Penny Stock Pros and Cons

I keep running into emails and popup ads about penny stock millionaires investing in  micro cap "picks" and earning incredible returns in a very short time. It seems easy--spend a bit, make a lot, but is it too good to be true?

Weeding Out the Good Picks

Micro cap or "penny" stocks are defined as shares in companies with a market capitalization of under $250 million. Some of these companies are venture miners or start-up internet projects, others are well-established small companies with real income, real sales and real customers. Others have been identified as scams built to simply create an investment and scam their investors.

So, how to weed out the good from the bad? What are the pros and cons of penny stock investing.

Micro Cap Stocks Outperform

There are some very strong reasons why an aggressive investor would choose these microcap companies as a serious investment strategy.  Over the last decade, micro cap and small cap stocks have outperformed the larger entrenched higher priced blue chip companies, especially in recessionary times or during the earlier stages of recovery.

When micro caps stocks take off, they tend to rise very quickly, doubling or even tripling in a matter of hours or days. They cost less, so more shares can be purchased to earn more return on investment.

Penny Stock Newsletter Services and Marketing Reports

Microcap companies often employ newsletter services and other marketing techniques to promote their stock to investors which creates an environment of hype and increased interest in the stock which then sends the price higher rather quickly. These same newsletters often provide in-depth coverage of the micro cap companies which help investors better understand their structure, focus, direction and financial status.

Not for the Risk Averse Investor

These stocks are volatile and often trade on limited volume making them very risky investments. It's sometimes difficult to gather accurate unbiased research on the company or to know if the business is a legitimate.  Some of these companies are venture projects with no clearly marketable product as yet and of questionable financial status.

How to Sift Through Penny Stock Jungle

Penny stocks trade less on fundamentals and more on sentiment. A hyped stock may spring up as the "next big thing" only to drop dramatically a mere hours or days after the spike as day traders and scalpers take profits. Some newsletter services may not be considered reliable and simply act as a marketing service to hype a stock in order to drive its price up for short term investment profit.

Choose penny stock advice from recognized well-established sources that offer other larger stock investment ideas, strategies and have been in business for several years, preferably quoted by other reliable sources.

Don't invest in penny stocks if you don't have the risk tolerance required. Your investment dollars can disappear as quickly as you earn it. Investing in a sleepy portfolio of index funds would certainly be safer.

Apply the same due diligence to these stock choices that you do to a regular investment. Pass the stock through your technical analysis software, consult your financial advisor, and look carefully at the company fundamentals including market capitalization, trading volumes and length of time in business. Does the stock seem to follow the underlying index or is a confusing mess of high and lows with no apparent definable pattern that correlates with anything other than wind direction.

Places to Search for Micro Cap Ideas

Here are some places to find investing ideas which include both well established mid and large cap stocks as well as well-researched and trusted small and micro cap investing ideas:

The Canadian Venture Exchange

Pat McKeough's TSI Network

The Motley Fool

And here are some penny stock investment sites that provide various tips, strategies and investing ideas for micro cap stocks:

Canadian Penny Stock Blog

Penny Stock Rumble

MicroCap Canada

Happy Investing!

Disclosure: Microcap stocks comprise approximately 5% of the author's personal investment portfolio.

Bargain Basement Investing!

How to be a Value Investor like Warren Buffett


Shopping for deals in the stock market is something for the value investor. It involves finding stocks trading below fair value. Akin to discount shopping name brand items at outlet malls, value investing involves identifying stocks of solid companies, with a history of consistently growing revenue and earnings per share (EPS).

By comparing the current stock price to the company's historical fair value it can give you a place from which to compare potential investments. Stock brokerage analysis tools such as the Recognia Inc. research kit allows you to plot price movement of stocks along the fair value line.

Choose Stocks Priced Below Fair Value

Prices that currently fall below this line represent good value stocks as they are expected to eventually rise to where they should be. Many stocks tend to trade far above fair value--typically hyped stocks with lots of investor appeal, the "next big thing" stocks and tech stocks.


What Would Warren Buffett Say?


If you follow this blog, you'll see frequent reference to the great Buffett and buffettisms of trading. Buffett is a life long value investor who has made gazillions of dollars buying and holding value and growth-worthy stocks. A $10,000 investment in Buffett's Berkshire Hathaway in 1965 would be worth 30 million according to Investopedia.

Buy and Hold Value Stocks

Buffett screens companies with respect to consistency of performance with return on investment (net income/shareholder's equity); the avoidance of excess debt (debt/equity ration); high and increasing profit margins; age of the company on the market (at least 10 years public); companies with unique products that do not rely heavily on commodities (external influence); value--is the stock selling at a discount of at least 25%? Although it's difficult to determine a company's true intrinsic value, value analysis can provide a good source of value investment direction.


Not for the Active Day Trader


Value investors are Warren Buffet fans--the buy and hold gang. As long as a company continues to grow and earnings chime in at their expected marks, the stock will remain attractive to the value invester.


Remember, when using technical analysis to chart a company's historical market performance, future performance is not a given. There are no genies in bottles locked away in the analyst programs. But we do know that the past often equals the future, and the more often an event occurred, the more likely it is to recur. And this is what stock speculation analysis counts on.


Some Stocks to Value Analyze for Yourself:


Bonterra Energy Ord Shs BNE: TSX


Computer Model Ord Shs CMG: TSX


AlarmForce Industries Ord Shs AF: TSX


Calian Tech Ord Shs CTY: TSX


Toromont Inds Ord Shs TIH: TSX


WaterFurnace Renewable Energy Ord Shs WFI: TSX


Happy Investing!

Stay Away From Bonds?

Are Bonds A Bad Investment?

My first investment was the gift of a 500 dollar Canada Savings Bond from my grandparents on my 12th birthday. I think I lost the certificate somewhere between high school and university. Nonetheless, the old adage "buy bonds" seems to no longer apply in today's economy as a sure fire way to secure your retirement income. In fact, financial guru Pat McKeough says "Stay out of Bonds" in his publication, How to Trade Stocks and Make Good Investments in Canada. Does this shift in conservative investing philosophy make the heavily bond invested coach potatoe portfolio and other conservative investing strategies obsolete? Are all bonds off the block or are there certain types of bonds and fixed income investments which continue to be appropriate and acceptable instruments to secure my retirement?


In this issue of TheInvestobot, we'll explore the real story behind McKeough's rejection of bond investments, what type of fixed income investments are available to balance the conservative side of your retirement portfolio, and I'll propose some ideas that may quell the bond-fear breakdown in the old "buy a bond and forget about it" strategy of our parents and grandparents.


What is a Bond?


First things first, what are we talking about? Technically speaking, a bond is an IOU of sorts issued by various government treasuries, companies or international organizations that entitles holders of these investments a coupon payment at periodic intervals until maturity. These coupon payments are typically a fixed amount represented by a percentage of the face value, or a floating rate of return in relation to some index or reference.

This is a summary from Wikipedia concerning bonds:
"Governments issue government bonds in their own currency and sovereign bonds in foreign currencies. Local governments issue municipal bonds to finance themselves. Debt issued by government-backed agencies is called an agency bond. Companies can issue a corporate bond or get money from a bank through a corporate loan ("preferred stock" can be "fixed income" in some contexts). Securitized bank lending (e.g. credit card debt, car loans or mortgages) can be structured into other types of fixed income products such as ABS - asset-backed securities which can be traded on exchanges just like corporate and government bonds".

The difference between bonds and stocks can be simplified to this: Bonds retain their nominal value, stocks may lose value from the date purchased. A bond with a $1000 face value will be worth $1000 at the end of the term. Bonds pay interest, some stocks pay dividends. Governments issue bonds but never issue stocks.

Other Types of Fixed Income Investments

According to TD Canada Trust, investors can purchase the following types of fixed income products in Canada: Government of Canada Bonds, Federal Crown Corporation Bonds, Provincial Bonds, Stripped Bonds, Mortgage-Backed Securities Term Deposits and Guaranteed Investment Certificates. You'll notice that 4 out of 6 of these choices are "bonds". So if we are to heed guru warnings about staying out of bonds, that leaves mortgage linked term deposits and GIC's as the only other way to fill up 25-75% of your investment portfolio depending on your stage in life for conservative investors. Seriously? That seems odd since so many mutual fund and ETF companies tote bond diversification as part of a balanced investment strategy. Some sources include preferred stock as a type of fixed income investment since they usually issue regular dividends.

Why The Negative Attitude on Bonds?

Enter new google search: "stay away from bonds".

In summary of the multiple pages of results that came up, there seem to be three major reasons to avoid bond investing through managed funds and ETF's which boil down to lack of control as to which bonds are purchased, limited returns, and bond fund fees which might eat up any profits in low return investments. There are newer funds which offer no-load fees and low MER's, but the overall sentiment was that your money simply won't grow.

I found this somewhat hard to believe since the average annual return on investment in the TD e-series Canada Bond index fund was just over 5% and many of the low MER ETF's like the iShares XBB which is based on the DEX Universe Bond Index was a modest but acceptable 6.25% since inception. That still pays more that the average 5 year GIC at 3%. So why the negative press on bond investing as a whole. I'm not yet convinced.

Pat McKeough says "STAY OUT OF BONDS"!

Pat McKeough is an intelligent, experienced, revered and highly recommended financial guru, writer, expert and advisor here in Canada. As a subscriber to his newletter The Successful Investor, I received a free report on investing in Canada entitled How to Trade Stocks and
Make Good Investments in Canada. In this primer, Mr. McKeough has written a chapter entitled "Stay Out of Bonds".


McKeough writes that interest in bonds has been revived due to recent market volatility as bonds provide a source of steady income and guaranteed returns. However, according to his analysis, bond prices are projected to fall over the next few years as interest rates inevitably rise due to government deficits. He suggests investing only a small portion of your portfolio in bonds and other fixed-income instruments, and in place, "aim to build a diversified portfolio of well established companies with long histories of rising dividends".


McKeough suggests that the right equities/fixed return ratio in your portfolio will depend on your financial circumstances, temperament and how close you are to retirement. He suggests that if you chose to hold some fixed-income investments, stick with Canadian T-bills with maturities of around three months and stay of long-term bonds.


Hunting for Fixed Income Investments

Summary of my research? For the fixed income portion of your portfolio, purchase short term T-bills, GIC's, mortgage-backed securities and solid dividend-paying equity or preferred stock. Here's the breakdown:

1. National Housing Act (NHA) Mortgage-Backed Securities:
This is an investment in a pool of Canadian residential first mortgages which  provide monthly interest, a competitive rate of return and good liquidity, which means you can easily convert your investment into cash. NHA Mortgage-Backed Securities are sold in $5,000 denominations in terms of six months to 25 years and are backed by the Central Mortgage and Housing Corporation, an agency of the federal government.
REITs qualify as fixed income instruments if they lend money directly to real estate owners and/or operators or indirectly through the purchase of mortgages or mortgage backed securities. There are ETF REIT's available through iShares, Claymore, BMO and Horizon's. I am going to review these in an upcoming issue of TheInvestobot.
2. Treasury bills and other money market instruments:
Issued for terms of one month to one year with a wide variety of maturity dates, Treasury bills, bankers' acceptances and commercial paper provide higher yields than bank accounts and term deposits. Canadian T-bills with 3 month maturities can be purchased through brokers such as TD Waterhouse.
3. Guaranteed Investment Certificates:
GIC's can be purchased from any bank and most brokers and typically offer fixed term investments of 1 to 5 years with guaranteed interest at the end of the term.
4. Preferred Stock/ Dividend Paying Equities:
Preferred stock is stock that tends to act like a bond because it has a fixed dividend payout but isn't guaranteed if the company does poorly. From Investopedia: "There are a number of strong companies in stable industries that issue preferred stocks that pay dividends above investment-grade bonds. The starting point for research on a specific preferred is the stock's prospectus, which you can often find online. If you're looking for relatively safe returns, you shouldn't overlook the preferred stock market."


ETF's available for preferred stock include: Claymore's CPD  and iShares' XSP .

Happy Investing!

Taming the ETF Jungle

Are You ETF'd out?

There are so many ETF's out there that I've become dizzy reading prospectuses and delirious trying to design a mix. My initial wish-list consisted of 20 ETF's from various sources, including iShares, Claymore, and BMO with a few cool Horizon's beta choices for playing volatility and shorting downtrends. I realized that from a personal perspective this would be impossible to execute consistently and take far too much time. I wanted to design a core portfolio of ETF's some of which will be dividend producers, others which will be fixed income, and all that consist of good choices when balancing value, quality and health of companies held.

I decided to stray from the usual guru data on iShares ETF's which seem to be the most touted and focus on BMO. In comparing MER's across many of similar iShares and BMO offerings, BMO seemed to beat iShares on most equivalent funds.

Planning to Retire with Titans and Dogs!

The overall goal of this retirement portfolio is to have exposure to quality Canadian, US equity, and International equity from diverse sectors in addition to diverse fixed income sources, dividend sources and some emerging market exposure that would allow easy rebalancing and fit the retirement investment needs of a 40 something with about 20 years left to retirement.

Titans Meet Dogs Meet Income

Here is the gist of the portfolio:
ZCN: BMO Dow Jones Canada Titans 60 Index ETF 25%
ZDJ: BMO Dow Jones Industrial Average Hedged to CAD Index ETF 25%
ZGI: BMO Global Infrastructure Index ETF 25%
ZMI: BMO Monthly Income ETF 25%

ZCN: BMO Dow Jones Canada Titans 60 Index ETF: Portfolio Strategy: BMO Dow Jones Canada Titans 60 Index ETF has been designed to replicate, to the extent possible, the performance of the Dow Jones Canada Titans 60 Index, net of expenses. The Fund invests in and holds the Constituent Securities of the Index in the same proportion as they are reflected in the Index.

Top Holdings:
Royal Bank of Canada    
Toronto-Dominion Bank              
Suncor Energy Inc.          
Bank of Nova Scotia       
Cdn Natural Resources Ltd          
Barrick Gold Corp.           
Potash Corp of Saskatchewan
Goldcorp Inc.    
Bank of Montreal            
Canadian National Railway          

Performance: One year:  MV/NAV   21.71%/22.18%    MER   0.15%

Sector exposure:  financials, energy, materials, industrials, telecommunications, consumer discretionary, information technology, consumer staples, utilities

Geographic: Canada

ZDJ: BMO Dow Jones Industrial Average Hedged to CAD Index ETF: Portfolio Strategy: The BMO Dow Jones Industrial Average Hedged to CAD Index ETF has been designed to replicate, to the extent possible, the performance of the Dow Jones Industrial Average (CAD hedged), net of expenses. The Fund invests in and holds the Constituent Securities of the Index in the same proportion as they are reflected in the Index. The U.S. dollar currency exposure is hedged back to the Canadian dollar.

Top Holdings

IBM Corp.
Chevron Corporation
Caterpillar Inc
3M Company
Exxon Mobil Corp
United Technologies Corp

McDonald's Corp
Boeing Company
Coca-Cola Company
Procter & Gamble Company

Performance: MV/NAV 1 year 18.55%/19.33% MER 0.23%

Sector Exposure:  industrials, information technology, consumer staples, energy, financials, consumer discretionary, health care, materials, telecommunications

Geographic: US

ZGI: BMO Global Infrastructure Index ETF:Portfolio Strategy: BMO Global Infrastructure Index ETF has been designed to replicate, to the extent possible, the performance of the Dow Jones Brookfield Global Infrastructure Index, net of expenses. The Fund invests in and holds the Constituent Securities of the Index in the same proportion as they are reflected in the Index. The Manager may also use a sampling methodology in selecting investments for the Fund.

Top Holdings:

Hutchison Whampoa Usp ADR
National Grid plc ADR
TransCanada Corp
American Tower Corp
Enbridge Inc
Gpo Aeroportr Pafco ADR
Spectra Energy Corp
Keppel Corp Ltd, ADR
Consolidated Edison Inc
Sempra Energy

Performance: One year MV/NAV 18.66%/18.68% MER 0.55%

Sector exposure: utilities, industrials, energy, telecommunications

Geographic: US, Canada, Hong Kong, Brazil, Mexico, Singapore, UK, Netherlands, Greece

ZMI: BMO Monthly Income ETF: Portfolio Strategy: BMO Monthly Income ETF has been designed to deliver the performance of the underlying basket of higher yielding BMO ETFs. ETFs are selected by having a higher yield than either the equity market represented by the BMO Dow Jones Canada Titans 60 Index ETF (ZCN) or the fixed income market represented by the BMO Aggregate Bond Index ETF (ZAG). The holdings are weighted by yield, with 50 percent investment in each of equity and fixed income and a cap of 20 percent for each security with a range of 6 to 10 ETFs. The ETF is rebalanced quarterly and reconstituted semi-annually in June and December. In addition, as ZMI is a fund of fund, the management fees charged are reduced by those accrued in the underlying funds.

Holdings:
BMO Eq Wgt REITS ETF
BMO High Yield US ETF
BMO Eq Wgt Utilities ETF
BMO Emerg Mkt Bond ETF
BMO Cvd Call Cdn Bank ETF
BMO Mid Corp Bond ETF
BMO Long Corp Bond ETF
BMO Equal Wgt Banks ETF
BMO Short Corp Bond ETF
BMO Eq Wgt Oil & Gas ETF

Sector exposure: financials, corporate bonds, high yield bonds, utilities, emerging market bonds, energy

Geographic: Canada, US, emerging markets

No performance data available yet. MER: 0.55%

ZCM       25%
ZDJ         25%
ZGI         25%
ZMI        25%

Disclosure. I don't yet own these ETF's. Fifty percent of my savings is directed towards a sleepy portfolio such as this. Currently I have investments in TD-e series funds including the Canadian Index, US Dow Jones Industrial Index, International Index and Canadian Bond Index. Yawn!

Happy Investing!