This is a guest post by Peter Hodson. Peter Hodson is CEO of 5i Research (www.5iresearch.ca), an independent and conflict-free investment research provider. Prior to founding 5i Research, he was Director of Sprott Inc., and Chairman of Sprott Asset Management LP where he managed his own $150 million fund as well as part of a team that managed more than $9 billion. He also writes regularly for the National Post.
After 17 years of working as a portfolio manager on Bay Street, you begin to pick up on various trends, strategies and tips that can have a huge effect on your investment returns. Sometimes the practice can be in clear view, other times it is a little trickier to uncover. In order to pursue your own million-dollar journey, it is important that investors be aware of some of the tools, tricks and issues in the investment industry.
1. Mutual Funds
The first and maybe most written about topic is that of mutual funds. Quite simply, Canada is the unfortunate recipient of some of the highest mutual fund fees in the world. While it does not sound significant, saving half of a percent on management fees can make a huge difference to an individual over many years. The savings from reducing fees is one of the few ‘sure-things’ when investing. The way we see it at 5i is that if you have the ability to save even a couple of bucks while generating the same returns, why wouldn’t you? That savings, compounded over years if not decades, will result in very big dollar amounts.
Mutual funds also have a tendency to hug an index (also known as closet indexing) while charging high fees. We have seen some funds hold up to 750 positions! The reality, especially in Canada, is that if a diversified fund is holding over 50 positions, it is more than likely going to act similar to a comparable ETF. If your going to pay a fund to invest your hard earned dollars, at least make them earn it and not shadow a lower-cost ETF.
2. Research Reports
Company research reports are another area to watch out for as they are not meant for the retail investor. They are made for companies that the brokers want business from, or do business with. Large and complex documents nicely bound and printed on glossy paper are shown to executives in the hopes that the next financing or deal goes to that broker. This is also why you rarely see a negative report. There is an inherent conflict of interest when other departments do business with a client that is also on a research coverage list due to the fear that a client may take business elsewhere in light of a negative report being issued.
This conflict of interest is also why you often see confusing and non-committal types of recommendations such as sector underweight (if you like the sector, does that make it a regular hold?) and market-perform (a.k.a. “we don’t know, so assume it follows the market”). Between confusing recommendations and target prices that help to generate trading commissions, investors that follow these reports too closely could stand to lose out on some good returns.
An example I like is a Credit Suisse analyst that had a sell recommendation and $10 price target on Netflix; only to flip 16 months later when the stock was at $300 with a buy recommendation! The lost profits to those who heeded the recommendation almost make you want to cry.
Over my career I have also learned what to look for in potential investments, which are now deeply ingrained in how we look at companies at 5i Research. The number one positive signal for us is when a company pays its first dividend. The first dividend alone does not make a stock a buy necessarily but when the announcement is made, investors should pay attention.
One area to watch on financial statements are company sales or revenues. At 5i, we hate declining sales because it means that there is something wrong with either the company or the industry as a whole. We try not to allocate research resources to companies that will have less tomorrow than they do today. Earnings at a company may still improve through cost savings but it does not change the fact that customers are either buying less of or paying less for a good/service and this is something that we have learned to avoid.
4. Share Dilution
One final thing we like to look out for at companies is share dilution. No matter how good the prospects of a company are, if they continually issue shares and dilute your ownership, no one benefits other than the bankers doing the deals. When a share issue is carried out, we would far prefer it to have a specific purpose (such as an acquisition) and to be done at higher prices.
Beware of share issues consistently done at lower prices as these do nothing but erode value and make it all the more difficult to recoup any losses. We use the example of Katanga Mining here. Eight years ago, it had less than 100 million shares outstanding. Today, it has 1.9 billion shares. Guess what? The stock is down 92% in that time, including a 34% decline in the past year.
The million-dollar journey can be a treacherous one but we think investing is a key component to completing the journey. The goal is attainable as long as investors start early, save often and invest intelligently while keeping in mind the various tips, tricks and conflicts inherent to the investment industry. If you can avoid investment mistakes and reduce trading and fees, you goal will be far more attainable.