Friday, 24 August 2012

IPOs: Avoiding the Dangers and Spotting the Opportunities

When a company offers its stock for sale to the public for the first time, that is called an Initial Public Offering. From closed private ownership, the company stock begins to be traded on an exchange such as the TSX and it becomes available to any investor to purchase. It is usually an exciting time, especially when a highly visible company like Facebook launches its IPO, as it recently did. Unfortunately, sometimes the excitement turns to anger and disappointment, as it has in the case of Facebook (NASDAQ:FB) - its stock has plummeted about 50% in the few months since launch.

Facebook is not alone either. Six years ago Canadian fast food icon Tim Hortons (TSX: THI) attracted a lot of attention when its stock went IPO. There was an initial spike upwards then over the ensuing months the stock price sank considerably. However, as Globe columnist Rob Carrick described in Tim Hortons serves up a valuable IPO lesson, that was not the end of the story and the picture (see Google Finance chart below) over the long term looks much more positive than the initial disappointment.
Carrick's lessons are well worth noting: "... the smarter play here for the buy-and-hold investor was to be patient and let all the excitement die away before buying in". list a few more factors to be wary of in the immediate post-IPO period in the Don't Just Jump In article of its useful primer IPO Basics. Stingy Investor's Is That a Hole in Your IPO? backs up the idea to be cautious at first by citing extensive research on Canadian and US IPOs that showed a pattern of big first day price rises followed by under-performance on average over the next five years. Does that mean individual investors should just ignore IPOs entirely?

Maybe not, here's why. The initial excitement followed by disappointment may well, as Stingy Investor says, cause the stock to fall unduly far through over-reaction. That could be a good buying opportunity.

Even if there is no hype and no over-reaction, recent IPO stocks can be attractive opportunities. A good IPO where a company is enjoying success and is going public to obtain more capital for expansion can lead to much better than average returns, as seen in the following example of the largest Canadian IPOs from two separate years.

Canadian IPOs - the 2004 and the 2010 Vintages
When we took PWC Canada's listings of the top IPOs in its handy Survey of IPOs in Canada, we discovered a contrast between the performance of the 2004 and the 2010 crop. It seem that, as for wines, some years are better than others! as our summary tables below show, 2004 produced a more bitter taste for the investor than 2010.

Almost half - eight of the nineteen - biggest IPOs that year have produced decidedly disappointing returns (highlighted in red) and only a handful of four have done really well (highlighted in green)
Of the ten big IPOs three look to be big successes for the investor. A few of the other companies like Tahoe Resources (THO) and Pretium Resources (PVG) look risky - though there has been a big run up of the stock, they are mining companies in the development phase so long term success is not assured and they are incurring significant negative net income in the short term. One company, SMART Technologies (SMA), the maker of those ubiquitous interactive whiteboards, is struggling and has really hurt early investors. (Update August 27: thanks to reader Mohamed who spotted that the table below as first posted gave ATH credit for good stock performance whereas it has in fact been fairly dispappointing, as measured from the first trading day. It's a classic example of a big drop from IPO price that Rob Carrick talked about. Whether the rest of the Tim Hortons story comes about - recovery and long term good stock performance - remains to be seen. Though ATH has briefly traded above the $18 IPO price, it has been very volatile and is now trading around $13.)

Differentiating the Good from the Bad IPOs
There is thus no reason to automatically buy or avoid recent IPO stocks. Such stocks, especially those that have gone through a couple of years of market seasoning and have developed a track record, can be worthwhile hunting grounds (in this regard, PWC's survey has lists of the major IPOs each year going back to 2004).

The first obvious discipline for the investor to apply to these companies is thus the usual fundamental analysis of accounting data e.g. see our previous post Getting Started in Value Investing.

A second special set of IPO-specific factors arises from the findings of the 2010 research paper Management Quality and Operating Performance: Evidence for Canadian IPOs by Lorne N. Switzer and Jean-Fran├žois Bourdon. They found that a successful IPO company had a larger management team with more years at the company and also included chartered accountants. Management teams with years of tenure at the company that varied too much, as well as the presence of dominant CEOs and MBAs on the top management team were bad for performance! Interestingly, the equity stakes of directors and managers did not seem to have a consistent association with the company's success.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Friday, 17 August 2012

Canadian Equity Market Darlings and Dogs: August 2012 Update

Every six months or so, we take a look at which sectors and companies are currently in (the Darlings) or out (the Dogs) of favour in the market. Our method is simple - compare the weightings of sectors and stocks in two popular ETFs, the iShares S&P/TSX 60 Index Fund (TSX symbol: XIU), which is market cap based and tracks market sentiment, against the iShares Canadian Fundamental Index Fund (CRQ), which chooses holdings based on past hard accounting results likes sales, dividends, cash flow and book equity value. When an XIU holding weight far exceeds its weight in CRQ we can conclude that the market likes the stock and expects it to do better than its past results suggest, and similarly in the contrary sense.

The Numbers
The table below shows the companies and the sectors colour-coded - Darlings in Green and the Dogs in Red with the really big differences between XIU and CRQ highlighted in Yellow. The table also shows the change in internal weighting over the past eight months for each ETF, which tells us stocks and sectors that have been on the up- or down-swing, either in terms of price (XIU) or fundamentals (CRQ).

Financials - A few Darlings: Big banks are back in demand, at least the three biggest are; the Royal Bank (RY), TD Bank (TD) and Scotiabank (BNS) all exceed their fundamental weighting by a considerable amount. That's a continuation of the trend we noted in January at our last update and a reversal of the situation a year ago. The enthusiasm towards financials is not uniform across the board. Some others are neutral as Bank of Montreal (BMO) and CIBC (CM) trade with similar weight in both funds.

Some still are Dogs: Manulife (MFC) and Sun Life (SLF) still get no enthusiasm from investors, though a glimmer of hope is that the market weighting has stabilized. Are these stocks a turnaround play?

Materials - Still Darlings, only less so: The sector has double the weight in XIU of that in CRQ. Three companies are primarily responsible - Potash Corp (POT), whose market value weight is an amazing 2.5% more than its accounting fundamentals justify, Barrick Gold (ABX), which is still 1.67% over-weighted despite a considerable drop in that over-weighting since January, and Goldcorp Inc (G), which has dropped some too but is still 1.7% over-weighted.

Energy - the Darlings deliver: It looks like the market anticipation was right, as the weighting for the sector in CRQ has caught up with that in XIU. Some companies, namely Suncor (SU), Canadian Natural Resources (CNQ) and Enbridge (ENB), still qualify as Darlings as their market weight continue to far outweigh their accounting weight.

Meanwhile, the one sector Dog is Encana (ECA). We wondered a year ago, and still wonder now, what significant future events justify the market negativity suggested by its hugely lower weighting in XIU. Is ECA hugely under-priced or are the poor results in the most recent quarter a harbinger of things to come that will pull down the weighting in CRQ? A June article in Real Money, when the price was a bit lower than currently, called ECA value play.

Telecommunications - how much more Darling can it get? BCE Inc (BCE) and Telus (T) have been riding high for over a year. They have become even more in demand by investors as their market weight has increased since our last update. Meantime they are far down the list in CRQ's holdings, both having slid a bit further down. In other words, fundamentals are going the opposite direction of market sentiment. Is this a possible shorting opportunity?

Utilities - Individual companies are neutral but the sector is a Dog: Both companies included in XIU - Fortis (FTS) and TransAlta (TA) - have similar weighting in CRQ and thus they look neutral. But there are several other utilities included in CRQ and not at all in XIU - Canadian Utilities (CU), Emera (EMA) and Atco (ACO.X) - that cause the sector to be under-weight and a Dog as a whole despite the out-performance of these stocks year-to-date.

Information Technology - a Dog because of Research in Motion (RIM). The fall from grace of this technology leader that was a Darling a few years ago now sees it far less valued than its accounting results indicate. The market is in effect predicting even worse accounting results in future - will that happen?

Consumer Staples - still a Dog: The sector is severely under-weighted in XIU compared to CRQ both because some companies like Viterra (VT), Empire (EMP.A) and Alimentation Couche-Tard (ATD.B) do not even appear in XIU and because those which do, like Loblaws (L) and George Weston (WN), have a market cap weight much below their fundamentals. Is this possibly a buying opportunity? (see our post on this stock-picking method) rates one stock of this sector a Buy - WN, while SC, MRU and ATD.B are rated over-priced at current prices.

Consumer Discretionary - neutral, neither Darling nor Dog. This is the one and only sector where XIU and CRQ are more or less in balance with about the same weighting in each.

Health Care - a Darling: Valeant Pharmaceuticals (VRX) is the sole health care company in both XIU and CRQ. Its weighting is three times in XIU what it is in CRQ, a sign of a definite market Darling.

Looking back at previous Darlings vs Dogs reviews and comparing to what has happened since, we see that sometimes the market is right, but other times it is not and changes its mind.

The comparison between market sentiment as seen in XIU and accounting fundamentals as captured by CRQ continues to provide good leads for further investigation (see our previous post Getting Started in Value Investing for some ideas on that process) of possible stock purchases.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tuesday, 14 August 2012

Elite Women Directors in Canada - How Do They and Their Companies Perform?

Last week we looked at the general picture of women on boards of directors of publicly traded Canadian companies and concluded that there was a tendency for such companies to do better. This week we go a step further and examine the idea of elite women directors, the cream of the crop and see how they might be associated with better-performing companies.

What is an elite director and why should an investor care?
The idea of elite directors comes from the Clarkson Centre for Business Ethics and Board Effectiveness, which found in a 2004 report with a follow-up in 2006 that a tiny select group of directors were largely responsible for driving improvements in board governance. The CCBE's definition of an elite director is quite simple - those individuals who sit on the most boards are the most sought after and most influential. If women are generally good for companies and investors, then elite women might be even better. Let's have a look.

Who are the elite women directors?
Using the same definition of elite to mean multiple directorships, we sifted through the Sedar regulatory website for the director listings within Proxy Circulars of large Canadian public companies. We counted in directorships of major foreign companies (which goes beyond the CCBE method). It turns out that a mere eighteen women are the elite directors with 3 or more board of director positions in listed Canadian or foreign companies. The list below shows the women and their professional background, along with the companies' stock symbols and the latest CCBE board governance score. Most (2/3) of the elite women are associated with companies that have high governance scores.

Which companies have the elite women on their board?
The elite women are spread across forty-six firms. A number of firms have more than one elite woman on their board. Banks and insurance companies dominate the multiple elite directors. Manulife has the most elite women of all, with three.

No doubt, it is not a coincidence that many companies with elite men directors from the CCBE 2006 study have re-appeared on the elite women's list. We counted nineteen such companies - BMO, BCE, BBD.B, CCO, CNR, CP, ECA, GWO, PWF, POW, RCI.B, RY, SC,, SLF, SNC, X, TA and TD (TSX stock symbols). Using the 2006 CCBE definition of elite-ness, four women would today make it on an overall both sex list. That's up from only two in 2006, so there's been progress of women's equality on boards.

How have the companies with elite women directors performed?
Now we get to the crucial question for the investor. We entered all forty-six firms with elite women into the Globe Investor's My Watchlist tool, and then sorted by several of the return measures available in the tool. We also entered as benchmarks the iShares passive index ETFs with symbols XIU (TSX 60 largest companies) and XIC (TSX Capped Composite).

Five-Year Total Return (share increase + dividends)
The elite women firms have generally outperformed, with almost 60% (27/46) doing better than both XIU and XIC. This is in,line with our previous blog's conclusion that having women on boards creates a tendency but not a guarantee of out-performance. Perhaps the most telling evidence that the elite women factor is also a tendency and not a guarantee, is that the company with the most elite women - MFC - is also the second worst performing over the past five years with an abysmal minus 18.5% compounded vs XIU's basically flat minus 0.3% total return.

One-Year Total Return
The results for the past 12 months give an almost identical proportion of companies with elite women that have done better than the benchmarks - 28 of 46.

Five-Year Dividend Growth
On this measure, results are not as good, as less than half - only twenty-one of the forty-six firms - managed to grow their dividends faster than XIU's 5.0% growth rate. Compared to XIC, which includes many smaller companies that pay less dividends and is thus an easier benchmark to beat, the result is much better - thirty-two, or 70% of elite women companies beat XIC's compounded dividend increase. The MyWatchlist screenshot below includes all we could fit on one screen. The bottom four worst performers are cut off - SLF, CCO, MFC and RIM.

Return On Equity (ROE)
On this basic metric of company profitability, results are similar to those for Total Return - only five companies have a negative ROE, i.e. a net loss in the past 12 months, but only twenty-seven exceed a healthy 10% ROE level.

Analyst Recommendations
Analysts seem to have the same generally positive view of these companies. Again, about 60% (28 of the 46) are rated Buy or Strong Buy.

Olympic Stock Medalist Overlaps with Elite Women
When we cross-checked the sixteen Olympic champion Canadian stocks that have come out as looking good again and again in our many past comparison posts, ten out of the sixteen (62.5%) showed up with elite women directors - BBD.B, BCE, BMO. CM,EMA, GWO, PWF, RCI.B, TA, TD AND TRP.

Bottom line - Elite women directors tend to help companies and investors outperform
Our various measures all say the same thing - the odds of outperformance run about 60% in favour of those companies with elite women on their board. It's another positive factor to add to the due diligence process for assessing a stock as a potential purchase.

Further Reading
One of the elite men directors, David Beatty, a few years ago explained his suggested method for assessing whether a Board will foster good long term company performance - SPISE − style, performance, investment, spine, evaluation. The article contains links to two excellent free CFA Institute guides for investors - one on corporate governance, the other on executive compensation.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tuesday, 7 August 2012

Women on Boards of Directors in Canada - Should Investors Care?

A few days ago, Credit Suisse released Does Gender Diversity Improve Performance? The study of 2360 companies worldwide from 2005 to 2011 did indeed find a positive answer to its question, as the Financial Post reported in Shares of companies with women directors outperform those with men-only boards. A 26% stock return outperformance by companies with at least one woman on its board is certainly something to take notice of. So the natural question is, how strong is the relationship, does the presence of women on a board more or less guarantee great returns and is this factor a good stock selection screening criteria as a result? Since Canadian investors place more emphasis on the Canadian market, let's focus on the Toronto Stock Exchange.

How many women directors and where are they concentrated?
Credit Suisse looked at the 102 largest Canadian companies and found that women only made up 14.5% of directors but the study doesn't say how many companies have at least one woman on the board. The data doesn't seem to be already compiled anywhere, so we laboriously tallied, using Sedar's database search to pull up the latest Management Information Circular (which Sedar labels Proxy Circular), the women directors of the 100 largest firms traded on the TSX.

  • Women directors are concentrated in the largest companies. 73 of the top 100 companies have at least one woman director i.e. only 27 had none.  These are already all big companies, but the bigger the company, the more likely there is a woman director - when we take the top 60 largest we find that 54 (90%) of them have a woman director. Moreover, the biggest companies all have more than one woman e.g. #1 Royal Bank has five as does #2 TD Bank, the most women we found ( we're not sure if any Canadian company has more than five, or if any board is actually majority women).
  • Women directors are concentrated in certain sectors: Consumer (only 1 out of 14 companies has a men-only board), Industrials (0/5 men-only), Telecommunications (0/5), Utilities (0/5), Banks and Insurance Companies (0/10). Men-only boards are found much more often in Energy (11 men-only/29, Materials/ Mining (9/18) and REITs (3/4).
Women directors do not automatically ensure outperformance
Taking the Energy sector, where about half the companies have no women directors, we entered the stock tickers on the Globe and Mail's My Watchlist tool to get total stock return for one- and five-years as well as return on equity and operating margin. The results deny a simple automatic outperformance by companies with women directors. In fact, as our table from Globe data shows, the men-only companies have done better!

Boards with women tend to be better boards and companies with better boards tend to outperform
The idea of vetting companies using women board members as a test is not completely useless since their presence looks to be associated with more effective boards. The Clarkson Centre for Business Ethics and Board Effectiveness each year rates all the TSX company boards. Taking the latest 2011 tables and matching against our data on women directors, we find that very few men-only boards rate very highly. Only one of our men-only largest 100 - Vermilion Energy - got as much as an AA rating from CCBE. All fifteen of our 100 largest firms that attained CCBE's highest AAA board rating had at least one woman director, as did 10 of 11 AA boards and 13 of 16 A boards. As we noted a year ago in Stocks & Board Governance - Do the Good Guys Finish First or Last? companies with better boards do seem to reward investors but it is a tendency, an average. Credit Suisse also couches its conclusions in terms of tendencies, despite the huge glaring headline outperformance number.

When we recently winnowed out the Olympic Champion Canadian Stocks, we did not consider whether they had women directors, but lo and behold, all sixteen companies in our list have at least one woman director. We suspect this is more than mere coincidence.

The Credit Suisse report notes specific strengths and attributes that women can bring to boards. The bigger talent pool argument certainly makes sense - looking again to the Olympics for inspiration, we note that, as of time of writing, four of the seven Canadian medals to date have been won by the women!

Another group that tracks boards is the Canadian Coalition for Good Governance, a group of large institutional investors such as pension funds. Their take on the issue of women on boards from their website was expressed in a presentation to a Senate committee: "... gender diversity alone is not sufficient to ensure a high quality board ..."  Companies that include token women, or which don't do a good job selecting board members in general, are not likely to magically outperform with women directors.

We don't know whether the Financial Post intended the irony but the photo accompanying the above-cited news article is of a rather attractive newly-appointed first woman director of a well-known company. Perhaps this was not the best photo choice, given the performance of Facebook stock. Caveat investor, always.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.