So you have some cash to invest.
Ten year Government of Canada bonds currently yield 2.12%.
Today the dividend yield of Enbridge is 2.54% without considering tax advantages of a taxable individual taxpayer.
Plus look at the rates of return on Enbridge Inc. over the last 5 years. Enbridge is up 180% over the last 5 years not including dividends. Chuck in the dividends earned and assume Treasury bill returns on your dividend cash and you increase the return to some 210%. That’s 25% compounded over the last 5 years.
Your investment advisor recommends Enbridge as an investment, considering the alternative what choice do you have. Or you’re doing equity database screens looking for possible investments and Enbridge sticks out like a lighthouse on a foggy night.
The investment public and financial advisors alike have no defense when they look at these numbers. With Enbridge an investor ‘picks up’ or receives an uptick in current yield and no one has lost any money in recent memory. What is there not to like?
Ah! Smart Money.
The Fly in the Ointment!
Unfortunately there is something wrong here. But nobody can figure it out because it’s complicated. And we all know when things get complicated the majority of the people are lost. Hell, the whole investment industry is lost by my account.
What’s wrong with Enbridge? It’s overvalued. It costs too much. And we all know what happens when you overpay for something… anything? You get burned. You lose some or all of your money that you’ve invested.
But being wrong, or not understating something because it’s complicated won’t lose you money immediately. Nope. Sometimes it takes time. When strong money flows are being invested in a stock or investment theme usually certain fundamentals are considered but not others.
Because we equate making money in the stock market with being smart. But the truth is being smart and making money in the market have little to do with each other.
Let me put it this way. I have seen some truly bright people (few I admit) in the investment business that were unlucky and financially wiped out. Yes, their analysis was top drawer. They were totally logical and analytically correct and as I remember in one or two cases… eloquent. But the market did something unexpected. “How is this possible?” each one said to me rhetorically and in a couple of instances tearfully.
And I have seen a lot of financially unsophisticated individuals in the financial business and some ‘stupid as a post’ (more than I care to admit) that were lucky. Right time, right investment. No analysis whatsoever. Truly throwing a dart at the proverbial dartboard. And you guessed it, they were heralded as true geniuses. If there was a cocktail party or a crowded bar they were the ones surrounded by the most people, five rows deep, hanging off their every word.
When I looked at the investment business critically when I first started in the business…luck, whether good or bad, plays a very important part in a persons’ success or failure. Please don’t tell a newly minted MBA or CFA this fact. I have and received more than my share of scorn.
The truth is if an investor or portfolio manager is consistent with his or her investment style over long periods of time they will have good and sometimes great investment returns. However there will be short periods of time when this same investor will endure subpar to nonexistent returns not because the investor is wrong or lost his marbles its just the market or better still a sector of the market (say gold or utility companies) that can perform in such a way to make the investor and portfolio manager look stupid or out of touch.
So forgetting luck, let’s grind some numbers and do some analysis.
Snap shot of Enbridge from our Model Price app.
Screen Shot of Enbridge Inc. from our Facebook Model Price app
The first observation one can make is that our calculation of model price has always been below the stock price of Enbridge over the last 6 years. And currently Enbridge is trading at a 40% premium above its calculated fair market value. This is what I mean by expensive. Someday Enbridge will be trading at or at a discount to our calculation of model price, we just don’t know when that will be.
The second observation I can make is from our EBV Lines. I have looked at our database that goes back to 1995 and at no time has Enbridge traded at EBV+5! Yes, that’s almost 4 times accounting book value that for a utility with limited growth prospects is exceedingly pricey (expensive).
But investors don’t care. The yield differential is compelling and everyone has made a ton of money riding the boom to lower Canadian interest rates.
Do I feel bad for missing out?
The great reckoning will come (I’m sure of it) and besides I’ve been making investment dollars elsewhere. Places that make sense. Where the market has been discounting assets while other assets are selling at premium prices.
Sometimes simplistic investment themes can work to an investor’s advantage. And work over long periods of time – say six years in Enbridge’s case. But investors relying on ‘TINA’ (There Is No Alternative) will get a shock one of these days and their luck will run out.
Investors doing the second iteration of financial analysis, Model Price Theory [MPT] analysis, will be joyful and ‘lucky’ not to be picking up yield at the expense of valuation.
Spend any time on the Internet looking at financial information and you’ll see the phrase ‘financial bubbles’ used often. And asset bubbles can and will form in the most unlikely places (i.e. tulip bulbs). Who would expect an asset bubble in a industry sector known for conservatism and coupon clipping? Fortunes of conservative investors taking huge valuation risk for little additional income will end badly, guaranteed, unfortunately the critical question is when.
And to predict when you have to be… lucky or not play at all. I choose the latter.