Twitter exploded higher after its late-2013 IPO. By May, 2014, it was trading under the issue price.
LendingClub soared after its December, 2014, IPO. Just over two years later shares are down 78%.
Not every big IPO has been a disaster, of course. Long-term investors who bought Facebook during its first day of trading don’t regret the decision. The Alibaba IPO went relatively well, too. And Shopify is up about a million percent since its 2015 IPO. That math is 100% right. No reason to check it.
Still, buying the latest IPO is a pretty bad idea. Here’s why.
The logistics of IPOs
Basically, an IPO works like this. A company decides it wants to go public, usually for one (or more) of the following reasons:
- Prestige of trading on a major stock exchange
- The chance for employees to cash out stock
- Pressure from investment bankers looking to make a buck
- Easier to raise money in the future
- Valuation gap between public and private investment money (i.e. retail investors giving it a richer valuation because they’re suckers)
A company wishing to go public will contact several investment bankers and ask them to draw up some sort of plan. They’ll discuss logistics like the size of the deal, the potential offer price, and so on.
Once the company picks one or two underwriters to work with, it’ll start discussing the real details of the deal. Say a company wants to raise $100 million, consisting of 10 million shares at $10 each. The underwriters will then ask for a bonus allotment, which they’ll exercise if the deal goes well.
The company then gets to work on its prospectus, which is a long and boring document investors are supposed to read before they plunk money down. Spoiler alert: they never do. The prospectus is half sales copy and half risk factors, and is designed to give investors an idea of what they’re buying. It’s a lot like an annual report.
Up next is the road show, where the underwriters and company management go and sell the deal to potential investors. It’s usually only big investors who are invited to such a thing. The road show will last 10 days or so, and hit every major market. Depending on the size of the deal, they might even make a stop in Europe or Asia. OOOH EXOTIC.
After speaking to investors on the road show, the underwriters decide where to price the deal. Say demand for my imaginary IPO is strong. They’ll come back and recommend a price of $11 or $12 per share. The opposite happens if demand is weak. Remember, the underwriters want to under price the IPO so it pops on its first day of trading.
Finally, the big day comes. Demand usually outweighs supply, so it takes the stock exchange anywhere from a few minutes to over an hour to start matching up buy and sell orders. If the stock is up, the underwriter will exercise their bonus allotment. If the stock is up, usually everyone is pretty happy.
What happens after the IPO?
Study after study have looked at IPOs a year or two after they debut on the stock market, and they all say pretty much the same thing. On average, IPOs underperform. You’d be better off to buy a boring ol’ index.
The reason for this is pretty simple if you think aboot it. When the underwriter does their job, they’re creating a huge demand for shares. The IPO usually represents peak demand.
A few months after the IPO, the same investment banker will often quietly arrange a secondary offering, which usually allows more insiders the chance to cash out. This will also help push the share price down.
Investors who get a piece of an IPO aren’t stupid, either. They usually only hold for a few hours, flipping their shares to some other sucker amid the frenzied first day. If the IPO is hot, CNBC or BNN will cover the hell out of it. This attracts retail investors. The cycle completes itself a few months later when they get bored and sell.
The Snap IPO is the perfect example. It’s more overvalued than popcorn at the movies. Eventually the people buying shares will sit down and realize that.
The bottom line? Just avoid IPOs. At a minimum, give any new shares six months before taking a look, just to let the dust settle.
As every major North American stock index (including the little-known Nelson index, which just tracks stocks I think have fun ticker symbols) starts hitting new all-time highs, us value investors tend to take our proverbial ball and go home. I am not above acting like a petulant child.
My default reaction in today’s markets is to do a few different things. First, I’m focusing on paying down my mortgage, using funds I’d normally be pouring into the stock market. I’m also looking heavily at alternate investments, things that will provide me cash flow without the risk of falling 20%. I just did another private mortgage, for instance.
Surprisingly, I haven’t sold anything lately, which is usually the final step. The last stock I sold was in 2016, and that was because it got taken over. Most of the stocks I own pay pretty succulent dividends, so I’m happy to hold, even if I think they could easily fall 20%. The dividends are safe no matter what the stock market does.
Remember that I’ve been saying stocks are expensive for years now. This is another reason why I’m reluctant to sell just because markets seem a little bubbly. Besides, I kinda got that one right. I wrote that article on August 13th, 2014, when the TSX was at 15,300. 18 months later the TSX was below 13,000 and I was buying stocks with all the gusto of a crack addict just outta rehab.
Besides, I’m not sure today’s the same as 2014. There’s a major source of funds that could propel stocks higher. Much higher, actually.
Enter scared millennials
God, you millennials make me sick. Always making it about you like a bunch of GLORY HOGS. Why can’t you just suck it up and be more like your grandparents? They got shot at in World War II and THEY LIKED IT, DARGBLOOMIT.
Millennials are scared of everything. Home ownership is hard, so they prefer to rent. Building up a career isn’t as fun as bouncing around, so they change companies faster than my cheap ass uses Subway coupons. And most alarming of all, they all pretty much refuse to invest in the stock market.
These are U.S. numbers, but I’d bet a lot of money that Canadian millennials have about the same asset allocation:
Only 14% of millennials’ portfolios are in stocks. You’ve got to be kidding me. And 46% of millennials think “investing” is too risky. Not stocks; or crazy penny stocks; or even Bitcoin. Just investing in general. It’s the equivalent of refusing to go up an elevator because 9/11 happened.
Look, millennials, I don’t like making fun of a whole generation, but you people are basically asking for it. And I thought I was wussing out by paying my mortgage instead of investing.
Notice the small print of that graphic there, too. These aren’t poor millennials. These are people with at least $50k in assets. They are the 1% of millennials.
What happens when they start investing?
One of the things propelling the 1990s tech bubble boom was baby boomers putting their cash to work in the market. Granted, a lot of that money went into insanely overvalued tech stocks, but it still got invested in equities.
Millennials could start doing the same thing. They’ve got the money and most hardly remember the meltdown of 2008-09. And if they insist on continuing to rent they won’t have a house to pour all of their disposable income into. Equities will be the default investment choice.
When baby boomers and generation X started investing, you could get a decent return on a GIC. Sure, a 6% GIC isn’t very exciting when inflation is at 3.5%, but the average person doesn’t care about that. A 2% GIC sucks, even if inflation is basically zero.
Let’s face it. The average person with a bunch of money in a savings account is hardly a sophisticated investor. They’re the kinds of people who will get wrapped up in the hysteria of a market heading 20% higher in 2017.
Nobody knows if millennials are going to flood the stock market in the next couple of years. What I do know is that there are a million things that can cause an overpriced market to keep rising. Be wary of doing stupid stuff like selling everything just because markets are expensive. The better course of action is to hang on, be picky buying new stocks, and perhaps taking capital and putting it to other uses.
There’s no telling how much higher the market could go. Be cautious, but don’t be stupid. Keep investing in stocks you like, but maybe do some other stuff with the money.