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Top Stocks with Share Purchase Plans

The long-term risk-averse investor should consider three factors when selecting stocks with Share Purchase Plans (SPPs). First, they should demand a low price. Second, they should require earnings stability. Finally, investors should look for modest, but not necessarily spectacular, earnings growth. I've used these three criteria to find interesting stocks for Canadian MoneySaver readers since 2001. Let's take a look at how last year's picks fared and then examine the new list of Top SPP stocks.

The seven SPP stocks of 2005 were Imperial Oil (IMO), Bank Nova Scotia (BNS), Enbridge (ENB), National Bank (NA), Bank Of Montreal (BMO), Fortis (FTS), and Dofasco (DFS). From May 11, 2005 to August 10, 2006 these stocks outperformed with average capital gains of 35.6% versus 28.0% for the S&P/TSX60 index (as represented by the iUnits exchange-traded fund (XIU)). That's a handy 7.6 percentage point advantage for the SPP stocks.

The biggest SPP mover from 2005 was Dofasco which gained 114.4% before it was taken over by Arcelor. The second largest advance was seen by Imperial Oil which climbed 54.7%. Trailing the pack, the lowest gain came from Enbridge which moved 11.4% higher.

I'm pleased to say that the Top SPP stocks have performed marvelously since the list was first started in 2001. Since inception, the Top SPP stocks list has provided capital gains of 137.4% which far exceeds the 29.0% capital gain of the S&P/TSX60 index (as represented by the iUnits exchange-traded fund (XIU)).

Currently there are twenty-one companies that offer Share Purchase Plans to Canadians. Two of the twenty-one are closed-end funds which I've excluded in an effort to stick to regular common stocks.

I like to start looking for good stocks by demanding low prices. Good relative value can be obtained by selecting stocks with high earnings yields (or high earnings-to-price ratios). Conservative investors should look for stocks with earnings yields that are higher than the yield of long-term government bonds (currently near 4.38%). After all, stocks are riskier than bonds and investors should rightly demand a premium for the extra risk.

Given the parsimonious yield on government bonds, I'm also reminded of Benjamin Graham's advice to avoid stocks with price-to-earnings ratios of more than 20 (or earnings yields of less than 5%). I'll take Graham's advice to heart and cut out stocks with earnings yields of less than 5% which is a slightly higher hurdle than that provided by a 4.58% bond yield. Seven of the remaining nineteen SPP stocks fail to pass the 5% test and are excluded.

I next consider each stock's earnings stability. Here the ten-year annual earnings-per-share history of each company is examined and any stock that suffers from losses in any annual period is discarded. Of the twelve remaining SPP companies only one failed the earnings stability test.

Modest growth is next on my list. After all, 5% annualized growth provides a gain of about 41% over seven years and any business worth its salt should be able to do better. To determine earnings growth I start with the last ten years of annual earnings-per-share history. (The exception being Fortis and Scotiabank where I had only eight years worth of earnings data.) I average the first three years of earnings data and then average the most recent three years of data. Growth is found by dividing the recent average by the past average. This procedure helps to reduce the impact of an exceptional year on the calculated growth rate. In the end, nine of the remaining stocks managed to achieve a long-term earnings growth rate of more 41%.

The nine SPP companies that pass all three tests are shown in Table 1. I've also provided each stock's price-per-share, earnings-per-share growth, earnings yield, and Standard & Poor's debt rating. Almost all of these stocks have investment grade debt ratings (BBB and higher) and, as a result, are relatively safe. Only cyclical IPSCO has a slightly lower BB+ debt rating, despite its recent robust performance, which makes it slightly riskier.

Table 1: Top SPP Stocks
Company Name Price Earnings Growth* Earnings Yield Debt Rating
Suncor (SU) $95.21 443% 6.9% A-
Imperial Oil (IMO) $44.61 320% 6.9% AAA
IPSCO (IPS) $106.07 299% 14.0% BB+
Manulife (MFC) $35.65 182% 6.1% AA-
National Bank (NA) $59.04 135% 8.5% A
TransCanada Pipe (TRP) $35.26 90% 7.5% A-
Bank of Montreal (BMO) $62.93 89% 7.8% AA-
Fortis (FTS) $23.60 94%** 5.5% BBB+
Bank of Nova Scotia (BNS) $46.18 82%** 7.2% AA-
Sources: msn.com, tsx.com, standardandpoors.com, August 10 2006. * 7-year EPS growth, not annualized ** 5-year EPS growth, not annualized


Of course, a portfolio of nine stocks does not provide adequate diversification for most investors but this problem can be overcome by moving beyond SPP eligible stocks. It is more important to select good long-term stocks than to stick with poor stocks just because they have share purchase plans.

Use my SPP list as a starting point and dig further to make sure that a particular stock is right for you. You'll also want to confirm that a company's situation hasn't suddenly changed in some important way. Read the firm's latest press releases, regulatory filings, and scan newspaper stories to make sure you're up to speed on all of the most recent developments.

Although I'm hopeful that my approach will continue to perform well, there are no guarantees when it comes to stocks.

First published in September 2006.

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