Investing in the Canadian Mortgage Market: Home Capital vs. First National

Investing in the Canadian Mortgage Market: Home Capital vs. First National

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?


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:

home capital insured vs. uninsured

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:

first national

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.

The dividend

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. 

Just Say No to The Latest IPO

Just Say No to The Latest IPO

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.

Could This Stock Market Rally Just Be Getting Started?

Could This Stock Market Rally Just Be Getting Started?

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.

Too soon?

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.

The end

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.

3 Interesting Value Stocks in an Overpriced Market

3 Interesting Value Stocks in an Overpriced Market

I was at a party on Saturday night (SUCK IT, HATERS) when I got roped into the following conversation after revealing what I do for a living:

“So, what stocks should I buy?”

(I assume this person knows nothing about the market, which is true 99% of the time) “Just buy a good S&P 500 or Russell 2000 ETF and call it a day.”

“What? Boring! Give me some stock picks.”

“Okay, fine. Here’s what I would buy today: nothing. I think the market is overvalued and is more likely to go down versus up.”

And that’s usually enough to shut people up.

I’m not just saying this stuff to extract myself from awkward conversations at dinner parties. I really do believe the market is overvalued. I look for cheap stocks constantly. There just aren’t that many out there.

But there are a few, which I will talk about in a minute. Before we do, here’s some big picture stuff about investing.

Eventually, you gotta do the work

I spend a lot of time talking about big picture investing stuff on this here blogening. I also talk about a lot of individual investment ideas, but the majority of discussion is pretty broad. This is for one simple reason: because I know that some of you hate discussions of individual stocks.

I’ve seen the stats. The numbers don’t lie.

Allow me to put my parent hat on, even though I’m nobody’s parent (that can be proven anyway, NO, I’M NOT TAKING THAT PATERNITY TEST LEAVE ME ALONE KATHY GOD). I’m going to force you kids to read about individual stocks in 2017. Yes, you little bastards will eat your broccoli — even if I have to sit here all night.

At the end of the day, all this big picture stuff is for is to learn how to analyze potential investment opportunities. If you don’t start doing that, all the words I’ve typed on this screen are useless.

Trust me; it’s far more fun to read Buffett quotes on finding one-foot bars to step over than it is to dig out an annual report and read all the footnotes. But if you don’t do the work, you’ll never get rich. Buffett has read thousands of annual reports in his time. I know investors who have yet to read their first.

That’s a problem. It’s a big problem.

So allow me to help y’all out, just a little. Here are three cheap Canadian stocks I’ve been looking at lately. I don’t own any of them yet, but will likely buy one or more in the near future. Don’t just buy any of these stocks because I like them. Use these ideas as the beginning of your own research.

Canaccord Genuity

Canaccord Genuity (TSX:CF) is Canada’s forgotten investment bank. It has also expanded into the wealth management business in Europe, which was supposed to serve as a nice hedge when the investment banking business falls off a cliff. Which happens from time to time.

Canaccord was humming along nicely in 2014. It had carved out a nice niche in the energy sector and was becoming the go-to name that energy producers would call when they wanted to IPO or just issue more shares. Then the sector fell upon hard times and Canaccord got hurt. Shares fell from a high of $13 to a low below $4. They sit at just under $5 today.

Things still look relatively bleak in the short-term, but you can’t beat the valuation. Shares trade at under book value and at 13 times 2017’s earnings estimates. It has a great balance sheet, and management has been buying back stock of late. It also posted $1.39 per share in free cash flow over the last year. Not bad for a stock that trades at $4.80.

The most encouraging thing about Canaccord is the recent price movement is a pattern. Every few years the stock falls off a cliff. It consolidates for a little while and then explodes 100% or 200% higher. This is the third time in a decade such a thing has happened.

Morguard REIT

Morguard is a simple investing idea that has multiple ways it could turn out pretty nicely.

There are several Morguard stocks out there. The one I like the most is Morguard REIT (TSX:MRT.UN), which owns retail, industrial, and office real estate from B.C. to Ontario. About a third of the portfolio is in Alberta (strike one!), with much of it in small regional malls (strike two!) and its largest single tenant is Penn West (strike three!).

But there’s no denying one thing. The stock is cheap. Damn cheap. Shares currently trade hands at $15.23. Book value is just under $26. That’s a 41% discount to book value. It’s the equivalent of paying 14.7 cents for a quarter. And you get a 6.3% dividend to wait that’s easily covered by cash flow.

There are two ways this investment turns out well. The first is Alberta recovers (which it’s already starting to do) and the market prices the stock at much closer to book value. The other is Morguard Corporation, the parent company, takes it private. Morguard owns 51% of the stock already. The guys running Morguard aren’t stupid. I’m sure they’ve at least thought about it.

Just Energy

Wait. Those assholes that knock on my door and bug me during dinner? Yep.

I’m the first to admit there’s a lot to not like about Just Energy (TSX:JE)(NYSE:JE). One search on the internet proves they’re about as unpopular as any one of Donald Trump’s policies. OH ZING HE’S STILL GOT IT. Sales reps constantly get accused of misleading customers.

The sales pitch is simple. You can lock in the price of natural gas or electricity, and save money. Which works when prices go up. The problem? Prices haven’t been going up lately.

Everybody fixates on the residential side of the business. This is wrong thinking. It’s the commercial side that really matters.

A business has a very clear benefit to locking in the price of electricity or gas. It creates cost certainty, something accounting guys LURVE. Many businesses will gladly pay a little more in exchange for predictability. About 60% of Just Energy’s customers are businesses.

I also like its expansion potential. It did $4 million in revenue in the United Kingdom in 2012. That grew to almost $600 million in 2016. Management is now looking to do the same thing in Germany. It’s also looking to expand more in the United States.

Shares trade hands at $7.74. It did $0.95 per share in free cash flow in the last year. That’s the kind of valuation I like. It also pays a 6.5% dividend.

Finally, I want to mention the company’s two largest shareholders. One is MY BOY, Jimmy Pattison. The other is Ron Joyce, the guy who built up Tim Hortons. Together they own about 30% of the company.

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How to Invest in Mexico

How to Invest in Mexico

This is the fifth installment of the “invest in blank” series. Today’s topic is how to invest in Mexico. I’ve previously looked at how to invest in Poland, Russia, Turkey, and Pakistan. I’ll probably look at a couple more countries before the series is over. Or not. I like to keep you guys on your toes. 

Ah, Mexico. Your beaches are fine, your ladies lovely, and your streets are filled with millions upon millions of drug dealers. Or so the internet has told me. What do y’all expect, research?

Also, this picture:

Don't run into this guy. Sean Penn I mean. His friend seems nice.

The guy on the right is El Chapo. Remember him? He’s much less dangerous than Sean Penn.

Mexico has been in the news lately for being Donald Trump’s bitch. The new President campaigned on the promise of building a wall to keep Mexican workers fleeing the country out of America, a project that looks like it’ll be paid for by a tariff on Mexican goods coming back to the United States. The country exported a little less than $250 billion worth of stuff to the United States (or about 80% of total exports), so a 20% tariff would be a big deal.

Mexico’s economy has slowly grown into one of the world’s largest, with a GDP of $1.1 trillion. Canada’s GDP is $1.6 trillion, but we manage to produce that much with about half the population. GDP per capita is a little less than $9,000. Economic growth has averaged between 1-2% for the last decade. Nothing exciting.

Oil’s decline has hurt Mexico, and so will anything that impacts the industrial sector. If the 20% tariff on Mexican goods comes into force, it could impact everything from making cars to growing tomatoes.

Mexico isn’t a particularly cheap country, either. Its main stock market index has a CAPE ratio of 21.5 and a trailing price-to-earnings ratio of 21.1. It trades at 2.4 times book value and 1.4 times sales. It is one of the most expensive stock markets in the world, and pretty much twice as expensive as Turkey, Russia or Poland.

If you’re going to invest in Mexico, I’d suggest picking individual stocks. The good news is this is far easier to do with Mexico versus almost every other country. Dozens of Mexican stocks trade on U.S. exchanges.

How to invest in Mexico — individual stocks

I’m going to borrow the first individual stock idea from Ian Bezek, the guy who’s probably responsible for 100% of Financial Uproar’s Mexico-based visitors. He’s a former hedge fund guy who lives there.

He likes Gruop Aeroportuario del Pacifico (NYSE:PAC), four words my spell check does not. It’s a holding company that owns a bunch of Mexican airports, including Guadalajara, Tijuana, Cabos, and Puerto Vallarta. Despite its largest airports posting fantastic growth, it trades at a little over nine times enterprise value-to-EBITDA. That compares to valuations of between 15 and 20 times EBITDA for comparable European airports. It’s cheap and pays a 5% dividend.

About a year ago I took a closer look at Grupo Mexico (OTC:GMBXF), which owns a big chunk of Southern Copper Corp (NYSE:SCCO), along with owning FM Rail Holding, which is Mexico’s largest railway. It has more than 10,000 km of track.

There were rumblings the company was going to spin out the rail division into its own company. Based on the valuation of other North American rails, there was some value there. But that plan looks to be shelved, so don’t expect any near-term pops from that. Could be a decent long-term play though.

The ETF route

As always, it’s much easier to use ETFs to invest in Mexico. But like I mentioned, it’s hardly a cheap country. I’d be more inclined to avoid it if I was a guy who only invested with ETFs. It’s a stock pickers market, in other words.

The big Mexico ETF is the iShares MSCI Mexico ETF (NYSE:EWW), which has a market cap of just under $2 billion. It trades about a million shares per day on average and is flirting with a 52-week low because of the whole Trump dealie. It has a yield of about 2.5%, which isn’t bad, and an expense ratio of 0.48%.

The largest holding is America Movil L, which provides wireless service to customers in about 20 countries. About 12% of the portfolio is invested in that one stock. Other large holdings include Fomento Economico Mexicano (FEMSA), which is a conglomerate that owns a bunch of different holdings including a Coca-Cola bottler, a chain of convenience stores, and a soccer team. It’s 8.3% of assets.

Other top holdings include Cemex (7.5%) of assets), GPO Finance Banorte (7.1% of assets), and Grupo Mexico (6.5%). I just cannot get enough of these goofy Mexican names. My favorite is definitely Grupo Bimbo, a company I surprisingly did not name in a drunken stupor.

Let’s end this

Personally, I wouldn’t invest in Mexico. Not right now, anyway. Their market is every bit as expensive as Canada or the United States. The country has a bunch of conglomerates that would probably create some value if they broke themselves into pieces, but I doubt that’s going to happen. You’ll do better putting your money somewhere else.