SPPs for the Long Term
Share Purchase Plans (SPPs) are a great way to buy blue-chip stocks without paying big commissions. They also encourage long-term thinking and curb the urge to trade. As shown in Table 1, there are only a limited number of SPPs available in Canada. Selecting which SPP to invest in can be a daunting process.
I believe that earnings stability and growth are two of the most important factors to consider. After all, in the long run, investors will reap rewards proportional to those earned by their companies. With this in mind, I decided to discard any SPP stock that suffered an annual loss in the last ten years. A bit draconian perhaps, but, in this regard, I like to follow Warren Buffett's rules:
Rule 2: Never forget Rule 1"
I naturally expect the same of the companies I invest in.
Of the universe of 28 SPP stocks, only 9 have avoided taking a loss in the last ten years. The earnings history of this select group is shown in Table 2. Three stocks (AIT, EMA & T) were removed because they didn't report (or have) 10 years of earnings data. EMA was privatized seven years ago, and the others are the result of recent mergers.
After earnings stability, I look for earnings growth. After all, a 5.4% bond (compounded annually) produces 52% growth over 8 years. Any business worth its salt should be able to do better. To calculate long-term growth, I start by averaging the first three years of earnings-per-share data (1990-1992) and then the most recent three years of data (1997-1999 or 1998-2000). Growth is then determined by dividing the recent average by the 1990-1992 average. This procedure minimizes the effect of an exceptional year skewing the results and the results are presented in Table 3. Only 6 of the 9 remaining stocks achieved more than 52% growth.
Having reduced the initial list of 28 SPP stocks to 6, it's time to check how expensive they are (See Table 4). For this purpose, I like to focus on the earnings-to-price ratio, which is also known as earnings yield. Stocks should only be considered if they have an earnings yield that is more than the yield of a 10-year government bond (near 5.4%). After all, the return from stocks is riskier than that from bonds, and investors should rightly demand a premium. This leaves five candidates: AEC, BCG, BMO, BNS and IMO. All have shown growth, stability in earnings, and seem reasonably priced on an earnings-yield basis. Will they outperform in the long run? I can't say for sure, but the outlook appears quite promising.
Unfortunately, a portfolio composed of five stocks doesn't provide the investor with adequate diversification, but this problem can be overcome by moving beyond SPP eligible stocks. In my view, it is more important to select good long-term stocks than poor stocks that have a SPP. The patient investor may also consider setting some money aside and waiting for the regulations to change. As Dale Ennis has reported, the OSC will hopefully allow for a proliferation of SPP plans in Canada. Such a change would allow investors to both save on fees and receive the benefit of a broader selection.
First published in March 2001.
|Disclaimers: Consult with a qualified investment adviser before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, financial advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...