Sunday, 24 February 2013

Investing in Illiquidity - Where the small guy has an advantage

It's not very often the average investor has an advantage over the professionals with their training, their unceasing close monitoring of stock markets and their sophisticated computer tools. However, one such area is illiquidity. Liquidity or its opposite illiquidity, refers to how actively traded a stock is, either in total dollar value or number of trades per day. The Investopedia definition focuses on the fact that liquidity means the ability to quickly convert the shares into cash without affecting the price (i.e. you don't have to take a big discount to sell it) but the other side of the coin is obviously trading volume and that is easier to gauge. In short, illiquid stocks don't trade much.

Investors, especially big investors managing mutual funds and pension funds with massive amounts to invest, want and need high liquidity. The most popular mainstream market cap indexes like the S&P 500 and the TSX 60, eliminate stocks with insufficient liquidity. The illiquid stocks are left mainly to smaller individual investors.

Illiquidity pays off - the research
Yale University finance professor Roger Ibbotson has been the main researcher and proponent of what he calls the liquidity style or premium in stock investing. His technical paper, written with Zhiwu Chen, Daniel Y.-J. Kim and Wendy Y. Hu, is on his website here, while a summarized version presented in easily followed slides is on the Canadian Investment Review website here. What he found is that, in the USA at least: a) the least liquid stocks outperformed market averages and by a lot; b) liquidity is not simply a reflection of small cap stocks or value stocks, it is a separate factor that he isolated using standard financial statistical techniques and c) many stocks change in liquidity over time and as they become more liquid their prices rose more strongly, benefiting stock owners. One of Ibbotson's slide images copied below gives an idea of how impressive the results are.

A practical caveat - what works as an average won't work for every stock
There seems to be money to be made but no individual investor can afford to buy a portfolio of the 850+ stocks that Ibbotson combined in the lowest liquidity group. The average paid off but surely not every stock did.

The options for the investor are limited - funds or selected individual stocks. In terms of funds, it seems that the only offerings on the market are a couple of US-traded mutual funds (from American Beacon allied with Zebra Capital, a company co-founded by Ibbotson), which Canadians are not allowed to buy. There seem to be no specialized illiquidity-oriented ETFs and in Canada, no such mutual funds at all.

The Canadian investor is left to individual stock picking and in that case, the investor will be obliged by limited funds to invest to choose a manageable number. To put the odds on your side, we'd suggest applying normal value tests to pick stocks that look better. We're guessing this is the "dedication and experience" investor requirement that value investor Norm Rothery meant when he recently wrote Small, illiquid stocks offer best value in the Globe and Mail.

Finding illiquid Canadian stocks
We turned to the TMX Money stock screener since it provides as a selection criteria under Trading and Volume a wide choice of average daily trading volume levels ranging from the past 10 days to 90 days. We chose the 50 day average of 100,000 or less, the third lowest band. We are interested in common stocks of solid growing companies of mid to large cap size. We don't necessarily need to use the lowest volume band (which would give a lot of tiny companies and many listings of preferred shares). Liquidity is a relative term. The benefits Ibbotson identified work continually through the range of volume and market cap - the smaller the company and the less the volume, the greater the benefit but it still works comparatively through segments of the market (see the slide presentation linked above for details).

Our screening criteria:
  • daily average share volume over the past 50 days - 100,000 or less
  • share price - $1 or more to avoid penny stocks
  • market capitalisation - at least $500 million to avoid the smallest companies
  • price to earnings (P/E) - under 20 to avoid the too-richly valued and limit the riskiness of the companies selected
  • 5-year annual revenue growth - greater than zero to find growing companies
  • 5-year annual income growth - greater than zero
  • return on equity (ROE) - 5% or more to find companies with reasonable profitability

The criteria still gave us a list almost all made up of small to mid-size companies. The screenshot below of the TMX results shows 13 stocks and 12 companies (Atco's two entries are for the two classes of stock - voting and non-voting). The right-most column, whose title partly runs off the screen, is Return On Equity. The ROE is solid for all companies. All but one pays a dividend and most have P/E below the current 14.2 TSX Composite market average. In addition, the 60-month trailing beta, a measure of fluctuation versus the overall market, indicates that about half the stocks have quite stable prices as their beta is much less than the market average of 1.0.
(click chart to enlarge)

The largest by market cap in our list is Boliden (BLS), which is the 90th largest stock on the TSX. Interestingly, Boliden is not a member of the TSX Composite Index, probably because its headquarters are in Sweden along with the stock's low liquidity.

Less liquid larger cap stocks could be isolated by boosting the minimum required market cap in the filter and/or the maximum average volume.

Further analysis can and should be done comparing for example, price to book value, price to cash flow, debt to equity ratios, consistency of cash flows and profits, interest coverage etc in the classic value investing assessment mode. Other useful tests of stock attractiveness could include: dispersion of analyst EPS estimates (see our posts here and here); social responsibility (post here); the presence of women on the board (posts here and here); characteristics such as being dividend growers (posts here and here) or Purple Chips (post here) or low volatility / low beta (post here) or well governed (post here). Putting all these factors together should paint a picture for the investor about the stock. A further step is, of course, to go on the company website to read annual reports and management commentary on financial results, plans and strategies.

Bottom line: Seeking less liquid stocks is a worthwhile investment strategy that will work on average but it requires doing some sorting and digging through data to buy individual stocks since mutual funds and ETFs are not available.

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, 15 February 2013

Income Tax Checklist for the Canadian Investor

Tax season is starting. A few days ago, the Canada Revenue Agency opened up the NETFILE online electronic tax filing service. It's time for Canadian investors to start getting ready for filing their 2012 income tax return. There can be a multitude of slips and receipts to assemble, not to mention older records to dig up and preliminary calculations to do in order to be ready in time for filing on or before the deadline of April 30. We therefore present a calendar of key CRA dates and a document guide / checklist that shows what type of documents to expect and from whom, as well as links to explanations of how to do trickier calculations when more is required than simply copying numbers from slips.

Key Dates
January – mid CRA pdf tax forms for printing available for download at
February - 11 CRA online filing service NETFILE starts accepting 2012 tax returns – certified software list at
March – 1 RRSP contribution – last day for making contribution applicable to 2012 tax year
April – 30 CRA – last day to file 2012 return and pay amounts owing to avoid penalties
June – 15 CRA – last day to file 2012 return for self-employed though amounts owing deadline is still April 30
November – 30 CRA – last day for online filing service NetFile to accept 2012 tax returns

continual CRA issues tax refunds, often within days, if return is filed electronically

CRA dates are rigid; don't be late even by a day or you will miss out or suffer penalties. On the other hand the tax documents below relating to the 2012 tax year flood in progressively from mid-January to the end of March. There can be weeks or more of variation amongst companies that issue the slips and receipts. If in doubt check the website or phone the company involved but don't leave it to the last few days before April 30. It is likely to be hard to get a response in time to file.

Checklist and guide for interest, dividends and capital gains
If your investing involves … look for these documents … from these organisations ....

Borrowed money to invest Investment interest expense on statements from broker for margin, or bank for loan
Canada Savings Bond interest T5 slip (min $50 interest) from broker if held in a broker account or from Bank of Canada if bought directly from BOC;
GIC interest T5 slip (min $50 interest) from broker if held in a broker account or from bank or trust company if bought directly
T-Bill and Stripped Bond interest Annual summary of security transactions Interest = redemption/sale amount – purchase cost; for details see

T5 does NOT show it, even when over $50 e.g.
Mutual fund distributions T3/T5 slips mailed directly by Mutual fund companies, NOT brokers, even when fund is held in a brokerage account
Mutual fund capital gains (sales) Annual summary of security transactions from broker if held in a broker account or from mutual fund company if held directly with the mutual fund company
Bond interest T5 slip (min $50 income) broker
Bond capital gain or loss (sale or maturity) Annual summary of security transactions broker provides statement at purchase year and at maturity or sale; for how to calculate see
Stock dividends T5 slip (min $50 income) broker
Stock capital gain or loss (sale) Annual summary of security transactions broker provides statement at purchase year and at maturity or sale
ETF and REIT distributions T3/T5 slips broker
ETF and REIT (Income Trust) capital gain or loss (sale) Annual summary of security transactions + own records broker for trading transaction summary

Investor must track own adjusted cost base – see

ETF providers publish tax breakdown of distributions on their website. ETF providers in Canada list and links at
Split Corporation income T5 broker

Checklist and guide for account withdrawals, contributions
If your investing involves … look for these documents … from these organisations ....

RRSP contributions RSP Contribution Receipt RRSP account trustee, be it broker, bank, mutual fund company
RRSP contribution room various see four ways to find out -
RRSP / RRIF / LIF / LRIF withdrawals T4 RRSP / RRIF slip RRSP/ RRIF account trustee
RRIF / LIF / LRIF withdrawal limits Evaluation letter or phone call broker
Annuity payouts T4A and T5 slips mailed by insurance companies, both for registered or non-registered annuities
RESP withdrawals T4A Educational Assistance Payment or Accumulated Income Payment slip brokers or financial institution where RESP is held
Non-resident taxpayer NR4 slip broker
TFSA interest, dividends, capital gains, contributions and withdrawals none None – happy days! No tax reporting to do
TFSA contribution room and contribution or withdrawal history phone call or online Canada Revenue Agency – see

In addition to the above checklist, we also refer blog readers to our previous post Tax Resources that can help with preparing taxes

Do it electronically!
Preparing and filing electronically makes much sense. Not only do refunds come much faster but the best of the software packages really help ensure you do not miss or mis-report anything and they may even find deductions or optimizations that save you money. Web software packages are reviewed and rated every year by CanadianFinancialDIY – see last year's results. Wikipedia also has a table comparing basics of all the packages, including the Mac and PC download versions.

Hopefully our lists prove useful to you in reducing the time, effort and frustration of tax preparation. The less time spent doing this necessary task, the more time can be spent profitably investing!

Disclaimer: this post is my opinion only and should not be construed as investment or tax advice. Readers should be aware that the above comparisons are not an investment or tax 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, 8 February 2013

15 Canadian Stocks to Provide Either Thrills or Spills

Perhaps you are a speculator, wanting to make large profits quickly. Or maybe you just want to invest in stable stocks and avoid the stocks with the widest potential price swings. Small capitalization stocks are often thought of as being volatile while bigger companies are seen as being stable but many large cap stocks are also quite volatile. Let's get specific and try to pin down the Canadian mainstream stocks most likely to power ahead, or drop precipitously.

Finding the Volatile Stocks
Using the TMX Money stock screener we extracted a spreadsheet of the 199 largest cap stocks trading on Toronto's TSX. These stocks comprise the vast majority of the TSX Composite Index's 244 stocks, which covers 95% of the public Canadian equities market. Then we combined the following factors to paint a picture of volatility and uncertainty:
  • Beta - This is a statistical measure of the sensitivity a stock's price has had relative to the market average, which is 1.0 by definition (see Investopedia video on Beta). A Beta above 1 means the stock has been more volatile than the market (in this case the TSX average), the higher the number the more volatile it has been. We took the Beta over the past 60 months (from the TMX Money screener's extra columns) and focussed on stocks with Beta of 1.5 or more. We also obtained the Beta for the past 36 months from the Globe and Mail's My WatchList to get an idea of shorter term volatility.
  • 52 week spread - This is the difference between the highest and the lowest price during the past year, which gives us an idea of even more recent volatility.
  • Price/Earnings ratio (P/E) - When a stock has a high P/E, it relatively richly valued. If the market's implicit high expectations of earnings growth are not met, there is danger of a big downward price move. Companies that have net losses over the trailing twelve months show up as N/A in the table. For comparison, we note that TSX Composite has an average P/E of 14.1 currently. Some of our volatile stocks have P/E's much more than double.
  • Short interest ratio - The number of shares sold short divided by the average daily trading volume gives a notion of how many speculators think the stock is going down. The higher the number, the more numerous and hungry the vultures, a sign of potential danger (see Investopedia article on Short Interest)
  • Stocks analysts love or hate - We recently posted a review and list of those stocks in, or out of, favour. To the extent professional analysts reflect or influence investor thinking, a matter which we previously noted needs to be considered with a grain of salt, it is worth throwing that data into our mix.
  • Analyst Earnings Per Share estimate spread - Another useful piece of information from those same analysts is the dispersion of their EPS forecasts, as we explained here. From that post we took the stocks that had the greatest degree of disagreement among analysts. Those stocks have the most true uncertainty and are likely to produce the greatest positive or negative surprises with consequent effects on stock price, i.e. more volatility.
Putting it all together, we took the top 15 stocks with four or more of the above high volatility indicators to give us an overall picture. We note that there are more extreme numbers amongst the remaining TSX stocks for any single measure but we feel the overall combination gives a bit more strength to the idea that the future of these stocks is likely to match past volatility.

The 15 stocks most likely provide thrills and spills
Perhaps no surprise, there are lots of energy and mining companies in our table.
  1. Tahoe Resources Inc. (TSX: THO) - Analysts love the stock but short sellers have massively put their money on the line against it. Who will be right?
  2. PetroBakken Energy Ltd. (PBN) - PBN been extremely volatile for years and probably will continue to be so. The high P/E reinforces the warning sign. Anyone want to try day trading?
  3. MEG Energy Corp. (MEG) - Another stock that pits loving analysts vs short sellers
  4. Athabasca Oil Corporation (ATH) - Ditto for ATH
  5. New Gold Inc. (NGD) - Another volatile, richly-priced stock but this time there's no analyst fan club
  6. BlackBerry, formerly Research In Motion Limited (BB) - We all know about newly renamed BlackBerry if we read a newspaper or watch the news so no doubt we all have our own opinion or guess as to the company's future, which seems to be hanging in the balance. This time, it's the other way way round, with analysts uniformly negative on the stock while short sellers are notably quite cautious. 
  7. Turquoise Hill Resources Ltd. (TRQ) - There are lots of short sellers and the company is losing money. This might be called a longshot for an investor who thinks of going long on the stock.
  8. Westport Innovations Inc. (WPT) - A change of pace, both analysts and short sellers think negatively about this stock!
  9. Nexen Inc. (NXY) - For such a large company (27th largest company in Canada), there is huge uncertainty about its financial prospects as the analyst EPS estimate dispersion shows.
  10. Walter Energy, Inc. (WLT) - No earnings, sales declining and volatile, not a pretty picture
  11. Precision Drilling Corporation (PD) - This stock is interesting with its low P/E, low short interest but high EPS estimate dispersion. Seems to be a solid company but its earnings vary wildly, a case of true uncertainty. Maybe a value stock to investigate?
  12. Coeur d'Alene Mines Corporation (CDM) - Optimistic investors have hung on as the company reported a large decline in its last quarterly earnings, obviously expecting a big rebound. If not, an astronomic P/E of 94.5 is crazy.
  13. Uranium One Inc. (UUU) - Another mining company scraping along the bottom with net losses and an understandably volatile stock
  14. Inmet Mining Corporation (IMN) - A takeover bid often does create a lot of stock price volatility as the battle unfolds.
  15. Suncor Energy Inc. (SU) - Here is an unusual occurrence, a giant company, the 4th largest in Canada by market cap, that is extremely volatile, more than most in the energy sector. It has continued to pump out profits and positive cash flow. Its P/E is fairly low at 11.1 and analysts love it - could they be right in this case?

Though our above commentary suggests that we have preliminary notions about the likely direction, whether up or down, of some of these stocks, in most cases it looks more like a coin flip than a good bet. However, it remains a highly uncertain and risky call to make, and is only for those with a strong taste for risk. One thing we do feel is fairly certain, the good or bad consequences will be pronounced.

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, 1 February 2013

Canadian Equity Market Darlings and Dogs: February 2013 Update

As has been our custom, we are again taking a look at the Canadian equities market to see which sectors and companies are currently in hot demand (the Darlings) or out of favour (the Dogs). To do that we compare the relative weightings of sectors and stocks in two ETFs:
We will also examine interesting changes in the Darlings and Dogs from previous comparisons in August 2012, January 2012, June 2011 and the original post in April 2010.

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 six months for each ETF, which tells us stocks and sectors that have been moving up or down, either in terms of price (XIU) or fundamentals (CRQ). The bigger shifts are highlighted in Bold.
(click on table image to enlarge)

Finally, just to be sure the sector differences are not due to the fact that CRQ has 29 more holdings than XIU (which might tend to result in XIU being more concentrated and have higher individual percentages than CRQ) we've re-calculated weights as if CRQ only had 60 holdings like XIU. As the table shows that makes little difference to the results.

Financials - The revived love of a few big banks makes for a couple of Darlings, TD Bank (TD) and Scotiabank (BNS), is mixed in with some, Bank of Montreal (BMO) and CIBC (CM), where market and fundamental weights are in line, along with same Dogs as last August, Manulife (MFC) and Sun Life (SLF). Financials have been increasing in weight in both XIU and CRQ at the same pace but CRQ continues to have a much heavier weighting in Financials, mostly because a number of companies that are in CRQ don't even figure in the XIU portfolio (see the list of the main stocks not held by the other fund at the bottom of the table).

Energy - The market's anticipation of future results appears to have been borne out as this sector's weight in CRQ, which we recall is determined by actual results, has dropped substantially since August. Overall this sector is neutral, being neither Darling nor Dog. Suncor (SU) and Enbridge (ENB), still qualify as market Darlings. We wonder, will the market optimism about these two companies be right?

The one sector Dog is Encana (ECA) has become even more so. The poor quarterly results released in November confirmed market pessimism but the fundamental weighting drop still has not nearly caught up with XIU's market weighting. There may be more bad news to come. The recent retirement of the CEO is a sign the company needs to make changes.

Materials - Perpetual Darlings seems to be an apt description. The same three companies are the belles of investors (or is it speculators ?) - Potash Corp (POT), whose market value weight is still a massive 2.3% more than its accounting fundamentals justify, Barrick Gold (ABX), which is still 1.47% over-weighted with only a slight drop in that over-weighting since August, and Goldcorp Inc (G), which has dropped some too but is still 1.55% over-weighted.

Telecommunications - The two Darlings BCE Inc (BCE) and Telus (T) continue to set the market's heart a fluttering, being vastly overweight in XIU compared to CRQ. Those may have attempted to short the stocks, a possibility we raised last August, will have lost money so far. It's a lesson to dig deeper before making investment decisions.

Industrials - neutral, neither Darling nor Dog as a sector, though there is one Darling company, Canadian National Railway (CNR).

Consumer Discretionary - another neutral sector, where market views and fundamentals are closely in balance.

Consumer Staples - still a Dog: The sector is still severely under-weighted in XIU compared to CRQ because almost every company has a market cap weight below its fundamentals.

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

Utilities - This is the one sector where taking account of the different portfolio sizes of XIU and CRQ matters. Individual companies are neutral. However, the sector is only mildly a Dog when we adjust for the fact 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.

Information Technology - remains a Dog because of Research in Motion (RIM). The large day to day shifts in price reflects the enormous uncertainty about the company's future results that are likely to bear little relation to past results.

The Darling and Dog sectors and stocks since 2010
As the table below shows us, some sectors and companies have been stuck in a rut of being either Darlings - Materials (Barrick, Potash Corp and Goldcorp) and Suncor - or Dogs - Consumer Staples, Utilities, Financials (Manulife and Sun Life) and Encana. The other sectors and stocks have shifted into or out of favour.
(click on image to enlarge)

How do the Darlings and Dogs stocks' numbers look?
We plugged the stocks into a Globe&Mail WatchList to see if the stock evaluation data it contains could back up or refute their attractiveness or not. The table screenshot below shows that ranking the stocks by Return on Equity puts the Dogs at the bottom. Moreover, the other numbers, whether it is P/E, dividend growth, 5-year total returns, are generally worse for the Dogs. Poor RIM gets a rare Analyst Under-perform (i.e. Sell) rating. Among the Darlings, CN Railway has a surprising Analyst Hold rating. Maybe those stellar results have got ahead themselves.
(click on table image to enlarge)
It is food for thought for the stock investor. There is more useful data to review in other WatchList columns not shown (to get all the data, it's very easy and quick for any reader to re-create what we have done by making a new list and re-entering the stock symbol or name). It's a start in the due diligence investigation to consider whether the shunned Dogs are primed for a rebound or best avoided and whether the Darling are indeed prime targets for investments or merely over-hyped.

And, as ever, we can simply buy these ETFs themselves, or similar Canadian equity ETFs (our reviews here, here and here), which spread the risk of individual companies and sectors over a much broader base of holdings.

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.