tag:blogger.com,1999:blog-50427052917351349712024-03-13T01:57:39.561-07:00Financial BlogsAnonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.comBlogger42125tag:blogger.com,1999:blog-5042705291735134971.post-23346862194119542852015-08-24T18:02:00.000-07:002015-08-24T20:43:19.243-07:00August 24 2015 Special: Volatility + Fear is a good combination for long term investors<div style="text-align: justify;">
What exactly happened today? Near the open, the futures were pointing to a negative start to the day but nothing too extreme. The S&P 500 was down 2-3% but the decline accelerated to near 5% at the opening bell. Stocks rallied heavily until losses were less than 1%. However, by the closing bell, stocks began to show losses again with major indices closing about 4% lower. A ride of down 5%, up 4% and then down 3% in a matter of 6.5 hours is not normal. It's no wonder that the CBOE VIX Index, nicknamed the "fear gauge", soared to levels not seen since spring of 2009 (even higher than the U.S. debt ceiling crisis in 2011). Fear was evident in the market.</div>
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<b>Potential Explanations:</b></div>
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Most market commentators and analysts would point to China, which set the stage for today's turbulence. The Shanghai Composite lost another 8.5%, erasing most of the gains it made this year. The fact that the government was unable to stop the market from declining, even with hundreds of billions of dollars pumped into the system, made investors extremely nervous. With the recent Yuan (RMB) devaluation and a slowing PMI number that came out late-last week, investors worry that a Chinese economic slowdown would significantly impact global growth. </div>
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Investor's fear about China also leads them to evaluate some of the other potential negatives in the market such as weak earnings growth and the negative effects from oil's rapid decline from $60 (late June) to below $40. The large capital expenditure reductions by many energy companies have been impacting growth numbers in Canada and as well as United States. The high yield market has also been hurt by the increased distress in energy names and we just saw the bankruptcy of Samson Resources last week. </div>
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Investor's confidence was pretty shaky to begin with. After a 8.5% decline in Chinese markets and the continued decline in oil, many investors would prefer to sit this one out and run for cover. </div>
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<b>A Lehman Moment:</b></div>
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Some analysts argued this could a Lehman moment brewing. I think that's an overstatement. </div>
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First, the fact that the Dow dropped 588 points - more than the 508 point it lost on September 15,2008 after Lehman was bankrupt - doesn't mean we're in a crisis. The index was at a much lower level back then and in percentage terms, today's 3.6% decline was much lower than the 5% decline on September 15, 2008. </div>
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Second, it's important to understand that the Lehman failure caused a credit crisis, not a stock market panic. The credit crisis stopped the credit market from functioning properly, a key criteria for a prosperous economy. When money markets, which are suppose to guarantee your principal, lose money (due to Lehman debt), that's when credit/bond investors get really nervous and essentially refused to re-finance the money market, which eliminated liquidity of many corporations. With no liquidity to pay bills, even corporate giants like GE and Honeywell faced bankruptcy even with enormous assets and future cash flow generation ability. </div>
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It is worth noting that a credit crisis is less likely now because:</div>
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<ul>
<li style="text-align: justify;"><b>Better Bank Balance Sheets:</b> Due to the new Basel III banking regulations, the need to deleverage balance sheet became important. Many banks already got ahead of regulator's time schedule of the <a href="http://www.bis.org/publ/bcbs270.htm">Leverage Ratio</a> (basically an asset to capital multiple) implementation and sold off risky assets to meet that new rule. Because banks are important credit and liquidity providers to the financial system, healthier banks means lower chances of a credit crisis. </li>
<li style="text-align: justify;"><b>More liquidity at the banks: </b>This point is very important. Before the financial crisis, many banks borrow extremely short funds in the repo market. When the credit markets froze, they couldn't refinance and faced a cash crunch. However due to new Basel III rules on the <a href="http://www.bis.org/publ/bcbs272.pdf">Liquidity Coverage Ratio</a>, banks are holding liquid assets enough to fund cash outflows for a minimum of 30 days to a maximum of 1 year. This new rule reduces the risk of bank failures and decreases of credit in the economy. </li>
<li style="text-align: justify;"><b>High Yield Spreads Looks Reasonable: </b>High Yield spread provides a good signal to credit distress. Before the Lehman failure, the BoAML High Yield Masters II's OAS was about 850 basis points. Today, it was only 586 basis points before the big drop today. After factoring the credit distress of certain energy names, the overall high yield spreads looks reasonable. </li>
<li style="text-align: justify;"><b>Libor-OIS spread also OK: </b>The Libor-OIS is one of the best indicator of credit conditions. Libor is the interbank interest rate paid by banks while OIS is the Overnight Index Swap that is based on risk free instruments like the Federal Funds Rate. Despite the recent controversy with Libor, it still showed the cracks of the financial crisis of 2008 way before Lehman's failure. The spread was well over 150 basis points before Lehman failed. It's now at 30 basis points. While that figure is slightly high, it is not high enough for a credit crisis. </li>
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While there is spillover risk from China, I think the Chinese government can be more effective stabilizing the economy than the stock market. It'a command economy and the government controls major credit sources like the banks. The reason that it failed to stop the stock market decline was because it was simply too hard to stop emotional retail investors (90% of the market participants) from rushing out at once. Chinese retail investors are clearly panicking but investors in developed market should be more mature and not let the panic in China cloud their judgement. </div>
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<b>A Logical Course of Action:</b></div>
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<i>"Be fearful when others are greedy; be greedy when others are fearful" </i> Warren Buffett </blockquote>
After seeing the markets down over 5% with some names down more than 10%, my first reaction was to pull out cash to buy. Crazy? I don't think so.<br />
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My contrarian reaction was built over time. I was quite scared during the financial crisis seeing stocks dropping more than 10% in one day. However, as I observe the market fluctuations over time and understand a company's fundamentals more, I have more reason to believe that investors should listen to Buffett's famous quote.<br />
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The illogical course of action would be to sell during these large market panics, provided that your holdings are of good quality. The illogical course of action was actually a result of our primitive senses. Back in the caveman days, when one person sees a crowd running for whatever reason, that person would assume that the crowd is right. For the person that ran with crowd, he or she could have avoided being someone else's dinner. Even in present day, this social proof effect is still powerful as shown by Robert Cialdini (highly recommend his book "Influence"). Thus in the financial markets, when an investor sees everyone selling, the most logical sense is to sell as well. But that's exact the wrong course of action.<br />
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The reason is a stock is not a ticker that trades on an exchange. A stock is a fractional ownership in a business that produces cash flow and profit. Most of the time, a major stock decline does little to impact company's future earnings power in the long run.<br />
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It's also worthwhile to review my favourite paragraph from Ben Graham's The Intelligent Investor about "Mr.Market":<br />
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Imagine that in some private business you own a small share that cost you $1000. One of your partner, named Mr. Market is a very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly. If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise. Only in case you agree with him, or in case you want to trade with him... the rest of the time you will be wiser to form your own ideas of the value of your holdings on full reports from the company about its operations and financial position (p.204-205)</blockquote>
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Today, Mr. Market decided that some of the stocks I like are suddenly valued 10% lower because he was a bit moody. Most of time I do nothing but I did what Ben Graham said an Intelligent Investor should do when there is high market volatility such as a day like today's:</div>
<blockquote class="tr_bq">
<span style="text-align: justify;">Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operation results of his companies. </span><span style="text-align: justify;">. (P.205) </span></blockquote>
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<b>In sum: Volatility + Fear = Opportunity</b></div>
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As Ben Graham stated many years ago, price fluctuations' main purpose is for investor to buy cheap and sell dear. It is not a negative thing as many investor think. In fact, if you are not close to retirement and in your accumulation stage, you should prefer declines over advances. If you love a 10% sale in the mall, why is that feeling different in the stock market? </div>
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Of course, not all stock is a buy but today's selling was pretty wide spread, even in high quality stocks. Selected buying based on fundamental and patience will reward investors in the long run. Instead of viewing the high volatility as a negative thing, I think investors should change their prospective and think that Volatility + Fear = Opportunity. Of course, the volatility won't end that quickly and declines may continue but patience will be key riding out the storm. </div>
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I'll end with an excerpt from <a href="http://www.berkshirehathaway.com/letters/1997.html">Buffett's 1997 letter</a> in a section called "How We Think About Market Fluctuation":</div>
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A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves. </blockquote>
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But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices</blockquote>
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Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com16tag:blogger.com,1999:blog-5042705291735134971.post-65717284722062734282015-07-05T19:40:00.001-07:002015-08-25T04:24:19.916-07:00BlackBerry 2015 Annual Meeting and Latest Quarterly Result<div style="text-align: justify;">
Although I tried to keep this blog mostly focused on investment strategy, I do want to comment on BlackBerry (BB/BBRY) because it is one of the my larger positions. I have held it for about 2 years. Despite significant improvements in the company's financials and operating performance, the stock price continues to languish because of extreme viewpoints between the bulls and bears on the company and its stock price. Moreover, the latest<a href="http://www.nasdaq.com/symbol/bbry/short-interest"> NASDAQ short report</a> shows 91 million shares are shorted, a figure that no doubt has gone up since the June 23rd earnings report, </div>
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When I traveled to Waterloo on June 23rd for the annual shareholder meeting, I summarized the whole meeting into three takeaways, which I will explain below. Readers can view a recorded version <a href="http://ca.blackberry.com/company/investors/events.html">here</a>. </div>
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<b>Takeaway #1: Original Plan On Track</b><br />
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"The company continues to anticipate positive free cash flow. The company continues to target sustainable non-GAAP
profitability some time in fiscal 2016." <i>BlackBerry FQ1 2016 Outlook Statement </i></blockquote>
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The outlook statement issued two weeks ago is much more positive than the one issued a year ago (see below). The "maintaining..cash flow" has been replaced with "positive FREE cash flow" [caps for emphasis]. </div>
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FQ1 2015 Statement:<br />
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"The Company anticipates maintaining its strong cash position, while increasingly looking for opportunities to prudently invest in growth. The Company is targeting break-even cash flow results by the end of fiscal 2015."</blockquote>
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Furthermore, readers should take note the use of the word "sustainable" in the outlook statement. From his past interviews, Chen has indicated he would follow the same playbook he used at Sybase before. When he has achieved profitability after stopping the bleeding, he wants it stay there. He has achieved 55 consecutive profitable quarters after stabilizing Sybase and the progress he made at BlackBerry has been impressive. He is carefully laying the that strong foundation to support sustainable profitability. </div>
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With services revenues (SAF revenue) continues to decline at a rapid pace of 15% per quarter, execution risk is high. However, Chen's report card shown at the meeting displayed a good track record of execution in the past year. </div>
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<li><b>FY 2015 Break-even cash flow: </b>Achieved. Of course, the cash balance increased significantly during the year from $2.7 billion to $3.1 billion by the end. However, since most of that was due to the land sales, the proper way to see the cash flow is <a href="http://ca.blackberry.com/content/dam/bbCompany/Desktop/Global/PDF/Investors/Documents/2015/Q4_Fiscal_2015/BlackBerry_Reports_Non-GAAP_Profitability_and_Positive_Cash_Flow_for_the_Fiscal_2015_Fourth_Quarter.pdf">consider the following</a>:</li>
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<li>Reported FY 2015 Cash Flow from Operations was $813 million</li>
<li>Capex consist of the $87 million for PP&E additions and $421 million for purchases of intangibles. Total $508 million.</li>
<li>Land sales (from the Proceeds from PP&E sale line) was $348 million. </li>
<li>Net cash outflow was $43 million. While still negative, it is a remarkable improvement from the first quarter when Chen here when he had to report a quarter (2/3 of the quarter he wasn't in charge) with cash outflow of $1 billion. It should be noted that the purchases of intangibles has been reduced to $11 million or 90% on an annualized run-rate basis in the latest quarter (FQ1 2016). </li>
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<li><b>FY 2015 Cost Reductions:</b> Costs are down 58% (ex non-recurring items like restructuring charges) since Chen arrived. The cost base is well position for sustainable profitability. I expect it'll be around the $350 million level going forward. </li>
<li><b>Launch New Products: </b>Launched three new phones last year with new software offerings such as BES 12, Blend, VPN authentication, BBM Protected and BBM Meetings. </li>
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Chen has been consistent at delivering results. Although he gave hints he would like to see more revenue, he never formally targeted for revenue growth. The tone of the MD&A has been for "revenue stabilization", which quite different from outright growth. The rate of decline has slowed, which is encouraging. </div>
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<b>Takeaway #2: Shifting Gears to Software </b><br />
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Chen showed a pie-chart of the revenue mix in the recent FQ1 2016 quarter with 20% in software revenue. He said he'll need to "grow the size of the pie" since he understands the importance of replenishing the lost services revenues that are rapidly disappearing. While analysts were disappointed that the majority of the $137 million in software revenue was due to a patent licencing deal, $137 million in revenue (with gross margin around 90%) is still $137 million earned. </div>
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Chen has shown he has many ideas on how to get to his $500 million software goal for this fiscal year. First, he has grown the customer list of BES by another 400 customers, stealing notable customers like RBS from key competitors like Mobile Iron. Second, Chen told analysts that number of gold customers was roughly half of the installed base, which is a higher conversion rate than most expect. Expect those new gold customers to contribute to the future company. Lastly, the monetization of the patents could add considerable profitable dollars even if they are delivered in big lumps. Therefore, investors should watch that software line. </div>
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<b>Takeaway #3: Watch IOT</b><br />
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Chen has been straightforward about his strategy of leveraging the company's security and productivity strength into the IOT. There is now over 60 million, up from the 50 million figure released in January, cars using the QNX software and there could be billions of more potential devices need a BlackBerry solution to connect safely and securely. While IOT is a promising trend, there has been many resistance against this trend because of privacy and security concerns [The Globe and Mail has a <a href="http://www.theglobeandmail.com/technology/connected-world-the-internet-of-things/article24587017/">good article series</a> on IOT which document this concern]. Since BlackBerry is known for its "privacy" and "security", I think it'll be a major player if it can partner with the right tech companies to deliver IOT solutions. It announced a partnership with Intel on a more advanced connected car system and I expect to see more of those going forward. Chen has utilize partnerships well on many fronts to improve the company's financial position and reduce internal resource needs. </div>
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<b><u>In Sum:</u></b><br />
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Overall, I think Chen has the right strategy but the market has not rewarded the strategy yet because the revenue growth is still negative. He has executed well last year despite the tough operating environment. I look forward to his execution in fiscal 2016, which could be a key turning point in this BlackBerry turnaround. </div>
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<b>What now after the 10%+ Share Price Decline After Earnings and Annual Meeting? </b><br />
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The stock declined on what has been perceived a weak earnings in the first quarter of the new fiscal 2016. However, I believe it was a decent quarter and the stock price decline is unjustified. I initially had a more negative view but after reading the MD&A and thinking about it from a second level, I believe the results aren't as bad as they appear. I will address two top concerns. </div>
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<i>About that Software Revenue....:</i><br />
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The stock initially rallied on the solid $137 million software but the stock dived when most of that number was revealed as licencing revenue, which are described as lumpy by Chen.<br />
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The concern here is about so called "core growth". Here is the math that Chen and his team fumbled a bit on the conference call:<br />
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<li>Looking <a href="http://ca.blackberry.com/content/dam/bbCompany/Desktop/Global/PDF/Investors/Documents/2016/IR_Supplement_Q1_FY16.pdf">the revenue lines</a>, software revenue was $54 million in FQ1 2015. Chen said the BES business, one that analysts consider "core", grew 23-24% in FQ1 2016. That would get the $54 million figure up in the range of $66-68 million, which is lower than $74 million reported in the previous quarter (FQ4 2015). </li>
<li>Although Chen is comfortable with the number, analysts don't like the negative Q/Q growth from $74 million to $66-68 million.</li>
</ul>
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Although I would like to see growth above the $74 million last quarter, I am pleased to see the 400 new customer additions. They will no doubt add revenue in the following quarters and I was also pleased with the conversion rate from silver to gold. In the past the mix was 30/70 for gold/silver and now it's at 50/50. I know the analysts are in the rush to see revenue results but I think they should read the section on pg 19 of its 40F filed in March:</div>
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"..Customers typically undertake a significant valuation process...can result in a lengthy sales cycle.". For the readers familiar with accounting, GAAP rules say you can only record revenue when the sales cycle is complete.</div>
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Also, like I mentioned above, the extra $70 million or so of licencing revenue is significant. It shows BlackBerry has a deep patient portfolio that can generate a stream of cash payments from established tech companies like Cisco . Chen is hinting for more deals later in the fiscal year. </div>
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<i>The hardware revenue is ridiculously low: </i><br />
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The hardware revenue of $263 million was disappointing given it was down from $379 million in the same quarter last year. However, hardware was operating with positive gross margin and there is limited inventory risk. </div>
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Here is another important point to consider:<br />
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<li style="text-align: justify;">In the last quarter before Thorsten Heins resigned, the hardware had a gross margin (my estimate) of -28% with 1.9 million devices recognized and ASP of $250. That means a gross profit of -$133 million on the hardware side. Even former <a href="http://www.forbes.com/sites/ericjackson/2015/06/09/jim-balsillie-defends-his-record-at-research-in-motion/2/">Jim Balsillie admitted</a> in a recent public appearance that "People thought we [RIM/BB] made money on handsets. It was all services money." </li>
<li style="text-align: justify;">In the latest quarter, the hardware had a gross margin of 2% with 1.1 million devices recognized and ASP of $240. That implies gross profit of $5.3 million. I would prefer $5.3 million than -$133 million but investors are not viewing in terms of gross profits. They prefer to see in revenue terms where the $475 million (1.9M x $250) is better than the $264 million (1.1M x $240). </li>
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As Jim mentioned, the old model was building devices and earn the service revenue. However, since Chen realized this is not a viable strategy anymore, he has to optimize the device business to make it at least slightly profitable, which meant it had to get smaller and rely on partners like Foxconn to reduce fixed costs. He is now improving those efficiencies by partnering with Wistron and Compel, which could be a sign of plans to ramp up future production. Moreover, he is also right that BlackBerry should not sell the device business because it is a key offering that complements its security value proposition and act as "first gate" to the enterprise customer as Chen likes to say. </div>
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A short technical note I would add is that the 90% year-over-year reduction in purchases of intangibles in the cash flow line. This means the cost of devices business, liscencing costs, has reduced significantly to reflect lower volumes. Since these costs are amortized over 2-3 years, the lifespan of the phone, the income statement's amortization line is much higher than in reality. </div>
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<b>Overall Conclusion:</b><br />
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In a press release announcement the share buybacks, <a href="http://press.blackberry.com/financial/2015/blackberry_announces_common_share_purchase_program.html">Chen inserted</a> a quite interesting phase. I asked him about this the Shareholder Meeting but he won't directly comment on the undervaluation of the shares but he does indirectly hinted that he standby the statement below. I agree and I'll wait patiently. The biggest asset for an investor is patience. As Ben Graham said, "You don't want to turn this basic advantage into your biggest disadvantage."</div>
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<blockquote class="tr_bq">
<i>"We intend to take advantage of our strong cash position to purchase our shares when the market price does not reflect what we view to be the underlying value and future prospects of our business, without adversely affecting our strategic initiatives" </i></blockquote>
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John Chen </blockquote>
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<b>Disclaimer: </b>The author is long BB (TSX-listed shares). The author has added BB in the past 2 weeks and will continue buy if prices remain low. </div>
Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com11tag:blogger.com,1999:blog-5042705291735134971.post-74056668400990501662015-02-28T11:40:00.000-08:002015-03-01T16:35:13.205-08:00On 2014 Berkshire Special Letter: Buffett's Confessions and Lessons <div style="text-align: justify;">
Berkshire released its <a href="http://www.berkshirehathaway.com/letters/2014ltr.pdf">annual chairman letter</a> to investors today. This edition is a special 50th anniversary edition that included two special sections. These two sections are commentary written by Bufffet and his partner Charlie Munger on Berkshire's past, present and future. The letter overall is a great read and I highly suggest everyone to read it.</div>
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Below are some of my own commentary on the key points in Buffett's section, which included several lessons he learned and the lessons he wanted readers to comprehend. I will write a separate post for Munger's section. </div>
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<b>Lesson #1: Don't focus on eighth or a quarter of a point</b></div>
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Buffett is a better storyteller than me so I won't go into all the details but he got himself into a lot of trouble when he decided to put more money in a sinking ship (Berkshire) because he was offered 1/8 ($11.375 instead of $11.50) for the shares he owned in a tender offer. Angry over 1/8th of a dollar, he bought more shares (more than doubled his initial position) and went on to sack the CEO and tried to "turnaround" the company by appointing new management. Buffett found out that the extra money he plowed into Berkshire was hardly earning anything. It would be a miracle just to avoid losing money. All this trouble was due to a temporary anger over 1/8th of a dollar. If he had sold his shares, which he bought for $7.50, at $11.375, then he could have used the proceeds to invest in other assets and the money would have grown into vast sums given the law of compounding and his investment record of achieving returns of 20% per annum (doubling every 3.5 years). </div>
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What's the lesson here for investors? Never focus on the tiny quarter of a point. If you want to purchase stock X because it looks very attractive, it's tempting to wait until the stock drops before buying. However, if you feel stock X is worth $20 and the stock is $10, why wait till it drops $0.25 or $1? Paying attention to these small amounts can cause you to miss large gains. The point is also valid when considering selling positions. Overall, step back and you'll realize that some of these small things never really matter. </div>
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<b>Lesson #2: Don't mix good business with bad ones </b><br />
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<span style="text-align: justify;">"When you mix raisins with turds, they are still turds" Charlie Munger</span></blockquote>
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The best decision in the early days of Berkshire was Buffett's decision to buy National Indemnity (NICO). This was the first step into Berkshire's success by entering the lucrative insurance business, which provides interest-free cash up-front that can be used to invest. This was one of Berkshire's secret sauces. Use interest-free float to generate more money through investments than the potential future claims cost. </div>
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If the purchase of NICO was a right decision, why did Buffett admit it was a mistake? His mistake was not regarding the acquisition but how he structured the acquisition. He merged NICO with Berkshire, allowing Berkshire's legacy shareholders to own 39% of the combined entity. By trapping lucrative cash flows in Berkshire's junky textile manufacturing business, growth of the combined entity was limited by the large bleeding within Berkshire's legacy business. The opportunity cost of this drag was estimated at $100 billion (with a B) by Buffett. Although he eventually closed Berkshire's textile business in 1985 (20 years too late by the way), the funds that were sunk into the textile business would have generated significant cash over time, through compounding, if he had just the nerve to close the business when he gained control. </div>
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What's the lesson here for investors? Investors should avoid even the most wonderful businesses if they make terrible acquisitions by buying terrible businesses with low returns and suck cash out of the parent (requiring high re-investment with no free cash flow generating potential). Forget the "synergy" pitch (a.k.a. 2+2 = 5) or the "cost savings" pitch (a.k.a. firing workers) management give investors when doing an acquisition, investors should always focus on the cash generating potential of the acquired asset. Although the monetary costs in present dollars may be small, the opportunity costs of mixing good businesses with bad ones can be huge in future dollars, especially because the funds used to buy the poor businesses could have been invested in other productive assets that compound over time. Buffett admitted that the attractive purchase of Waumbec Mills (another texile company) in 1975 fits this bill perfectly and added to his initial Berkshire mistake. </div>
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<b>Lesson #3: A good business can be wonderful</b></div>
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Buffett has mentioned plenty of times that his partner Charlie Munger has turned him into a better investor by buying "wonderful businesses at a fair price." The change took a while but was needed. As he admits in this letter, a cigarbutt approach (buying cheap businesses and selling them when they start to recovery) was fine for small amounts of capital but for larger sum of capital, a "good business" approach was needed. It's also something I think most fund managers need to understand. Their niche strategies - whether it is arbitrage, net-net, or spin-offs/corporate restructuring - may work well with small amount of AUM but cannot work at a high AUM figure. To perform successfully, buying good businesses with stable earnings, low leverage, and growing free cash flow is needed. </div>
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Buffett always used See's candy as the example and I did too in a <a href="http://kennyyang91.blogspot.ca/2014/04/what-is-value.html">prior post</a>. He reported that since Berkshire (or the predecessor Blue Chip Stamps) purchased See's in 1972, the business has earned $1.9 billion (or $1.25 billion assuming a 35% tax rate). That number is significantly bigger than the incremental $40 million that was plowed back into the business during the same time period. But wait, that's not all. These funds was re-invested in other assets so the overall future value of those cash flows are worth much higher than the sum of the cash flows received.<br />
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An investor who is investing in these kind of businesses would see exponentially higher dividends (more cash to re-invest with) or share repurchases (increase ownership and hence the claims of that company's future free cash flow) which enhances the value of their holdings. </div>
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<b>Lesson For the Reader: How to evaluate M&A and the dark side of M&A</b></div>
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To build on the lesson discussed above, buying bad businesses and mixing them with good businesses is especially dangerous when management use their own "stock" as currency. It doesn't make sense trading one $100 bill for four $20 bills. Yet management of corporations do that all the time because they focus on trading for the number, not the value, of the bills. The number in question is the "earnings per share" (EPS) that sell-side analysts and fund managers care about. Management even created a fancy term to justify their actions called "EPS accretion". </div>
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Even Buffett himself was not error-free in this case. He bought a company called "Dexter Shoes" with Berkshire stock in the 1990s. That mistake was extremely costly because it diluted the shareholders and received essentially nothing for that pain. </div>
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Furthermore, don't forget that management may become extremely sensitive to short term factors and become servants of the capital markets instead of the shareholders. Capital market participants, whether be the investment bankers or the corporate raiders (ahem...I mean activist investors), want a share of corporations' success by "encouraging" them to consider "strategic alternatives". As Buffett outlines in the letter, there is so much indirect frictional costs that shareholders never benefit fully from the success of the companies they own. It is surprising how companies pay 20-50% premium for business T and then spin it off later as business S. Companies like Kraft, which was bought by Philip Morris and then spun out (first as Kraft and then it was separated again into two more pieces), is a good example of the pattern Buffett described. Another example is BHP Billiton. The 2001 purchase of Billiton was completely reversed after its recent announcement to spin them off as South32. </div>
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The "helpers" - the bankers, consultants, lawyers - who propose the strategic alternatives will probably make more money than the shareholders in the company that undergoes such process. Companies should focus on the long term instead of considering all those strategic alternatives when the helpers come knocking at their doors. </div>
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It is fine to use acquisitions as vehicles for future growth but it has to be part of a long term strategy. In fact, many businesses will have to use M&A as a viable future growth path. Therefore, investors should evaluate the acquisitions decisions of the companies they own. Do they make sense in terms of strategy, culture (this one is commonly forgotten) and of course the price. The price is essential because you don't want to pay more than what you receive. The evaluation on the price is hard especially for stock transactions that require an intrinsic value estimate for the buyer as well as the seller. Thus, dig deeper than common first level details such as "synergies", "cost savings", "EPS accretion", or "revenue growth". </div>
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<b>Lesson For the Reader: Capital Allocation and conglomerate</b></div>
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Buffett has gave a great lesson on conglomerates in this letter. On the surface, the structure is hardly efficient at all but there is a method to utilize its advantage. It is something that not many managers understand: capital allocation. </div>
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Good capital allocation practices use free cash flows generated from stable businesses and re-invest them back into the most profitable opportunities. It's not rocket science: use free funds, that are generated from existing businesses, to invest in companies/subsidiaries that can generate the highest returns. The glue that sticks the subsidiaries together at a conglomerate is the culture. Berkshire's culture is unique because every subsidiary is an independently-run business with no interference from head office in Omaha. Buffett has given his managers the mandate to manage their own businesses with the independence they need and shield them from the short-termism of the capital markets. He often tells his managers that the businesses they run is not for sale and its the only asset they have. With that kind of mindset and culture for achieving long term success, it's no surprise that Berkshire flourished. The success snowballs because Buffett wrote in this letter that Berkshire has become home to many wonderful businesses that would rather be owned under Berkshire than under an owner such as a private equity firm. Thus, with many good businesses to re-invest in and the large amounts of float generated by its insurance subsidiaries, Berkshire has the ingredients it needs to be successful. </div>
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The lessons for investor here is good capital allocation and a strong culture is critical for any company. Berkshire won't have succeeded if it did not shut (although it was late) the cash bleeding textile businesses and re-allocated capital away from bad businesses. Moreover, Berkshire won't have succeeded if it did not have a cohesive culture that focused on the long term and ignored the noise from the short-term oriented capital markets. Investors want to invest in companies that can allocate capital efficiently and have a strong long term oriented culture. </div>
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<b>Lesson For the Reader: Preparing for the Future </b></div>
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In his outlook for the next 50 years, Buffett said he is confident that the business he built is strong enough to outlive him and succeed. For more on this topic, please see Lawrence Cunningham's new book called "Berkshire Beyond Buffett: the Enduring Value of Values ."</div>
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One interesting point I want to direct readers is his point on cash. In many companies and even investment funds, managers want to minimize cash because it is an un-productive asset yielding near 0% or even negative percent in case of European cash equivalence. On the contrary, Buffett argues that cash is the best asset especially as insurance to protect the unknowable future. I fully agree with him. There is nothing wrong with a portfolio of 10% or even 20% cash in a portfolio. Future is inherently uncertain and I have realized over the years that forecasting the future with precision is a fools game. Quoting Howard Marks: "You can't predict but you can prepare." Investor can prepare by having some cash in their portfolio. Berkshire is preparing for the uncertain future by holding at least $20 billion in cash all the time. </div>
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<b>Conclusion:</b></div>
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There is a lot of insights in Buffett's letters and his 2014 one isn't any different. Read it, study it and apply it. I'm sure readers will become better investors if they do. </div>
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Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com15tag:blogger.com,1999:blog-5042705291735134971.post-89081832044870125172015-01-18T19:54:00.002-08:002015-01-19T16:42:38.306-08:00How To Evaluate Opportunities After The Oil Price Slump <i>I apologize to my readers for not writing in a very long time but I will try to write a couple of insightful posts within the next week. Please stay tuned. </i><br />
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The biggest surprise in 2014, other than abnormal rally in the long term treasury market, was the 50% decline in crude oil price. Whenever I see a price decline of such large magnitude in a very short amount of time, I investigate to see if there are opportunities to pick up cheap stocks. Since I'm a fundamental based value investor, I only buy if I see the intrinsic value of the business significantly higher (>33%, preferable >50%) than the current price. Thus, I need to estimate roughly what the intrinsic value is. Note, I used the word roughly. No one can know exactly the value of the underlying business. I prefer to be "approximately right than precisely wrong". </div>
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This article will explain the NAV model, the most widely used method to value oil and gas companies. Then, I will explain why I believe the key input of the model is flawed. Finally, I will share with readers my methods to evaluate oil and gas stocks.</div>
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<b>NAV Models: </b><br />
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Analysts and industry professionals use a NAV (Net Asset Value) model to determine the intrinsic value of an oil and gas company. The NAV model is just a variation of the commonly used DCF model. The NAV model discounts annual free cash flows until the reserves of the company reach zero to calculate the present value of the operations. The value of equity is the sum of the present value of operations and net working capital minus all outstanding liabilities (bonds, short term paper and decommissioning liabilities).</div>
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<b>The Most Ridiculous Input: The Long Term Commodity Assumption:</b><br />
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The most ridiculous input, in my opinion, into analysts' NAV models is the"long term" commodity assumption. For oil and gas valuations, it is the long term assumption for WTI Crude Oil (Or Brent) and NYMEX Gas (Henry Hub). This long term assumption is often used for year 3 and beyond in the forecasting model, which will have a significant impact on the intrinsic value estimate since around 90% of the NAV model's value depend on the cash flows from year 3 and beyond.</div>
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How is this long term oil assumption determined? Using economic theory, a commodity like oil should trade around the marginal cost of producing one addition unit. However, many professionals discard this theory and place more emphasis on the current price. Succumbing to anchoring and availability biases, analysts input these inappropriate price assumptions into their models to justify their current price targets. I can't blame them for using current prices. It is much easier to justify your financial model in front of institutional clients by using an oil price that is not too far away from the current one. It is the most available snapshot of crude prices and a good anchor to use. However, I believe too many investors fall for this anchoring bias by focusing on prices that are easily observable.</div>
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When oil peaked at $147 in 2008, some analysts had $150 as the long term oil assumption. Conversely when oil bottomed at $32 six month later, the long term oil assumption dropped to near $50. The meaning of long term is probably 12 or 24 month in the eyes of the most analysts compared to the theoretical meaning of 30 or even 50 years down the road.</div>
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<b>My Method of Valuing Oil Companies: </b><br />
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How do I value an oil and gas company? Since I'm not an expert in that field and isn't an engineer, I pay extreme attention to what strategy players pay for oil and gas companies. The multiples in those transaction can be calculated and I use those multiples as a starting point to estimate intrinsic value. The trick here is to choose relevant transactions. For example, transactions in early 2014, when oil was well above $100, may not provide the correct intrinsic value multiple. However, a transaction that caught my attention was the $13 billion takeout of Talisman (TLM) by Repsol in December when oil was near $50. Despite the outlook for oil was extremely dire, Repsol decided it was time buy. The assets acquired wasn't high in quality and 70% of the asset mix was natural gas, which was extremely surprising to me. Nonetheless, the multiple paid , on an enterprise basis, was $50,000 per production (BOE/d) and $12 per 2P reserves (BOE).</div>
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Second, I try to look at potential hidden items on the balance sheet. One item I look for is land holdings that may possess resources that are not converted into reserves. Since analysts only model value based on reserves, potential future conversion of resources into reserve is one catalyst for higher share appreciation. This analysis is a difficult one but data is widely available for the discovered resources and reserves in major oil plays such as Montney, Cardium, Shaunavon, and Viking in Canada or Permian, Bakken and Eagle Ford in the US. Another balance sheet item is debt. Debt-heavy oil and gas companies have been hit harder than peers that have less debt. Nevertheless, every company's debt is different and it is wrong to evaluate a company's debt level purely on financial ratio such as Debt-to-equity or Debt to cash flow. The covenants should be examined to see if the debt is cov-heavy or cov-lite. The former is significantly different than the latter. A relatively debt heavy company is still a feasible investment if it has plenty of assets. The two options would be either sell certain assets or sell the whole company. Talisman had a lot of debt but it still managed to sell itself due to high quality assets in North American (outweighing the poor quality of its Asian and North Sea assets). The low valuation for Talisman was a bonus too.</div>
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With the transaction multiples and the balance sheet analysis, I can roughly estimate the intrinsic value of the company. The last step I do is a rough NAV model but with more realistic assumption for oil long term oil prices. Let's not forget the concepts taught in Economics 101. In a perfectly competitive industry, the price of the good should equal to its marginal cost, which is about $70-80 for oil. As oil prices reach below the variable cost (cash costs in the oil business), firms will close down, thus bring the market into balance. In the long run, market forces will balance out so price will reach near marginal cost. The industry has already slowed down with the number of rigs in North American dropping to the lowest since early fall 2014 according to Baker Hughes <a href="http://phx.corporate-ir.net/phoenix.zhtml?c=79687&p=irol-reportsother">data</a>. However in the short run, prices can be extremely volatile. Hence, the balance sheet must show strong signs that the company can at least survive a low price environment (e.g. having a good hedge book) for the next year or two.</div>
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<b>Conclusion:</b><br />
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The rapid decline in crude oil price since June last year has created an excellent opportunity to pick up a few beaten down energy stocks. All oil and gas stocks were sold, regardless of quality, valuation or potential hidden assets on the balance sheet. Thus, there are definitely few good names to buy.</div>
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I adhere to my motto: "Misconceived risk equals opportunity, miscalculated risk equals fiasco" as mentioned in my previous <a href="http://kennyyang91.blogspot.ca/2014/01/new-year-special-post-investment-risks.html">article</a>. Misunderstood risks create opportunities but I need to complete a full analysis to make sure I didn't miscalculate any risks.</div>
<br />Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com9tag:blogger.com,1999:blog-5042705291735134971.post-44672198816147139382014-07-18T12:13:00.000-07:002014-07-18T14:10:23.504-07:00Essential Lessons From Ben Graham<div style="text-align: justify;">
I recently read Joe Carlen's book called "The Einstein of Money", a book on Ben Graham. The book was half bibliographical while the other half tried to explain his investing philosophy. It was a great read and I would recommend the book. </div>
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I found myself looking back at the notes I made when I read <i>The Intelligent Investor</i> after I read Carlen's book<i>.</i> I would like to share some of the notes I made in this post. </div>
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Buffett was absolutely correct in claiming that the book was "by far the best book on investing ever written." The principles advocated by Graham remains relevant today even though the first edition of the book was written in 1949. Buffett's quote in the preface proves this point: "To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside information. <i>What is needed is a sound intelligent framework for making decisions and the ability to keep emotions from corroding that framework.</i>" (preface 4th edition revised, Graham 2003) Hence successful investing is about following a disciplined approach and controlling one's own emotion from getting too euphoric when the markets are rising and from getting to pessimistic when markets are falling. Investor may not realize this fact: an investor's worst enemy is himself/herself. Investors should note that no matter how intelligent or diligent they are, they will fall prey to their own emotions, which is often much harder to control and difficult to correct. Graham was correct when he stated, "the investor's chief problem - and even his worst enemy - is likely to be himself. (The fault dear investors is not in our stars - and not in our stocks - but in ourselves." (p.8) </div>
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Buffett said that chapter 8 and 20 were his favorites. I would add chapter 1 to the list. Therefore I hope reader will enjoy my notes for these chapters. </div>
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<b>Chapter 1: Investment versus Speculation </b><br />
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An investment operation is one which, upon thorough analysis, promises the safety of principal and an adequate return. Operations not meeting these requirements are speculative (p.18)</blockquote>
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The quote above is one of Graham's best quote on investing. Many investment operations are essentially speculations because they do not require a thorough analysis of the underlying securities to ensure the safety of principal and an adequate return. Many investors believe the key to make money is to forecast what the stock market, or any other financial market, will do tomorrow. These forecasting approaches, while popular, are not the right method to make money in the long run. Without an examination of the underlying security, any fancy method, such as using complex formulas, that claims to have the ability to generate high returns should be taken with a grain of salt. </div>
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What is "thorough analysis", "safety of principal" and "an adequate return"? Graham defined "thorough analysis" as "the study of facts in the light of established standards of safety and value." This simply implies the detailed study of the underlying security (stock or bond) with a close attention to the risks and facts relating to the intrinsic value of the security. His definition of "safety of principal" is "protection against loss under all normal or reasonably likely conditions or variations." Therefore, investors should ensure that all risks of the investment are analyzed and the price paid for the security is attractive versus potential risks that may result in a permanent loss of capital. Finally, his definition of "an adequate return is "any rate or amount of return, however low, which the investor is willing to accept provided he acts with reasonable intelligence." Thus, investors must make sure their investments can satisfied the minimum required returns in the long run. </div>
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For defensive investors, Graham warned that going after "hot" issues is speculative. Since defensive investors want to achieve a satisfactory result without much effort, they need to keep their investment operation simple. Graham suggestion that they should (1) purchase shares of well-established companies (e.g. S&P500 companies) or well-established funds. He also suggested the use of "dollar cost averaging" in order to limit the number of shares/fund units when prices are high and increase the amount of shares/fund units bought when prices are low. </div>
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For enterprising investors, there are three pitfalls Graham warned against:<br />
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<li>Trading in the market: He referred to this activity as "buying stocks when the market has been advancing or selling them after it has turned downwards." In today's terminology, this activity would be called "momentum chasing" or "trend following". Graham concluded that investors' overall of success in trading in the market is very low.</li>
<li>Short-term selectivity: He defined this method as "buying stocks of companies which are reporting or expected to report increased earnings or for which some other favorable development is anticipated." Graham warned this approach is dangerous because (1) the prediction of near-term events could be wrong or (2) the current price may already fully reflect or "discount" good events like upcoming earnings. </li>
<li>Long-term selectivity: This approach is about picking companies with unusual high growth in the future or picking stocks that are expected to establish a high earnings power later. The biggest problem in this approach is the selection of the right stocks that will do well even if an investor has found the growth industry. </li>
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Graham instead gave the following suggestion for enterprising investors: </div>
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To enjoy a reasonable chance for continued better than average results, the investor must follow policies which are (1) inherently sound and promising and (2) not popular on Wall Street (p.31) </blockquote>
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My translation: (1) boring, but sound, investment approaches (like value investing) that are ignored because it is boring as watching paint dry (2) must go against the grain<br />
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<b>Chapter 8: The Investor's and Market Fluctuations</b><br />
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This is an important chapter to understand and it took me years to understand the content because the principle espoused in this chapter is truly "unconventional" compared other finance theories.<br />
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Graham discussed the difference between the pricing and timing techniques. I explained these concepts in my prior post. The former is about trying to figure out the intrinsic value of the underlying business (pricing) and buy/sell dependent on the variance between price and value. The latter point is about timing the market or stock prices in order to profit from those forecasts. As stated above, Graham did not believe in market forecasting or timing because it is very competitive and no one seems to make right forecasts consistently over time. It is almost impossible to do that.<br />
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Graham advocated the pricing technique but many investors may not feel comfortable with the approach because of the wrong attitude towards price fluctuations. All investors should read the following paragraph carefully:<br />
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Imagine that in some private business you own a small share that cost you $1000. One of your partner, named Mr. Market is a very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly. If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise. Only in case you agree with him, or in case you want to trade with him... the rest of the time you will be wiser to form your own ideas of the value of your holdings on full reports from the company about its operations and financial position (p.204-205)</blockquote>
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As I stated in my prior post on intelligent investing, investors should transact with Mr. Market only if it is favorable to do so. Most of the time, investors should ignore Mr. Market. He'll just come back with another quote tomorrow and never feel bad when you ignore him. When discussing Graham's Mr.Market analogy, Buffett said: "the market is there to serve you, not to instruct you." Far too often however, investors cannot resist looking at daily quotations and trying to make a few quick bucks by looking at price trends because they believe Mr. Market can give them good instructions. Instead of trying to profit from price fluctuations, investors should keep the following Graham quote in mind:</div>
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Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operation results of his companies. (P.205) </blockquote>
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<b>Chapter 20: Margin of Safety as the Central Concept of Investment </b><br />
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Confronted with a like challenge to distill the secret of sound investing in three words we venture the motto, MARGIN OF SAFETY (p.512) </blockquote>
I completely agree with Graham that the margin of safety principle is paramount for successful investing. Buying stocks near intrinsic or underlying value does not allow wiggle room if the appraiser has made a mistake. Therefore, an investor must purchase the stock at much lower prices than the calculated intrinsic value<br />
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On the margin of safety principle, Graham explains:<br />
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The margin of safety idea becomes much more evident when we apply it to the field of undervalued securities. We have here, by definition, a favorable difference between price on the one hand and indicated or appraised value on the other. That difference is the safety margin. The buyer of bargain issues places particular emphasis on the ability of the investment to withstand adverse developments.... If these [value stocks] are bought on bargain basis, even a moderate decline in the earning power need not prevent the investment from showing satisfactory results (p.517-518) </blockquote>
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Hence a margin of safety is needed to prevent negative outcomes of the future and provide a safety cushion if the estimated intrinsic value is correct. The key here is buying dollar bills for 50 cents. </div>
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Graham stated the importance of considering the price paid when assessing the margin of safety for any investment: </div>
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The margin of safety is always dependent on the price paid. It will be large at one price, small at some higher price and nonexistent at some still higher price. (p.517) </blockquote>
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The margin of safety principle is also applicable to bonds. A bond must meet the minimum coverage ratios, even in recession years, in order to qualify as an investment. Graham utilize both pre-tax and after-tax earnings coverage ratios, unlike most professionals who prefer using EBITDA coverage ratios. If Graham was still alive today, I don't think he would change his methodology since EBITDA coverage ratios overstate the cash generation capability of the business by not considering capital expenditures.<br />
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<b>Conclusion:</b><br />
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Investment is most intelligent when it is most businesslike (p.523) </blockquote>
While most investors believe the most profitable method of investing is predicting future prices, it is not true. Trying to outsmart countless other geniuses who are trying to do the same will not yield handsome results. Instead, readers should realize that stocks are fractional ownership of businesses and investors should realize that the best results will be realized when they think like business owners. Hence I completely agree with Graham that "investment is most intelligent when it is most businesslike." Buffett also agree with Graham's conclusion and have referenced the same quote in many of his annual letters, including the most recent 2013 letter.<br />
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I hope this post was useful to readers. If you haven't read <i>The Intelligent Investor</i> yet, I hope this post has convinced you to at least try reading it.<br />
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<b>-----</b><br />
<b><br /></b>
<b>Appendix (More Quotes from The Intelligent Investor): </b><br />
<b><br /></b>
<br />
<blockquote class="tr_bq">
We draw two morals for our readers: (1) obvious prospect for physical growth in a business do not translate into obvious profits for investors (2) the experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries. (p.7) </blockquote>
<b>Comment:</b> Be wary of investing in the next "hot" industry. Even if you can guess the industry, picking the winners is extremely hard. Although investors may hear success stories of Facebook, Twitter, Linkedin etc., there must have been over thousands of social media company that failed for each one that succeeded.<br />
<br />
<blockquote class="tr_bq">
We hope to implement in the reader a tendency to measure or quantify. For 99 issues out of 100 we could say that at some price they are cheap enough to buy and at some other price they would be so dear that they should be sold. The habit of relating what is paid to what is offered is an invaluable trait in investment (p.8) </blockquote>
<b> Comment:</b> The attractiveness of a stock is always dependent on the current price. At some price, it is cheap enough to buy and at some other price, it is so expensive it should be sold.<br />
<br />
<blockquote class="tr_bq">
Buying a neglected and therefore undervalued issue for profit generally proves a protracted and patience-trying experience.And selling short a too popular and therefore overvalued issue is apt to be a test not only of one's courage and stamina but also the depth of one's pocketbook. (p.32)</blockquote>
<b>Comment: </b> Buying undervalued securities requires a boatload of patience. Shorting overvalued stocks not only requires patience but also it requires a large amount of capital. Investors often forget the latter point and lose money shorting stocks that eventually collapsed.<br />
<br />
<blockquote class="tr_bq">
Nearly all bull market had a number of well-defined characteristics in common, such as (1) a historical high price level (2) high price/earnings ratios (3) low dividend yields against bond yields (4) much speculations on margin (5) many offering of new common-stock issues of poor quality (p.193)</blockquote>
<b>Comment: </b> Goods indicators Graham wrote on identifying overvalued markets. Intelligent investors do not try to time the market top or bottom. Nonetheless, if the market is overvalued, they should reduce current positions and raise cash levels.<br />
<br />
<blockquote class="tr_bq">
A stock does not become a sound investment merely because it can be bought close to its asset value. The investor should demand, in addition, a satisfactory ratio of earnings to price, a sufficient financial position and the prospect that its earnings will at least be maintained over the years (p.200) </blockquote>
<b>Comment: </b>I believe many readers of the book overlooked the quote above and confused Graham's purchase of net-nets with his idea of buying a good business. In addition to selling near tangible asset value (tangible book), the companies under consideration should be selling at a low price in relation to its future earnings power, have a healthy balance sheet (low debt) and the earnings should remain stable. <br />
<br />
<blockquote class="tr_bq">
The development of the stock market in recent decades has made the typical investor more dependent on the course of price quotations and less free than formerly to consider as a business owner (p.198) </blockquote>
<b>Comment: </b> I believe this quote is more applicable to investors now than in 1972 when Graham wrote the 4th edition of the book. With the increased use of smartphones, investors have the convenience of checking prices no matter where they are. While technology has enriched our lives, I believe technology has also transformed many investors into speculators.<br />
<br />
<blockquote class="tr_bq">
The speculator's primary interest lies in anticipating and profiting from market fluctuations. The investor's primary interest lies in acquiring and holding securities at suitable prices (p.205)</blockquote>
<b>Comment: </b> Graham identifies the correct and incorrect method of thinking about market fluctuations.Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com4tag:blogger.com,1999:blog-5042705291735134971.post-88723991631522506852014-07-12T11:40:00.001-07:002014-08-18T08:04:52.631-07:00Kenny's Track Record of Value Investing (3-Years) I began an investment account to practice my stock picking skills in August 2011. It has been an amazing experience and I learned a lot on the way. I fully understand why most successful investor say that experience is the most important asset to a money manager.<br />
<br />
I have followed the markets since 2005 and picked stocks through the investopedia simulation. I also traded on my parent's account since 2006 but decided a long term investment approach is needed to build wealth. While trading can be profitable in the short-run (mostly due to good luck), it is not the right approach to consistently build long term wealth. That is why I decided to focus on value investing and to prove it is the best approach using my own hard earned money.<br />
<br />
The reason I'm posting my track record is I want prove a point: value investing works if practiced correctly. What I mean correctly is that the investor should follow all principles stated in Graham's books, <i>The Intelligent Investor</i> and <i>Security Analysis</i>, very closely. Don't try fancy formulas, leverage or chase a quick return. Therefore, if you haven't read those books, I highly recommend them as summer reading! Lots of investor claim they read them but I doubt those claims. Several re-reads are needed to fully comprehend the knowledge presented in those books. For the record, I read <i>The Intelligent Investor</i> 5 times (1973 edition 3 times and 1949 edition 2 times) and <i>Security Analysis </i>(1940 and 1951 editions) twice. I plan to re-read them again. <br />
<br />
<b>Kenny's 3-year Return (Time Weighted Total Returns, the method advocated by GIPS) </b><br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjyqmmMWaWatYoP6X4KRjdnBhs5q_MvLUgYbMm7Qxt0ky71gEbySBSWlEcUW2ueZiD-2G6-oAKEhHbkkQKJfLeew0pc8YRHr4TmydfUjxa4vRsj-geIxJ_ceAPWxG3SoiQVrg4F6K_xTfQ/s1600/Kenny's+Returns.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjyqmmMWaWatYoP6X4KRjdnBhs5q_MvLUgYbMm7Qxt0ky71gEbySBSWlEcUW2ueZiD-2G6-oAKEhHbkkQKJfLeew0pc8YRHr4TmydfUjxa4vRsj-geIxJ_ceAPWxG3SoiQVrg4F6K_xTfQ/s1600/Kenny's+Returns.jpg" height="194" width="640" /></a></div>
<br />
<div class="separator" style="clear: both; text-align: center;">
</div>
<br />
Some Items To Note:<br />
<br />
<ul>
<li>Three year annualized return of 17.1% vs. 7.1% for TSX on a total return basis. Total 3 year return of 60.6% vs. 23% delivered by the TSX.</li>
<li>I used no fancy strategies, just plain old value investing (Graham/Buffett style).</li>
<li>No leverage to juice returns, no options or shorting. No micro-caps or small-caps because I wanted to operated in the mid/large cap universe (my circle of competence) </li>
<li>Unlike most managers, I'm extremely concentrated. On average, I owned only 3 stocks most of the time (currently hold 3 as well). This is not ideal for a professional manager but I'll still own a very small number of stocks, say 10-30 stocks, if I manage other people's money. </li>
<li>My monthly returns are sometimes volatile especially when I build a position (i.e. BBRY) on the way down. This is a problem facing all value investors but eventually patience will pay off. </li>
<li>I'm extremely patient, especially for a 22 year old investor! I held one stock since I bought it in September 2011. My shortest holding period, among the 8 stocks I held, is 6 months. </li>
</ul>
<div>
One message I want to deliver, value investing works! </div>
Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com4tag:blogger.com,1999:blog-5042705291735134971.post-89011667437510181482014-05-15T12:15:00.000-07:002014-05-24T14:15:52.241-07:00Financial Shenanigans: A Deep Look At The Tricks Company Can Play With Its Accounting <div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<i><span lang="EN-US" style="font-family: "Times New Roman","serif";">The following is a talk I will present to a introductory financial accounting class. This piece is dedicated to Ms.
Hopwood-Jones. <o:p></o:p></span></i></div>
<div class="MsoNormal">
<i><span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></i></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">The source for this
discussion comes from a book titled "Financial Shenanigans" by Howard
M. Schilit. The discussion is aimed at explaining accounting tricks public
companies use to inflate their financial numbers in order to meet the
expectation of analysts. Management of public companies are often pressured by
analysts and investors to "make the numbers" every quarter.
Therefore, some may cheat to meet a net income target for a certain quarter. A
little cheating during one quarter can snowball into a lot of cheating (i.e.
Enron is a famous example). How does these corporate executives cook the books?
One may think they are rocket scientists but with a little accounting knowledge
you learned from Ms. Hopwood-Jones's class, you too can detect accounting
frauds. <o:p></o:p></span></div>
<div class="MsoNormal">
<b><span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></b></div>
<div class="MsoNormal">
<b><span lang="EN-US" style="font-family: "Times New Roman","serif";">Earnings<span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><b><span lang="EN-US" style="font-size: 11pt; line-height: 115%;">[1]</span></b></span><!--[endif]--></span>
(Income Statement) Manipulations: <o:p></o:p></span></b></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Investors often
scrutinize a public company's quarterly earnings report very carefully. They
often cheer when a company can meet or beat the consensus earnings (net income)
estimate. If a company failed to meet the consensus estimate, the share price
often declines. How do corporate
executives create "fake" earnings? They often just play around with
the fundamental income statement equation as listed below. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div align="center" class="MsoNormal" style="text-align: center;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Revenue - Expenses = Net Income <o:p></o:p></span></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Since
net income is calculated by subtracting expenses from revenue, corporate
management can manipulate net income by inflating revenues or making expenses
disappear. <o:p></o:p></span></div>
<div class="MsoNormal">
<i><u><span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></u></i></div>
<div class="MsoNormal">
<i><u><span lang="EN-US" style="font-family: "Times New Roman","serif";">Trick #1: Recording Revenue Too
Soon<o:p></o:p></span></u></i></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">A common trick is to
record revenue early before it is actually earned. In accounting, the revenue
recognition rule is used to determine if revenue is actually earned (see table
1 below for more details). <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">A common trick is to recognize
revenues that belong to a future accounting period. For example, if company A
is a magazine publisher that collected $100 for a 4-year subscription fee from
a customer, how much revenue can the company recognize in year 1? The answer is
only $25 because the other $75 should go into "unearned/deferred revenue"
(a liability account) since the $75 does not meet the GAAP revenue recognition
rule. Nonetheless, corporate executives often trick their auditors by using
fancy wording to convince auditors that these 4-year subscriptions are actually
1 year subscriptions. Therefore, it is vital
for investors to read the footnotes to financial statements. Read the footnotes
carefully! <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">One interesting method
to boost revenue is by billing the customer for work not completed yet. In the
real world, most transactions are not black and white as you see in accounting
textbooks and revenue is often recognized over several accounting periods
(construction industry is the common example). Since revenue is a credit
account, they need a debit account to balance the books. Since customers generally
don't pay cash unless the required work is completed, a common account to debit
is account receivables. Therefore, be wary of any abnormal increases in
accounts receivables or any receivable accounts. Also, if the accounts
receivable turnover ratio (revenue/accounts receivables) starts to slow while
revenues are still growing, it is a red flag and the company is probably
inflating revenue by borrowing future revenue. <o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<u><span lang="EN-US" style="font-family: "Times New Roman","serif";">Table
1: Revenue Recognition under IFRS and US GAAP<span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><u><span lang="EN-US" style="font-size: 11pt; line-height: 115%;">[2]</span></u></span><!--[endif]--></span>
<o:p></o:p></span></u></div>
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span lang="EN-US" style="font-family: "Times New Roman","serif";">IFRS Revenue Recognition
Criteria <o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span lang="EN-US" style="font-family: "Times New Roman","serif";">US GAAP Revenue Recognition
Criteria<o:p></o:p></span></b></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">(1)
The amount of revenue can be measured reliably<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">(1)
There is evidence of an arrangement between buyer and seller. For instance,
this would disallow the practice of recognizing revenue in a period by
delivering the product just before the end of an accounting period and then
completing a sales contract after the period end <o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">(2) It is probable that the economic benefits
associated with the transaction will flow to the entity <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">(2)
The product has been delivered or the service has been rendered. For
instance, this would preclude revenue recognition when the product has been
shipped but the risk and rewards have not actually passed to the buyer <o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">(3) The stage of completion of transaction at
the balance sheet date can be measured reliably <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">(3)
The price is determined or determinable. For instance, this would preclude a
company from recognizing revenue that is based on some contingency<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">(4) The costs incurred for the transaction and
the costs to complete the transaction can be measured reliably <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">(4)
The seller is reasonably sure of collecting money. For instance, this would
preclude a company from recognizing revenue when the customer is unlikely to
pay<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Source:
IASB and FASB <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">As shown in table 1, a
company cannot recognize revenue unless the risk and rewards (economic
benefits) is transferred from the seller to the buyer. A trick used in the
1990s by Sunbeam is to use a technique called "bill and hold." In
essence, Sunbeam bills the customers and recognizes revenue despite the
products were held in Sunbeam's warehouses. Although this trick is difficult to
detect, a closer look at the revenue recognition footnote can discover
aggressive revenue recognition. Below is the paragraph disclosed in Sunbeam's
annual report:<o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="margin-bottom: 10.0pt; margin-left: 1.0cm; margin-right: 1.0cm; margin-top: 0cm; text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">"In limited
circumstances, at the customers' request the company may sell seasonal products
on a bill-and-hold basis provided that goods are completed, packaged and ready
for shipment, such goods are segregated and the risks of ownership and legal
title have been passed to the customer."
<o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">With the grills sitting
at Sunbeam's warehouses, there is no doubt that the economic benefits have not
been passed onto the buyers despite Sunbeam tried using the words "risk of
ownership and legal title have been passed to the customer." Also,
customers often do not request goods on a bill-and-hold basis. Always be
suspicious when the words "bill-and-hold" comes up in the financial
footnotes. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Finally, another trick
is to inflate revenues is to extend generous terms to buyers despite low creditworthiness,
which fails criteria (4) listed in table 1 since the probability of collection
is low. An acceleration of revenue along with growth in accounts or note
receivable is a red flag. Although not all red flags imply revenue
manipulation, investors should be careful when these red flag appear. If the
company is showing abnormal growth in accounts or note receivable while also
disclosing that it is extending credit to customers with generous terms, watch
out! <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="MsoNormal">
<i><span lang="EN-US" style="font-family: "Times New Roman","serif";">Trick # 2: Boosting Income Using
One Time Items<o:p></o:p></span></i></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">One-time items, also
known as "extraordinary items", are often used to boost net income.
By definition one-time items should occur infrequently such as gain/loss from
sale of equipment<span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 11pt; line-height: 115%;">[3]</span></span><!--[endif]--></span>
or damage incurred from a natural disaster. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Corporate management
often tell investors to ignore one-time items because they do not reflect the
continuous business operations. They
tell investors to focus on normalized income, which is often called
"operating income." You will often see a corporate income statement
organized as follows:<o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Table
2: Sample Corporate Income Statement<span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 11pt; line-height: 115%;">[4]</span></span><!--[endif]--></span> <o:p></o:p></span></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Revenue
<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 104.8pt;" valign="top" width="140"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">XXX<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> COGS <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 104.8pt;" valign="top" width="140"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<u><span lang="EN-US" style="font-family: "Times New Roman","serif";">XXX<o:p></o:p></span></u></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Gross
Profit <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 104.8pt;" valign="top" width="140"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">XXX<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 104.8pt;" valign="top" width="140"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Operating
Expenses <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 104.8pt;" valign="top" width="140"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">XXX<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Operating
Income <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 104.8pt;" valign="top" width="140"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<u><span lang="EN-US" style="font-family: "Times New Roman","serif";">XXX<o:p></o:p></span></u></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> One-time Items <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 104.8pt;" valign="top" width="140"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<u><span lang="EN-US" style="font-family: "Times New Roman","serif";">XXX<o:p></o:p></span></u></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Earnings
Before Tax <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 104.8pt;" valign="top" width="140"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">XXX<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Income Tax Expense <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 104.8pt;" valign="top" width="140"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<u><span lang="EN-US" style="font-family: "Times New Roman","serif";">XXX<o:p></o:p></span></u></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Net
Income <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 104.8pt;" valign="top" width="140"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<u><span lang="EN-US" style="font-family: "Times New Roman","serif";">XXX<o:p></o:p></span></u></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Investors do pay more
attention to operating income than the net income number. Therefore, management
has the opportunity to inflate operating income by shifting positive benefits
from one-time items above the operating income line and shifting normal
expenses below the operating line. The former outcome can be achieved by
shifting a gain from the sale of an asset above the operating income line as
reduction to operating expenses. For example in 1999, IBM sold a business to
AT&T but instead of disclosing the gain on the sale in the one-time items
line on the income statement, IBM decided to book the $4.06 billion gain on
sale as a contra expense. The effect of IBM's accounting decision significantly
reduced operating expense by $4.06 billion (reducing the $18.8 billion
operating expenses to only $14.7 billion!). Investors thought IBM found a magic
way to reduce operating expenses and decided to give a higher valuation<span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 11pt; line-height: 115%;">[5]</span></span><!--[endif]--></span>
for the stock only to find out later that those expense reductions didn't
continue into future periods. Savvy investors reading the financial footnote
would have noticed this trick because the company, by law, had to disclose how
the sale of a business is accounted for. Companies often bury these unwanted
disclosures deep in the footnotes since they know most investors never bother
to read 100 pages of financial footnotes. However, it pays to goes through the
footnotes of financial statements! <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Another genius method
is to create a continuous stream of income from the sale of an asset. Because
income from a one-time sale is less impressive than a continuous stream of
income, corporate management will aim to create a continuous stream of income
from the sale of an asset. Let's use the traditional debits and credits to
explain this trick. Assuming an asset owned by company I is valued at
$1,000,000 (fair-value). Instead of selling it at $1,000,000, company I sells
the asset to company M at only $800,000. However, company I requires company M
to pay for future products at above market prices to make up for the $200,000
difference. Table 3 shows the correct way to account for this transaction while
table 4 shows the inflated approach. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<u><span lang="EN-US" style="font-family: "Times New Roman","serif";">Table 3: Correct way
to account the transaction by company I <o:p></o:p></span></u></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<u><span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></u></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Cash<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$800,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Receivable (from Company M) <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$200,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Asset Sold (Book Value)<span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 11pt; line-height: 115%;">[6]</span></span><!--[endif]--></span>
<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$700,000<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Gain on Sale of Asset <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$300,000<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">When the inflated
prices are paid by company M in the future, the following should occur:<o:p></o:p></span></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Cash<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$200,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Receivable (from Company M)<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$200,000<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<u><span lang="EN-US" style="font-family: "Times New Roman","serif";">Table 4: How to Create
A Revenue Stream From One-Time Sale<o:p></o:p></span></u></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Cash<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$800,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Asset Sold (Book Value) <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$700,000<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Gain on Sale of Asset <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$100,000<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">When the inflated
prices are paid by company M in the future, company I records:<o:p></o:p></span></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Cash<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$200,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Revenue<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$200,000<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Magically, company I
created $200,000 of revenue that should have been recorded as a gain on sale
from a prior accounting period. To create a continuous revenue stream, the
company could have recognized the $200,000 more slowly, such as $20,000 for 10
reporting periods. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">This example is
actually real. Company I was Intel and company M was Marvell Technology and
this transaction took place back in November 2006. Again, the only way to have detected this
fraud was to look in the footnotes when Marvell disclosed that it will pay
above market prices for Intel's products in future periods. When analyzing any
transaction, always try to understand the underlying economics and consider
which accounts are affected. It's critical for investors to understand their
debits and credits. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal">
<i><span lang="EN-US" style="font-family: "Times New Roman","serif";">Trick #3: Shifting Current
Expenses to a Later Period <o:p></o:p></span></i></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Two
examples will be illustrated for this trick. The first example is capitalizing
expenses. In order to understand the nature of this action, let's review the
fundamental accounting equation:<o:p></o:p></span></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div align="center" class="MsoNormal" style="text-align: center;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Assets = Liabilities +
Shareholder's Equity<span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 11pt; line-height: 115%;">[7]</span></span><!--[endif]--></span> (1)<o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Now we can expand
equation (1) above by expanding the Shareholder's Equity section as follows:<o:p></o:p></span></div>
<div align="center" class="MsoNormal" style="text-align: center;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div align="center" class="MsoNormal" style="text-align: center;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Assets = Liabilities + Beginning
Shareholder's Equity + Revenue - Expense (2)<span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 11pt; line-height: 115%;">[8]</span></span><!--[endif]--></span><o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">In order to decrease
expenses, the asset side must increase in order for equation (2) to remain in
balance. How can a company increase assets to reduce expenses? Let's step back
and revisit the accounting rules for a fixed asset. When a fixed asset is
purchased, is the entire amount expensed on the income statement? The answer is
obviously "no" since that action would distort the trend in net
income by having years with high net income when there are no purchases of
fixed assets and years with low net income when there are purchases of fixed
assets. Accounting rule states that a fixed assets must be capitalized (put on
the balance sheet) and the cost of the asset is allocated, by reporting costs
in the income statement, over its useful life. However, only assets that
provide economic benefits for more than one accounting period can be
capitalized. Normal operating expenses should be expensed on the income
statement. Nonetheless, managers who wish to reduce expenses will often
capitalize normal operating expenses in order to boost net income.<o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Let's use debits and
credits to explain this trick. To account for $1 million of normal operating
expenses, the following should be recorded:<o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Operating Expense <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$1,000,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Cash/Accounts Payable<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$1,000,000<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">To defer a portion of
the $1 million expense, consider what happens if the $1 million is capitalized
and recognized over 2 accounting period instead of 1. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Fixed Asset <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$1,000,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Cash/Accounts Payable<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$1,000,000<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Depreciation Expense <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$500,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Accumulated Depreciation <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$500,000<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<br /></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">By recognizing the $1
million expense over 2 periods, net income is overstated in the 1st period by
$500,000. Because the effect reverses in the 2nd period, a company that
capitalize expenses is often forced to repeat the trick over and over again
until it goes bust. This was the case with WorldCom in 2002. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Capitalizing expenses
is a simple trick, but shrewd investors can detect this fraud by looking at the
balance sheet instead of focusing exclusively on the income statement. If any
fixed asset is growing out of control and there is no good explanation in the
footnotes, management is probably capitalizing normal operating expenses. For
those grade 12 students who understand the cash flow statement, another method
to detect this fraud is look at free cash flow, which is defined as cash flow
from operations minus purchases of fixed assets, a line located in the cash
flow from investing section. If free cash flow declines rapidly, it is a red
flag. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Another method to
defer expense is to recognize them more slowly. Recall that
depreciation/amortization expense should be recognized by an amount equaling to [(cost-salvage)/useful life]</span><span lang="EN-US" style="font-family: "Times New Roman","serif";"> if the straight line method is used. The
useful life number is often an estimate and accounting rules allow management
to use its best estimate as a proxy. Therefore, management can record a lower
expense by simply assuming a longer useful life of its asset. The only way to
detect this fraud is to compare the useful life (estimated by cost/annual depreciation expense</span><span lang="EN-US" style="font-family: "Times New Roman","serif";">) one company compared to the
industry average. If the assumed useful life of a particular asset is
significantly higher than the industry average, the company is probably making
an aggressive assumption regarding the useful life of its assets.<o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<i><span lang="EN-US" style="font-family: "Times New Roman","serif";">Trick #4: Hiding Expenses <o:p></o:p></span></i></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Similar to how a
magician makes a rabbit disappear, corporate management often employ tricks to
make expenses disappear. The most simple trick to hide expenses is simply
failing to record accrued expenses. Let's apply what you learned in Ms.
Hopwood-Jones class on accrued expenses in the following example: company X
repaired a machine for company Y and bills company Y for $100. If company Y
does not pay in the current accounting period, an accrued expenses must be
recorded in Y's books. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Maintenance Expense <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$100<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Accounts Payable <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$100<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">However, to avoid the
recognition of an expense, company Y simply ignores this adjusting entry, which
would boost income (by reducing expenses) for the current accounting period.
Although outside investors cannot detect this fraud without looking at the
internal books, the expense recognition footnote may provide clues about aggressive
accounting for expenses. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Another method to hide
expenses is making aggressive assumption on "soft expenses" like
warranty expenses. Soft expenses often require the significant use of
management's judgement in determining the amount booked in the financials.
Let's illustrate with an example of warranty expense. Under GAAP, the company must record a warranty expense for
each accounting period using past experience as a proxy, similar to the
accounting for bad debt. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">To
illustrate with an example of warranty accounting. Let's see the following
entries: <o:p></o:p></span></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Warranty Expense <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$1,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Warranty Liability <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$1,000<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal">
<br /></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Warranty Liability <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$900<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Cash <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$900<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">The first entry
records the $1,000 expense incurred while the second entry books the $900
actual claim during the period. The figures should be similar for the two
entries. Nevertheless, a company wishing to reduce current expenses may book a
lower warranty expense, such as booking only $500 in the prior example instead
of the $1,000 justified using past experience. The easiest method to hide
expenses is to assume a lower expense figure for these "soft
expenses" like warranty expense or bad debt expense. <o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<i><span lang="EN-US" style="font-family: "Times New Roman","serif";">Trick #5: Shifting Future
Expenses to an Earlier Period <o:p></o:p></span></i></div>
<div class="MsoNormal">
<i><span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></i></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">This trick is to incur
the pain today while lowering expenses in future periods. Table 5 shows a
two-step process for expense recognition for balance sheet items. By accelerating
the expense recognition process, a company can recognize future expenses
upfront and incur zero expense in the future. Let's illustrate with an example
of an inventory write-down.<o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Table
5: Cost Recognition under a two-step progress<o:p></o:p></span></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="border-bottom: solid windowtext 1.0pt; border: none; mso-border-bottom-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Step
1: Asset <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border: none; mso-border-bottom-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Step
2: Expense<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border: none; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Prepaid
Insurance <o:p></o:p></span></div>
</td>
<td style="border: none; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Insurance
Expense<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Inventory
<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">COGS <o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Property,
Plant & Equipment <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 239.4pt;" valign="top" width="319"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Depreciation/Amortization
Expense <o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Under GAAP,
inventories on the balance sheet are accounted for using the LCM (lower of cost
or market) approach. If the market value (market price less estimated costs
incurred to sell) is lower than the book value on the balance sheet, the
difference must be written down as an expense (often through COGS) on the
income statement. However, the market value used in the write-down is estimated
by management and they could use an unrealistically low
number so the expense recognized is higher than it should be. By writing down
inventories close to zero, similar to how Cisco wrote down $2.25 billion in
2001, companies can report very low COGS numbers in the future and inflate
their profit margins significantly. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Another creative
method to overload current expenses is to book a large "restructuring
expense." This is a common trick used by companies during difficult times.
By booking a large restructuring expense today, companies can release the
excessive amount into net income through a reduction of operating expenses. Again,
let's demonstrate with the use of debits and credits. Assuming company R
decides to fire 100 workers and need to pay $10,000 to each worker as a
severance expense, which will paid in a future period. The proper method to
account for the transaction is shown below. <o:p></o:p></span></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">(1)
Current period to recognize the expense:<o:p></o:p></span></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Restructuring Expense (Wages)<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$1,000,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Wage Payable <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$1,000,000<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">(2)
When Severance is paid at a later period:<o:p></o:p></span></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Wage Payable <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$1,000,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Cash<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$1,000,000<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">However,
because the $10,000 per worker is a "soft expense" estimated by
management, there is a strong incentive to overestimate, such as using $20,000
per worker. <o:p></o:p></span></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">(1)
Current period to recognize the expense:<o:p></o:p></span></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Restructuring Expense (Wages)<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$2,000,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Wage Payable <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$2,000,000<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">(2)
When Severance is paid at a later period and only $1,000,000 is paid:<o:p></o:p></span></div>
<table border="0" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-insideh: none; mso-border-insidev: none; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Wage Payable <o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$2,000,000<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Cash<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$1,000,000<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 210.95pt;" valign="top" width="281"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";"> Wage Expense<o:p></o:p></span></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 106.3pt;" valign="top" width="142"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
</td>
<td style="padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">$1,000,000<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">By
booking an extra $1,000,000 of restructuring expense in the current period, the
company can reduce wage expense by $1,000,000 in a future period when the
restructuring liability is extinguished. This is a creative method but fails to
conform to the basic matching rule under GAAP. <o:p></o:p></span></div>
<div class="MsoNormal">
<b><span lang="EN-US" style="font-family: "Times New Roman","serif";"><br /></span></b></div>
<div class="MsoNormal">
<b><span lang="EN-US" style="font-family: "Times New Roman","serif";">Conclusion:<o:p></o:p></span></b></div>
<div class="MsoNormal" style="text-align: justify; text-justify: inter-ideograph;">
<span lang="EN-US" style="font-family: "Times New Roman","serif";">Despite real world
accounting is more complicated than what you learned in Ms. Hopwood-Jones's
class, I believe everyone has the necessary tools to detect accounting frauds.
As stated many times in this article, the key is to read the footnotes
carefully so that you can detect aggressive accounting assumptions, whether it
is related to revenue, expenses or one-time items. <o:p></o:p></span></div>
<br />
<div>
<!--[if !supportFootnotes]--><br clear="all" />
<hr align="left" size="1" width="33%" />
<!--[endif]-->
<br />
<div id="ftn1">
<div class="MsoFootnoteText">
<span class="MsoFootnoteReference"><span lang="EN-US" style="font-family: "Times New Roman","serif";"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 10pt; line-height: 115%;">[1]</span></span><!--[endif]--></span></span><span lang="EN-US" style="font-family: "Times New Roman","serif";"> The word "earnings" is often used in place of "net
income" when discussion financials of public traded companies (ones that
trade on a public exchange such as the TSX or NYSE).<o:p></o:p></span></div>
</div>
<div id="ftn2">
<div class="MsoFootnoteText">
<span class="MsoFootnoteReference"><span lang="EN-US" style="font-family: "Times New Roman","serif";"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 10pt; line-height: 115%;">[2]</span></span><!--[endif]--></span></span><span lang="EN-US" style="font-family: "Times New Roman","serif";"> When an accounting
textbook uses the word "GAAP", it is referring to the old Canadian
GAAP rules. IFRS, the international standard, replaced Canadian GAAP in 2011.
Nonetheless, IFRS is quite different and US GAAP is closer to the old Canadian
GAAP.<o:p></o:p></span></div>
</div>
<div id="ftn3">
<div class="MsoFootnoteText">
<span class="MsoFootnoteReference"><span lang="EN-US" style="font-family: "Times New Roman","serif";"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 10pt; line-height: 115%;">[3]</span></span><!--[endif]--></span></span><span lang="EN-US" style="font-family: "Times New Roman","serif";"> Recall that a
gain/loss is recorded from the sale of a fixed asset when the sale price is higher/lower
than the net book value (historical cost - accumulated depreciation) <o:p></o:p></span></div>
</div>
<div id="ftn4">
<div class="MsoFootnoteText">
<span class="MsoFootnoteReference"><span lang="EN-US" style="font-family: "Times New Roman","serif";"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 10pt; line-height: 115%;">[4]</span></span><!--[endif]--></span></span><span lang="EN-US" style="font-family: "Times New Roman","serif";"> When you read
financial statements of public companies, the income statement is commonly
called the "statement of operations" or "statement of
earnings." <o:p></o:p></span></div>
</div>
<div id="ftn5">
<div class="MsoFootnoteText">
<span class="MsoFootnoteReference"><span lang="EN-US" style="font-family: "Times New Roman","serif";"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 10pt; line-height: 115%;">[5]</span></span><!--[endif]--></span></span><span lang="EN-US" style="font-family: "Times New Roman","serif";"> Stocks valuation can
be explained by the P/E ratio which is market price of stock divided by its
earnings. Usually investors would use operating earnings (income) as the
denominator as those earnings are continuous in nature. Therefore, IBM's action
of moving a gain from sale of an asset above the operating income line inflates
operating income and increase the "E" in the P/E ratio, result in a
higher stock price. <o:p></o:p></span></div>
</div>
<div id="ftn6">
<div class="MsoFootnoteText">
<span class="MsoFootnoteReference"><span lang="EN-US" style="font-family: "Times New Roman","serif";"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 10pt; line-height: 115%;">[6]</span></span><!--[endif]--></span></span><span lang="EN-US" style="font-family: "Times New Roman","serif";"> The net book value is
credited for the sake of simplicity. In reality, the asset account (historical
cost) is credited while the accumulated depreciation is debited. <o:p></o:p></span></div>
</div>
<div id="ftn7">
<div class="MsoFootnoteText">
<span class="MsoFootnoteReference"><span lang="EN-US" style="font-family: "Times New Roman","serif";"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 10pt; line-height: 115%;">[7]</span></span><!--[endif]--></span></span><span lang="EN-US" style="font-family: "Times New Roman","serif";"> "Shareholder Equity" is the equivalent of "Owner's
Equity" and it is used for the equity account of a public traded company<o:p></o:p></span></div>
</div>
<div id="ftn8">
<div class="MsoFootnoteText">
<span class="MsoFootnoteReference"><span lang="EN-US" style="font-family: "Times New Roman","serif";"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 10pt; line-height: 115%;">[8]</span></span><!--[endif]--></span></span><span lang="EN-US" style="font-family: "Times New Roman","serif";"> Assuming no dividends
(Owner's withdrawals) or share issuance (Owner's deposit) <o:p></o:p></span></div>
</div>
<div id="ftn9">
<div class="MsoFootnoteText">
<span class="MsoFootnoteReference"><span lang="EN-US" style="font-family: "Times New Roman","serif";"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="EN-US" style="font-size: 10pt; line-height: 115%;">[9]</span></span><!--[endif]--></span></span><span lang="EN-US" style="font-family: "Times New Roman","serif";"> Salvage value is
ignored because it usually a negligible amount</span><span style="font-family: "Times New Roman","serif"; mso-ansi-language: EN-CA;"><o:p></o:p></span></div>
</div>
</div>
Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com15tag:blogger.com,1999:blog-5042705291735134971.post-49250707585220945262014-04-07T18:56:00.001-07:002014-04-09T07:44:19.431-07:00What is Value? <div style="text-align: justify;">
When the <a href="http://www.theglobeandmail.com/globe-investor/investment-ideas/young-investor-takes-his-stock-picking-seriously/article16497870/">Globe & Mail</a> inquired about my investing style, I had to choose the word "Value". I believe a value based approach is the only sound investment approach that can achieve sound results. Although not everyone wants to be value investors, I believe every investors can benefit by learning value based investment principles. </div>
<br />
<b>Value Is All About Pricing and Not Timing </b><br />
<div style="text-align: justify;">
In <i>Security Analysis</i>, Ben Graham described two different methods for predicting future security values. One is timing and the other is pricing. In essence, timing involves predicting future stock prices based on past information. Timing is dangerous because investors often extrapolate past trends into the future without ever questioning if the past trend can continue. The better approach is pricing, which involves the estimation of intrinsic value. The pricing approach is more dynamic and it captures the value of the underlying business through the estimation of future earnings power and cash flow</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
One example of timing is using past returns to predict future returns. Momentum investing, the act of buying past winners, has become very popular lately but there are numerous dangers with this approach. Investors often see the following warning on fund prospectuses: "past returns or performance is not an indication of future returns". Yet even with this warning, many investors still rush to buy momentum stocks because they believe past performance will continue. However, as Herb Stein famously observed, "if something cannot go on forever. It will stop". A $1 billion company can grow into a $10 billion company, but it may be extremely difficult to grow the same $10 billion company into a $100 billion company. Mathematically, it becomes harder and harder to grow a company at the same percentage rate because the base (in dollars) becomes larger.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
The timing approach also includes market timing, the act of trying to guess future prices based on past price patterns or intuition. Again, past price patterns are not reliable indicators of the future and guessing prices based on intuition is really unintelligent speculation. There is no guarantee that prices will move in the direction predicted and those who practice this approach will often lose money on average. Market timers may have great gains once in a while but they will also have great losses. The act of making continuous "bets" on the stock market is not a sound approach of building long term wealth. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
The pricing approach is attractive because it analyzes the underlying value of the company and avoids unnecessary speculation on the future price by ignoring the stock price. Instead, investors who practice pricing are more interested in the performance of the business rather than the performance of the stock price. Unlike the timing approach, the pricing approach is sound. Practitioners under the pricing approach avoid the extreme emotions of the stock market and can be confident that value can converge near their intrinsic value estimate if they have conducted a thorough analysis. <br />
<br />
To answer the question in the title, value is all about buying dollars for fifty cents. I will provide three sources of value in the sections below which will help readers find dollars that are selling for fifty cents because the crowd neglected to analyze the sources of value. </div>
<br />
<br />
<b>Value in a Cigar-butt (Method 1): </b><br />
<div style="text-align: justify;">
This was the main approach advocated in Graham's <i>Security Analysis</i> and <i>The Intelligent Investor</i>, which was referred to as the purchase of bargain issues. Buffett later named this method as the cigar-butt approach.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Under Graham's original approach, a bargain issue was a company selling below 2/3 of net-net value where net-net value is defined as working capital minus outstanding debt. Readers should note that by buying companies at 2/3 net-net value, the investor has at least a 50% margin of safety if the stock returns back to net-net value. Net-net value is extremely conservative because it only considers the liquid assets of the company while ignoring the value of all fixed assets.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Not many companies sell below net-net value presently but many obscured small-cap may fall below net-net value from time to time. These net-net stocks were very profitable because the valuations were so cheap that a small positive development can push the stock up 50% or even 100%. A diversification policy should be followed if readers want to practice buying cigar-butt companies. Many of these companies are often cheap for a reason but a broad basket of these net-net stocks yields sound results over time. Walter Schloss, who worked at Graham's firm in the 1950s, practiced cigar-butt investing for nearly five <a href="http://www.mrmarketblog.com/walter-schloss-returns/">decades</a>. He managed to earn a 15.7% compounded return (after-fees) vs. S&P500's 11.2% over 45 years. He holds about 100 stocks but they were all cheap cigar-butt stocks.</div>
<br />
<div style="text-align: justify;">
Although not many companies sell below net-net value, investors can consider buying companies selling significantly below the reproduction cost of the net assets on the balance sheet. That value can be calculated by adjusting the book value to reflect the actual cost of reproducing the various assets or liabilities. If investors can buy at 2/3 of the reproduction costs, it can be considered as a modern day cigar-butt but the classic definition offers a better margin of safety.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Value from this method is derived mainly from the assets owned by the company and the focus is solely on the balance sheet. If investors acquire cigar-butt stocks at low prices, the reversion to the correct asset value can yield handsome rewards for investors. Even though asset values can deteriorate, a low price paid and adequate diversification can often compensate for that risk. </div>
<br />
<div style="text-align: justify;">
<span style="font-weight: bold;"><br /></span></div>
<b>Value in Economic Moat and Talented Management (Method 2): </b><br />
<div style="text-align: justify;">
This approach is practiced by Buffett. After Buffett met his business partner Charlie Munger in the early 1960s, he realized that there are value in intangibles like competitive advantages and talented management. Before meeting Munger, Buffett was only buying cigar-butt stocks as described in the prior section. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Buffett's classic example of using this approach was the purchase of See's Candies in the 1970s. Berkshire bought See's at 5 times tangible book value, which would have been crazy under classic Graham rules. However, Graham's rules ignored intangibles such as the large economic moat enjoyed by See's. Economic moat was the term Buffett created to describe the competitive advantages possessed by the underlying business. </div>
<div style="text-align: justify;">
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The company was well known in California and has a well established customer base. Another feature that Buffett noticed was that See's had the ability to raise prices to combat inflation without losing customers. With a high return on capital and low sustaining capital required to run the business, See's can generate a valuable and growing cash flow stream for Buffett, which he can reinvest in other businesses or stocks for Berkshire Hathaway. </div>
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Management was also quite talented at See's. They ran the operations extremely well and had good capital allocation skills, a trait highly valued by Buffett. Most corporate CEOs often have poor capital allocation skills, which can destroy shareholder value because they squander a large amount of capital on exorbitant acquisitions or low return projects. Both initiatives can increase reported earnings but not underlying value. See's management ran the operations with minimum reinvestment and were modest in their spending plans. </div>
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Although See's was a private transaction, investors can apply the same principles in stock market investing because stocks are businesses. In fact, investors can buy a company similar to See's at a much lower price since, in theory, Buffett's price included a sizable control premium. Therefore, look for companies with strong competitive advantages such as the ability to raise prices. High return on capital and low capital reinvestment are two key characteristics of these attractive businesses. Furthermore, a strong management with good capital allocation skills can add considerable value.<br />
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Value from this method is derived mainly from the company's ability to generate consistent incremental earnings (high earnings power) and cash flow because of its competitive advantage and talented management team.</div>
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<b>Value in Profitable Growth (Method 3): </b><br />
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The right approach to growth investing is profitable growth. Under this approach, investors should purchase, at a reasonable price, firms that are expected to grow earnings faster than average and are expected to maintain or grow its return on capital. </div>
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Profitable growth is not the same as absolute growth. Absolute growth may refer to large percentage increase in revenues or earnings over a short period of time. As a result, investors often assign generous earnings multiples on these absolute growth firms with P/E ratios north of 25. The high multiples assigned to many growth stocks are not justified because the high valuations already reflect their high growth potential. Furthermore, absolute growth can be an illusion if growth is not accompanied by increased profitability. Many investors measure profitability by earnings growth rates but ratios such as return on capital (EBIT/Total Capital) are better at assessing profitability. Earnings can grow but return on capital will decrease if management decides to conduct lower return projects in order to meet absolute earnings targets. Although earnings can grow in this manner, the incremental earnings are value destructive if return on capital drops, especially if return on capital drops below the cost of capital. Therefore, profitable growth companies increase earnings and return on capital at the same time, which result in efficient capital allocation and higher value. </div>
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In order to assess the attractiveness of the current valuation vs. future growth potential, investors need to spend time analyzing the business and project future earnings streams under conservative assumptions. For example, growth rates should gradually diminish as the size of the firm becomes larger. Graham suggested projecting earnings 5-7 years out and apply a conservative earnings multiple less than 20 times the average projected earnings. Investors should favour growth but be wary of the price paid for growth. </div>
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If investors find an attractive growth opportunity, ask three simple questions: (1) Does the current price reflect the growth expectations already? (2) Is the company selling below 20 times the average projected earnings? (3) Can the company grow earnings while growing or at least maintaining its return on capital? Because high growth firms tend to sell above market multiples, investors often overpay for them. Nevertheless, these profitable growth firms can offer stellar returns if they are bought at rational prices. Ten baggers, firms that increase in value by 10 times, are often profitable growth firms. </div>
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Value from this method is derived mainly from the company's ability to maintain profitable growth over a long time period. This value can be negative if investors pay a high price for profitable growth. <br />
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<b>Growth vs. Value Investing?</b></div>
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Because I discussed growth investing in the prior section, I want to give my opinion on whether value is better than growth. In my mind, there is no distinction between value and growth. In fact, growth is a component of value. Ben Graham may be known as a value investor who loves to purchase net-net stocks (stocks that trade below tangible working capital), but he also championed a growth stock approach. For those who have read the original 1949 version of <i>The Intelligent Investor</i>, he stated that a growth stocks add value for an intelligent investor's portfolio only if bought after a thorough analysis of its prospects </div>
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In my opinion, the definition of growth and value used by finance professionals is wrong and misleading. A low P/E ratio, low P/B ratio, and high dividend yield are not strict yardsticks for value as commonly defined in financial literature. A stock can be a value stock despite having a high P/E ratio, high P/B ratio and low dividend yield. When Buffett bought Coca-cola in 1988, the stock's P/E ratio was in the high teens and P/B ratio was well over 5. The stock was nonetheless a value stock in Buffett's view because its future earnings power justified a high intrinsic value. On the other hand, a stock with low P/E, low P/B and high dividend yield may not be a value stock because its future earnings power is in a structural decline. A low P/E ratio may be misleading because the "E" in that ratio can decline rapidly in the future. Similarly, a low P/B ratio may be misleading because the "B" in that ratio is too high. Future operating losses can lower the "B" and the low P/B ratio will vanish. </div>
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By the same token, a growth stock is often defined as one that has increased earnings or sales at a high rate in the past few years. Investors often make the mistake that past growth is an indication of future growth. Also, investors are misled by absolute growth numbers. Growth can be value destructive if the incremental earnings is created by reinvesting more capital at a lower rate of return.</div>
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In short, if I was asked whether I prefer value or growth, I would answer value. However, I don't think there is a difference between value and growth. Growth is a component of value and can be extremely valuable if investors can identify profitable growth at reasonable prices (as discussed in section above). Even though I detest the standard definition of value investing, investors who buy stocks with low P/E, low P/B and high dividend yields should experience better investment results than those who buy high P/E, high P/B and low dividend yield stocks. </div>
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<b>The Bottom Line: </b><br />
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In the 1949 original edition of <i>The Intelligent Investor</i>, Graham famously stated that "it remains true that sound investing principles usually produce sound results." Investors should look for stocks that have the three sources of value as described in this article. Method 1 and 2 offer more safety than method 3 because method 3 requires the estimation of future earnings growth, which can be tricky for fast growing firms. </div>
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Intelligent investing is all about pricing and not about timing. Investors who want to practice timing should warned that they are speculating, which can be profitable but also risky at the same time. Intelligent investors who buy a portion of a business at a rational price should expect good results on average and minimal loss of capital. By investigating the underlying business through pricing, investors can unlock hidden values that are often overlooked by short term oriented investors.<br />
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By finding those sources of value, an investor can buy a dollar for fifty cents! </div>
Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com1tag:blogger.com,1999:blog-5042705291735134971.post-54666604481866859202014-03-10T21:07:00.002-07:002014-06-20T10:27:34.446-07:00My Thoughts on Investing<div style="text-align: justify;">
Buffett released his <a href="http://www.berkshirehathaway.com/letters/2013ltr.pdf">2013</a> annual letter to shareholders just over a week ago and it contained a very interesting section on investing. After reading it, I would like to share my own thoughts on investing, which is provided in the following sections. Everything written here reflects my current investment philosophy and I want to thank famous investors such as Ben Graham, Warren Buffett, Phil Fisher, Peter Lynch, Howard Marks, Marty Whitman, and Seth Klarman for sharing their insights on investing. They shaped my thinking and provided sound guidance that all investors should follow.</div>
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<b>Stock Investments Are Business Investments: </b><br />
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"Investment is most intelligent when it is most businesslike" </blockquote>
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<i>Ben Graham</i> </blockquote>
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This is the same quote Buffett highlighted in his 2013 annual letter. Investors often do not think like business owners and fail to realize that the underlying security is a claim against a company. Stocks are the residual claims of underlying businesses (the value left after liabilities, such as debt, are subtracted from assets), but investors often view them as alphabetical ticker symbols whose price moves around from 9:30 am-4:00 pm. If investors take the ticker symbols' point of view, they would be more interested in historical price movements or price volatility in order to make investment decisions. On the contrary, those who view stocks as actual businesses would be more interested in the underlying fundamentals such as future earnings/cash flows, the competitiveness of the industry the business operates in and the quality of management. Given there is constant chatter on the direction of "the market", it's difficult for today's investors to think like business owners. It's easy, or even unintentionally, to view stocks as ticker symbols in a fast moving market. However, I will illustrate with an example that shows it would be foolish to do so. </div>
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Since Buffett used real estate examples, I will too. Imagine you are purchasing a home, what factors would you consider to evaluate your purchase decision? Some factors may include the location of the home, the number of bedrooms/washrooms, the square footage of the house, the furnishings and the proximity to public transit or schools. If your real estate broker told you that those factors are useless and you should only consider historical prices or price volatility, you would think he/she is from <a href="http://en.wikipedia.org/wiki/La_La_Land">la-la land</a>. It's plain silly to buy a home because the price is in "an uptrend". What's even sillier is if the real estate broker tells homeowners that they should buy homes that exhibit less price volatility, which is the definition of a safer investment under Modern Portfolio Theory. Why waste time analyzing past home prices or price volatility when it is better to focus on the fundamentals such as location and the quality of the individual houses. If you buy a home in an excellent location and growing neighborhood, it's a no-brainer that the price would rise over time. While some home buyers might consider price trends or price volatility (especially during the height of housing bubbles like 2006 in US), the majority of home buyers only consider the underlying fundamentals when considering a prospective home purchase, without any thoughts on future prices or future price volatility. Hence, stock investors should act more like owners when considering prospective purchases similar to how they evaluate their home purchases. </div>
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When evaluating stocks, thinking like an owner means evaluating the future productivity of the assets owned by the business. It's important to predict future earnings and cash flows instead of future stock price movements. Similarly, it's important to evaluate the competitiveness of the industry the business operate in instead of the current stock market condition. And finally, it's important to evaluate the integrity of the managers running the company instead of the speed your broker can provide in order to trade the company's stock. True owners would only consider the former statements while ignoring the latter ones. In theory, it is easy to see why evaluating fundamentals is important but it's more difficult to put into practice especially when investors are emphasizing short term performance. To quote Yogi Berra, "In theory, there is no difference between theory and practice. But in practice there is." </div>
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<b>How to View Market Prices (Correctly): </b><br />
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In Buffett's opinion, there should only be 2 courses on equity investments: (1) How to value a business and (2) How to view market prices. I already discussed (1) in my <a href="http://kennyyang91.blogspot.ca/2013/07/intelligent-investing-for-average.html">prior</a> article so I will focus solely on (2) in this section. </div>
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Before I begin the discussion, let's focus on a few every-day examples. If you drive everyday and do not own a gas station, do you hope for higher or lower gasoline prices? Given the answer should be obvious, let's consider another example: if you are regular grocery shopper, do you hope for higher or lower produce prices? For both questions, the rational and obvious answer is lower prices. Now comes the final exam: If you are a saver who is not close to retirement (by at least 10 years), do you hope for higher or lower stock market. As Buffett pointed this out in his 1997 annual letter, most investors fail to answer correctly although there is no difference between this question and the preceding questions. Some may point out that savers should hope for higher markets because they will have more money to spend during retirement. However, I explicitly stated that the savers are not even close to retirement. Savers, who still have a stable income stream and wish to invest for the future, should hope for a bear market (lower market prices) so more stocks could be purchased on a bargain basis. If everyone rushes into retailer stores when there is a 50% sale, it is very confusing to see why the same group of individuals would rush out of the stock market when there is a 50% sale (2002 or 2009 sounds familiar?). There is no difference between shopping in the mall and shopping in the stock market. Doubling down is not a bad strategy. In fact, Fairfax Financial, ran by value investor Prem Watsa, uses the strategy of doubling down when buying and doubling up when selling (buying more when prices fall and selling more when prices rise). As Ben Graham reminds investors, "buy stocks the way you buy grocery, not the way you buy perfume" or in my own translation, "buy stocks the way you buy your own personal items, not the way you buy gifts for your significant other." </div>
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I have provided an excerpt from my prior article on Mr. Market, an allegory Ben Graham created to describe price movements in the stock market.<br />
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<span style="font-family: inherit; line-height: 18.399999618530273px;">Mr. Market is an allegory of the stock market made up by Ben Graham, the mentor of Buffett. Mr. Market is a fellow who comes to you daily to quote prices of many businesses and he is happy to buy your interest in those businesses or sell his interest at the price he quoted. Mr. Market is very emotional. He sometimes quotes a ridiculously high price because he only sees the positive sides of those businesses. He sometimes also quotes a ridiculously low price because he thinks the business is worthless.</span></blockquote>
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<span style="font-family: inherit; line-height: 18.399999618530273px;">Warren Buffett reminds investors of two important facts about Mr. Market investors need to know and remember at all times:<o:p></o:p></span></div>
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<span style="font-family: inherit; line-height: 18.399999618530273px;">1) You don't have to transact with him every day. Only do so if you can take advantage of his quotes. If he quotes a low price, you buy from him. If he quotes a high price, you sell to him. Most of time, it is simply better just to IGNORE him.<o:p></o:p></span></div>
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<span style="font-family: inherit; line-height: 18.399999618530273px;">2) It is Mr.Market's pocketbook (pocketbook describes the book traders used to keep track of their stock inventory back in Graham's days), not his opinions that should interest you. Many investors think Mr. Market is correct on the valuation of businesses and follow his opinions.</span></div>
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Let's revisit the real estate example again. If you bought a house and your neighbor offers an exorbitant price to purchase your house, what would you do? Sell your house to him of course! It would be silly to suddenly become more enthusiastic about the value of your house and reject his offer. However, in the stock market, investors do the exact opposite. When Mr. Market offers a ridiculous valuation, they would suddenly believe their stocks are worth more and hold them tenaciously despite clear signs of overvaluation. The opposite is true in bear markets when investors join Mr. Market's pessimism and dump every stock holding. If you won't sell your house to a lunatic neighbor who quotes a ridiculously low price, you should not sell all your stock to Mr. Market when the stocks are clearly undervalued in a bear market. Once again, thinking like a true owner will avoid the mistake of selling undervalued companies and holding overvalued ones (note I used the word "company", not "stock"). </div>
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<b>Second-Level Thinking: </b><br />
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This is a concept espoused by Howard Marks. In his book, <i>The Most Important Thing</i>, Marks described second-level thinking as deep, complex and convoluted while first level thinking as simplistic and superficial. For investors who want to achieve above average returns, their thinking should be deep and avoid common pitfalls. That deep thinking is called second-level thinking. Successful investors should be able to think at a higher level and consider all possibilities. First-level thinker, the majority of market participants, only focus on the obvious facts and fail to draw thorough conclusions. A common first level thinking is buy companies with a growing business or high earnings/sales growth. Without even considering the valuation or the competitiveness of the business, investors may lose a lot of money because of their flawed thinking. Nifty-fifty investors learned that lesson in the 1970s when they lost 90% of their money by buying stocks of the best 50 corporations. Many market participants still avoid in-depth thinking when making investment decisions. To quote Bertrand Russell, "most men rather die than think. Many do. "</div>
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Difference between first-level and second-level thinking: </div>
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<li style="text-align: justify;">A first-level thinker would say "the company is a great company and has a great brand; hence let's buy the stock" (Too much focus on quality). A second-level thinker would say "the company does have a good brand but it's already reflected in the share price. With its shares trading at 50 times earnings, the stock is priced for perfection. Time to sell." </li>
<li style="text-align: justify;">A first-level thinker would say "the company is trading only at 8 times earnings and has a high dividend yield of 10%. Time to buy" (Too much focus on yield and low PE ratio). A second-level thinker would say "although the company trades at 8 times earnings, it's not a value buy because it faces double digit revenue decline and higher expenses over the next few years. When those two factors are considered, the stock is actually trading at 25 times earnings. With its dividend payout ratio at 90%, any large earnings decline would impair the dividend. There is no margin of safety with this investment. Sell." </li>
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<b>Accounting Shenanigans: </b><br />
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There is an old accounting joking regarding the value of two plus two. According to the joke, the accountant's answer is "what number did you have in mind." This joke illustrates how accounting rules allow significant use of estimates. I will list two problems that investors should be aware of.</div>
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(1) Non-GAAP Measures:<br />
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I wrote an <a href="http://kennyyang91.blogspot.ca/2013/07/financial-reporting-and-use-of-non-gaap.html">article</a> on the problems of Non-GAAP measures but I would like to illustrates a couple of main points (readers are strongly encouraged to read my prior article). First of all, non-GAAP measures are not evil but management is starting to manipulate these measures to paint a better picture. One of the main problems is the extensive use of non-GAAP measures in earnings reports. The problem is most acute when the non-GAAP measures is spelled exactly the same as a GAAP measure. For example Operating Earnings and Cash Flow From Operations are items on GAAP financial statements. However, I have seen many companies using non-GAAP yardsticks that are exactly spelled the same as the GAAP equivalents. They only warn the reader in a tiny line on the bottom of the page that these measures are non-GAAP measures and do not conform to GAAP rules. The non-GAAP copies often ignore a few bad stuff. i.e. non-GAAP Operating Earnings may ignore a loss on a small segment and non-GAAP Cash Flow From Operations may ignore certain negative working capital changes. I'm not arguing to eliminate these non-GAAP measures but the way they are spelled deceive investors especially the amateur ones. Therefore, be on the lookout for non-GAAP copies of GAAP measures. Investors should understand how these non-GAAP measures are calculated. Companies are required to show the adjustments in their 10-Qs and 10-Ks. </div>
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If the non-GAAP measure paints a rosier picture of the company's finances, watch out! As social media and internet stocks keep on soaring, many analysts needed new measures to justify the high valuations. The managers and investor relations officials of those company are more than happy to help with this endeavor. One non-GAAP measure invented for this purpose is net earnings excluding stock based compensation. The rationale is these expenses are non-cash expenses and do not create a financial burden because the company simply issues the shares to pay its employees. Investors who buy this logic need an accounting 101 lesson on what is the definition of an <a href="http://www.investopedia.com/terms/e/expense.asp">expense</a>. Stock based compensation is a real expense because it is an economic cost incurred through the business operation. By assuming stock based compensation isn't an expense, investors are basically assuming the employees are working for free since the majority of the compensation in these social media companies are in the form of stock, not cash. </div>
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If [stock based compensation] aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And, if expenses shouldn't go into the calculation of earnings, where in the world should they go? <i>Warren Buffett</i></blockquote>
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Finally, because these non-GAAP measures are not regulated, companies are free to change the definition of the metric. A common trick used in the past is to change the definition so the non-GAAP measures appear healthier, i.e. changing the same-store-sales definition from measuring sales at stores that opened for at least 13 weeks to 11 weeks. Another example is to change the definition of "subscriber" to show a faster subscriber growth. To avoid scrutiny, companies will make the change when they file their 10-Qs, which is often a few days after they unofficially announce their quarterly results. Given managers know not many investors actually read 10-Qs, these non-GAAP measure changes almost go unnoticed. Therefore, I highly suggest investors to actually read 10-Qs although the information contained in it should be similar to the earnings press statement released a few days earlier. However, if you notice a definition change in one of the non-GAAP measures, re-evaluate your investment thesis immediately. A company with repeated disclosure problems is a sell candidate. </div>
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(2) One Time Items:<br />
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One time items are notorious for their manipulative uses. Unlike revenue and expense recognition, management have more leeway regarding the classification of one time items. By re-arranging lines on the income statement, management can receive a different reaction from investors because they often look above the line, which is an industry lingo for lines above the EBIT or operating earnings line. Anything below the EBIT line, which includes charges for discontinued operations or extraordinary items, are ignored because investors consider those items unimportant. Hence, management will attempt to stuff a few small expenses in the extraordinary items line so the company can meet earnings expectations. Although investors should ignore a few large one time items, such as loss on sale of a division, they should not ignore one time items if they occur on a regular basis. </div>
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There are many other manipulative tricks management can employ to fool investors but I included just two main issues I believe are most prominent in today's market. Management can still play some old tricks, such as inaccurate revenue recognition or improper capitalization of operating expenses so investors should still keep their eyes open. Overall, trouble can be avoided by avoiding companies with weak reporting and management. An ounce of prevention is worth a pound of cure.<br />
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<b>On Efficient Markets: </b><br />
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Many readers might have heard this joke before: an economics professor and a student are walking down the road and both see a $100 bill on the ground. The student wants to pick it up, but the professor encourage him not to. According to the professor, if that bill was real, somebody would have picked it up by now. Unfortunately for the professor, the student got $100 dollar richer by not following the rule of the efficient markets. </div>
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As a refresher, efficient markets theory states that the market should reflect all available information. Why is the market efficient? It's partly due to the actions of market participants who constantly search for mis-pricings. The value of most assets should revert to intrinsic value immediately after major announcements - such as earnings announcements, corporate restructurings, M&A etc.- if there is a large number of market participants buying and selling the assets. However, there are limitations that may prevent price discovery. There could be limits on short selling and market liquidity. Furthermore, a lack of interest among market participants to conduct price discovery operations in certain asset classes (i.e. micro or small cap stocks, distressed debt etc.) also creates inefficiencies. These price discovery limitation will prevent the certain asset classes from being efficient. </div>
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I'm not a big fan of the efficient markets theory although I do admit that the prices of major asset classes are frequently efficient. Readers should note that I used the word "frequently" and not the word "always". From time to time, investors can discover mis-pricings even in a well-covered space such as large cap stocks. Despite over 50 sell-side analysts covering Apple, none upgraded the stock or raised their price targets when the price hit $400 last April. The stock outperformed the S&P500 by a whopping 35% in the next 8 month. Even the price of a company with a $500 billion market cap can be inefficient. Markets are not comprised of machines but of people. The efficient market theory assumed all investors are rational and analyze the facts correctly. However, investor's rational judgments are often overruled by the emotions of fear and greed. They don't incorporate all the available information in their decisions and often make mental short-cuts. As Dale Carnegie famously said, "We [humans] are not creatures of logic, we are creatures of emotion."</div>
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Therefore, I believe markets will be inefficient from time to time and will offer mouth-watering opportunities for investors. Although I detest the efficient market theory, I encourage professors and academics to keep promoting the theory. The Buffett quote below explains why.</div>
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"We are enormously indebted to those academics [who promote efficient markets theory]; what could be more advantageous in an intellectual contest - whether it be bridge, chess or stock valuation- than to have the opponents who have been taught that thinking is a waste of energy" <i>Warren Buffett </i></blockquote>
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<b>Diversification or Diworsification: </b><br />
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Should investors place all their eggs in one basket or spread the eggs among many baskets? The answer should depend on whether you have the knowledge and will to spend the time to search for investment opportunities. For most non-professional investors, I would highly recommend an extreme diversification policy. This involves buying ETFs - like the SPY, XIU, IWM etc- that hold over hundreds of stocks. Because non-professional investors do not have the knowledge or will to select undervalued stocks, spreading out the bet is a wise choice.</div>
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However, for those who have the knowledge and are willing to take the time to select undervalued securities, I believe an extreme diversification policy is foolish. If investors mirror the approach of the mutual funds, they would find themselves owning over 100 stocks. If they own over 100 stocks, how would they know what companies they actually own? Imagine a man telling his wife that he wishes to diversify his marriage by marrying more women. If he really found the woman of his dream, why would he want to diversify? The logic is simple and it should be extended to investing. If investors found a few excellent companies, they should concentrate their positions. Although it is dangerous to own only a few stocks, I would suggest owning 10-30 stocks in a portfolio. Studies have shown that the co-variance (measurement of correlation between the stocks in a portfolio) significantly decreases after the number of stocks increases from 1 to 10. The decrease from 10 stocks to 30 is very marginal and the decrease beyond the 30th stock is so small that it isn't even worth it. </div>
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<br /></div>
<div style="text-align: justify;">
Diworsification is a word made up by famous investor Peter Lynch who condemns the practice of diversification. Owning too many stocks is akin to owning an index fund except the transaction cost is much higher. (why try so hard just to be average?) A concentrated portfolio may actually decrease risk because investors would exercise more prudence when they select their stocks. Pick a stock just like how you would pick your future spouse. In the final analysis, diversification can be summarized nicely with a Buffett quote, "diversification is a protection against ignorance."</div>
<div style="text-align: justify;">
<br /></div>
<b>To Sum it Up: </b><br />
<b><br /></b>
<br />
<div style="text-align: justify;">
Investment is most intelligent when it is most business like. It's worthy to repeat that phase because investors can achieve higher returns by thinking like an owner.<br />
<br />
By thinking like an owner, investors would:<br />
<ul>
<li>Have the proper attitude towards market price fluctuations</li>
<li>Think at higher levels regarding factors that influence the underlying businesses instead of factors that influence market prices</li>
<li>Understand that markets are not always efficient and those who have a superior insight of the underlying business can achieve abnormal returns</li>
<li>Understand the importance of a concentrated portfolio and realize that diversification is really diworsification </li>
</ul>
</div>
Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com1tag:blogger.com,1999:blog-5042705291735134971.post-37250696011170811752014-01-24T18:32:00.000-08:002014-06-02T17:12:29.691-07:00For New Readers: Must Read Investing Articles For new readers, I linked 6 articles on investing I wrote a while ago that I think many should take a look.<br />
<br />
<b><u>Investing Article Series:</u></b><br />
<a href="http://kennyyang91.blogspot.ca/2013/06/investing.html">Article 1: What is Investing</a><br />
<a href="http://kennyyang91.blogspot.ca/2013/07/intelligent-investing-for-average.html">Article 2: Intelligent Investing for Average Investor</a><br />
<a href="http://kennyyang91.blogspot.ca/2013/07/accounting-frauds-lessons-for-investors.html">Article 3: Accounting Frauds</a><br />
<a href="http://kennyyang91.blogspot.ca/2013/08/understanding-investor-psychology-and.html">Article 4: Investor Psychology</a><br />
<a href="http://kennyyang91.blogspot.ca/2014/03/my-thoughts-on-investing-long-version.html">Article 5: My Thoughts on Value Investing</a> (The Must Read if the reader needs the best pick)<br />
<a href="http://kennyyang91.blogspot.ca/2014/04/what-is-value.html">Article 6: What is Value</a><br />
<br />
<b><u>Other Recommended Articles:</u></b><br />
<a href="http://kennyyang91.blogspot.ca/2014/01/new-year-special-post-investment-risks.html">Investment Risk</a><br />
<a href="http://kennyyang91.blogspot.ca/2013/11/are-share-buybacks-really-meaningful.html">Share Buybacks</a><br />
<a href="http://kennyyang91.blogspot.ca/2013/11/some-real-thoughts-on-stock-splits.html">Share Splits</a><br />
My Seeking Alpha Article on <a href="http://seekingalpha.com/article/1922861-5-important-points-for-investors-to-remember-as-2014-approaches">5 Important Points</a> (Not part of this blog but I feel it's a very good article to read for any investor)<br />
<br />
My list of book recommendation can be found <a href="http://kennyyang91.blogspot.ca/2013/08/book-recommendations-for-investing.html">here</a>.Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com6tag:blogger.com,1999:blog-5042705291735134971.post-10976032438789750002014-01-09T14:37:00.002-08:002014-06-30T17:35:12.546-07:00Investment Risks<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">There is an old adage in investing that states the
more risk one takes, the more return one should expect. Many investors
understand that there is a positive relationship between risk and return. Therefore, to achieve excellent investment
returns, one must also take on a lot of risks. It may be important to step back
and actually ask the important question:
What is risk? <o:p></o:p></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">There are many proposed definition for a very simple
question. In this article, I will explore the conventional definition of risk
and contrast that definition to what I believe is the real definition of risk
in investing. <o:p></o:p></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></u></b></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Risk
Is Not Measured By Volatility Or Beta:<o:p></o:p></span></u></b></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Any student studying finance in the classroom will
learn that risk is captured by numbers such as standard deviation or variance,
which measure an asset's volatility. The wider the price range of a security is,
the riskier the security is assumed to be. <o:p></o:p></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">I see many problems with using volatility as a risk measure</span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
</div>
<ul>
<li><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-indent: -18pt;">Volatility can only reveal how crazy the
price of a security moved, but it does not measure the probability of a loss or
the possibility of a negative outcome</span></li>
<li><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-indent: -18pt;">Volatility measures both bad and good
outcomes when only the unfavourable outcomes should be the focus. For an
investor with a long position, an extreme price move to the upside is a favorable
outcome, not a unfavourable outcome</span></li>
<li><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-indent: -18pt;">Volatility is calculated using past data
and is backward looking. Many investors use historical volatility as a measure
of risk. However, past data is a poor indicator of the future because financial
markets usually moves in cycles. Periods of low volatility is usually followed
by periods of high volatility. For example, volatility during 2005-2007 was
extremely low. However, investors were incorrect to assume low volatility would
continue in 2008. Although investors often extrapolate past data to predict the
future, they should not forget that investing is a forward looking game. An
investor who invest based on past data (like historical volatility) is similar
to a driver who drives a car by looking at the rear-view mirrors. Warren
Buffett made an excellent point that if history was the road to riches, then
the Forbes's list of Billionaires should be all</span><span style="text-indent: -18pt;"> </span><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-indent: -18pt;">librarians.</span></li>
</ul>
<br />
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Another measure for risk is beta, which is the
correlation between the security and the market. In equities, the market is
represented by the S&P500 index. A stock with a high beta is considered
more riskier than one with low beta. Similar to volatility, beta also has
serious flaws as shown below:</span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
</div>
<ul>
<li><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-indent: -18pt;">Using beta as a risk measure, a stock
with a higher beta (fallen more than the market) is considered riskier.
However, shrewd investors like Warren Buffett argue that the opposite is true.
If a stock has fallen more than the S&P500, the lower valuation of that
stock makes it less riskier, not more riskier. Beta does not take into account
valuation levels. A lower price raises the expected return of the stock if the
fundamentals of the company is not permanently impaired. </span></li>
<li><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-indent: -18pt;">Similar to volatility, beta is
calculated using historical prices and is backward looking. Investors who
bought financial stocks with low betas in 2007 believed they were buying quality
investments with low risk. The low betas completely ignored the 30:1 leverage
ratios many of those financial institutions possessed. After a 75-90% decline
many of those stocks experienced, betas for those stocks increased
significantly. Investors started selling these financial stocks regardless what
the price was because the higher betas implied high risks. How can a stock that
dropped more than 75% considered more riskier than before the large price drop?</span></li>
</ul>
<br />
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">I believe measures such as volatility and beta are commonly
used by investing professionals because many investors want an exact number to
indicate the riskiness of an investment. However, the future is inherently uncertain
and I think it's a mistake to quantify the riskiness of an investment, especially
using past performance as guidance. In
the words of Buffett, "In their [academics] hunger for a single statistic
to measure risk, however, they forget a fundamental principle: It is better to
be approximately right than preciously wrong." <o:p></o:p></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">In my opinion, volatility only measures how crazy the
price of a security moves. Beta only measures the correlation between the
security and the market index. Wider price fluctuations or higher correlations
with the market does not imply higher risk. <o:p></o:p></span></div>
<div class="MsoNormal">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></u></b></div>
<div class="MsoNormal">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Risk
Is Not Measured By What Mr.Market Says:<o:p></o:p></span></u></b></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Some investors believe that an investment is considered
more risky if unrealized losses continue to grow. On the other hand, unrealized
gains may persuade investors that the investment is less risky because it appears
the only direction the asset is heading is up. Investors should not allow
Mr.Market (an allegory Ben Graham created to describe the behaviour of the financial
markets) to decide which investments are riskier and which ones are not. Graham
reminded investors that, "You are neither right nor wrong because the
crowd disagrees with you. You are right because your data and reasoning are
right."<o:p></o:p></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">The old rule on Wall Street is for investors to
"buy low and sell high". However, majority of investors practice the
exact opposite of "buy high and sell low". Aliens from Mars may
scratch their head at how dumb we humans are. However, many investors "buy
high and sell low" because they sell the majority of their holdings when
unrealized losses are high during bear markets and buy them back again when
prices are much higher in the following bull market. Investors are convinced,
due to their large unrealized losses, that prices will only continue to decline
further until it hit the floor and hence conclude their stocks are risky because
they are heading to zero. On the other hand, the exact opposite sentiment
prevails during bull market tops: investors believe prices will climb to the
sky and conclude that stocks are less risky because they can only appreciate. By
associating risk with price advance or decline, investors are more likely to
"buy high and sell low" instead of "buy low and sell high".
Mr.Market does not tell you which investments are risky and which ones are not.
Investors need to evaluate the risks themselves. <o:p></o:p></span></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">The
Definition of "Risk" in Investing:<o:p></o:p></span></u></b></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">I believe the definition of risk should clearly
defined as: "the possibility of a permanent loss of capital". An investment
is considered risky if there is a high chance of a permanent loss of capital.
The definition of permanent loss simply implies that the investor is likely to
lose money because the underlying fundamentals are poor or negative outcomes
are more likely to occur. The definition of risk above is appealing because
it's more generic and focuses on the possibility of a permanent loss of capital,
rather than temporary loss. <o:p></o:p></span></div>
<div class="MsoNormal">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></u></b></div>
<div class="MsoNormal">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Assessing
Risks: <o:p></o:p></span></u></b></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">When assessing the risks, it is important to
consider a wide range of outcomes instead of just listing the bull case, the
bear case and the base case. Value
investor Howard Marks encourages investors to evaluate risks by considering a
distribution of outcomes and consider the likelihood of those outcomes being
realized. In my own experience, I learned that my worst case scenarios were too
optimistic and I missed important risk factors because I considered them as
improbable. Instead of evaluating risk as a discrete distribution with a few cases,
investors should evaluate risk as a
continuous distribution. The expected outcome of the distribution is just as
important as the shape of the distribution. <o:p></o:p></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">It is important to assess the risks to any potential
investment. Below I listed some points to assess risks for an equity investment
and fixed-income investment. <o:p></o:p></span></div>
<div class="MsoNormal">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Examples of assessing
risks with equity investments:</span></div>
<div class="MsoNormal">
</div>
<ul>
<li><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;">Investors should pay attention to the valuation
of the stock. High valuations, such as stocks trading at extremely high
multiples, will lower the future expected return and raise the overall risk
level of the investment. If an investor pays a very high multiple for a stock,
the expected return will be negative. At
the height of the dot.com bubble, investors were paying 100 times earnings for
many technology companies. The negative returns that followed the crash did not
surprise those who paid attention to the valuation levels and recognized the
risk of paying too much. </span></li>
<li><span style="font-family: Symbol; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;"><span style="font-family: 'Times New Roman'; font-size: 7pt; line-height: normal;"> </span></span><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;">For equity investors, the quality of management
can have a significant impact on their investments. Buying a company with a
incompetent management will significantly reduce future returns because poor
capital decisions will significantly reduce earnings and cash flows, the
determinants of future stock prices. Investor should assess the likelihood of
poor capital allocation including the possibility of spending free cash flow on
empire building or investing in low return projects instead of paying a
dividend or conducting share buybacks. Warren Buffett provided a simple advice
to lower management risks, "invest in companies that idiots could run,
because someday one will". </span></li>
<li><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;">Industry</span><b style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;"> </b><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;">risks</span><b style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;"> </b><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;">are also important
to consider for equity investors because numerous companies are constantly challenged
by newer technology. Twenty years ago, it was impossible to imagine Eastman
Kodak would be forced into bankruptcy because it was a dominate player in the
film industry. Investors were blinded by Kodak's past success and failed to
evaluate all the negative outcomes such as the disruption of digital camera by Fuji
and Canon. Again, investors were looking at the rear-view mirrors instead of
looking straight through the windshield and failed to consider all the possible
outcomes of investing Kodak. Failing to consider the industry risks carefully
can be extremely costly. Warren Buffett reflected his mistake of investing in
Berkshire Hathaway (the original textile maker) in the 1989 Berkshire Letter:
"When a management with a reputation for brilliance tackles a business
with a reputation for a bad economics, it is the reputation of the business
that remains intact"</span></li>
</ul>
<br />
<div class="MsoNormal">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Examples of assessing
risks with fixed-income investments:</span></div>
<div class="MsoNormal">
</div>
<ul>
<li><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;">Fixed-income investors should also
consider valuation levels</span><b style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;">,</b><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;"> but in
terms of yield spreads instead of price multiples. In 2007, the yield spreads
on junk bonds relative to US treasuries was only 250 basis points. The high valuation
will depress future returns and increases the overall riskiness of the
investment. As junk bond investors experienced in 2008, the 250 basis point
spread paid in 2007 was too rich and the yield spreads blew up to over 2000
basis points. The price investors pay is key to assess the overall riskiness of
investment. The opposite was true in 2009 when spreads were above 2000 basis
points on junk bonds and investors were more than compensated for the credit
risks they were taking on by buying junk bonds.</span></li>
<li><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;">Fixed-income investors should especially
pay attention to balance sheet risks</span><b style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;"> </b><span style="font-family: 'Times New Roman', serif; font-size: 12pt; line-height: 115%; text-align: justify; text-indent: -18pt;">because
they are the first in line to receive payouts if a firm liquidates. Investors
purchasing bonds issued by companies with little tangible assets has very
little margin of safety. Therefore, investors should carefully assess all the
asset values of the company under all possible economic conditions. If once in
a century event occurs, can the liquidating value of the assets cover majority
of the principal value?</span></li>
</ul>
<br />
<div class="MsoNormal">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Managing
Risks: <o:p></o:p></span></u></b></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Why is important to manage risks when investors are
not rewarded for being prudent risk managers? It may be intuitive but investors
forget that great investing records are built by avoiding large errors. That is
why Warren Buffett's fundamental tenet is "Rule 1: Don't Lose Money, Rule
#2: Don't forget about rule #1" <o:p></o:p></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Most athletes understand that in order to win a
race, they must first finish the race. The same motto of "To finish first, you must first
finish" should be followed by investors as well. If investors do not practice
prudent risk management, they may face the same situation LTCM (a hedge fund
that lost a significant amount of its capital) experienced in 1998. Investors
should always remember that if they manage to lose almost all of their capital,
there is no chance of returning to the starting point. A zero multiplied by
anything is still a zero. Charlie Munger stated that Berkshire Hathaway was
very successful because he and Buffett avoided "stupidity".
Mitigating unnecessary risks is a brilliant method of building solid returns
over the long run. <o:p></o:p></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Managing risks involves having a thorough
understanding of the risks involved in any investment and being able to take on
risks intelligently. Investors need to understand what the real risks are.
Paying too much for any investment is a big risk while higher volatility is
not. Investors should recognize the possibility of a permanently loss of
capital and take actions to avoid negative outcomes. This involves recognizing
and controlling the risks involved with their investments. <o:p></o:p></span></div>
<div class="MsoNormal">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></u></b></div>
<div class="MsoNormal">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Misconceived
Risk = Opportunity: <o:p></o:p></span></u></b></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Most successful investors understand the importance
of taking advantage of misconceived risks. Because most finance professionals
still measure risks in terms of betas and volatility, there will be profitable
opportunities during bear markets to buy assets considered risky by most
investors but the underlying investment itself is actually not risky. During bear
market declines, investors will sell a stock because the volatility or beta has
increased, implying the stock is now more riskier under modern finance theories.
However, intelligent investors understand that large price declines, which
increase volatility and beta, actually decrease risk. The lower price level
enhances future expected return and offers a larger margin of safety for
investors assuming the fundamentals of the stock are not permanently impaired. Valuations
and fundamentals are key to assessing risks involved in any investment. The
2008 bear market presented patient investors the opportunity of a life time
because the herd was judging risks in terms of volatility and price declines
rather than absolute valuations. Misconceived risks often present wonderful
opportunities. <o:p></o:p></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">The opposite is also true in bull markets. Low
volatility and large price advances creates a false sense of security among
investors. After a long period of price advance, investors will forget to check
the necessary blind spots and assume risk has been banished. This common
misconception is very prominent during the height of bull markets such as in
2000 and 2007. Intelligent investors who understood the real risks would have
sold (or even shorted) technology companies in 2000 and financial companies in
2007. <o:p></o:p></span><br />
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">In both cases, misconceived risks by the herd
creates opportunity for investors who take the time to evaluate the actual
risks and understand when risk is misunderstood. Those who did their homework
will be handsomely rewarded. <o:p></o:p></span></div>
<div class="MsoNormal">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></u></b></div>
<div class="MsoNormal">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Miscalculated
Risk = Fiasco <o:p></o:p></span></u></b></div>
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<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Mis-calculated risks can result in a disaster. The
financial crisis of 2008 provides a perfect example of how risk was
miscalculated. Fixed income investors believed risks could be banished by
slicing mortgages and other loans into tranches. Equity investors believed risk
was low because the low interest rate would support the use of leverage
indefinitely. The danger of extrapolating near term trends many years into the
future can be very dangerous. Investors should rely more on their common sense
rather than the past to evaluate risks. <o:p></o:p></span></div>
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<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span>
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">As Howard Marks puts it: "There are few things
as risky as the widespread belief that there's no risk". No four words are
more dangerous in investing than "this time is different". In the
words of George Santayana, "Those who cannot remember the past are
condemned to repeat it" <o:p></o:p></span></div>
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<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></u></b></div>
<div class="MsoNormal">
<b><u><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Conclusion:</span></u></b><b><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"> <o:p></o:p></span></b></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">Understanding risk is important for investors
because investing is a forward looking game and the future is uncertain by nature. It
is important for investors to realize that the standard risk measures are
deceiving and do not measure the actual risks to an investment. Howard Marks
nailed the definition of risk with his own statement: " risk means
uncertainty about which outcomes will occur and about the possibility of loss
when the unfavourable ones do". <o:p></o:p></span></div>
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<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
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<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">After reflecting on the mistakes of other famous
investors and my own personal mistakes, I believe evaluating the risks to any
potential investment is key to guaranteeing satisfactory results. Evaluating
risks before making any investing is important. Minimizing risk will boost
future returns, which contradicts the positive relationship between risk and
return. Taking on more risks increases expected return, not actual returns.
Expected returns is increased because taking more risks increases the possible
outcomes of the investment (both good and bad), which increases the expected or
average future returns. However, I prefer to increase future expected return by
avoiding unfavourable outcomes and maximizing favourable outcomes. <o:p></o:p></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;"><br /></span></div>
<div class="MsoNormal" style="tab-stops: 176.25pt; text-align: justify; text-justify: inter-ideograph;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; line-height: 115%;">All in all, I created my motto of "Misconceived
risk = Opportunity, Miscalculated risk = fiasco" to use in my investment
decisions. Bear markets presents excellent opportunities for value investors
who spend time to understand the "misconceived risks" by the market
and take advantage of the bargains created by these misconceived risks. On the other hand, bull markets presents
excellent opportunity for value investors to sell their holdings to market participants
who miscalculated risks involved. Minimizing risks is key to maximizing future
returns despite many investors still believe they can only maximize future by
taking on more risks. One common risk, identified by many famous value
investors, is paying too much for an asset. Therefore, to minimize the risk of
overpaying, always remember Ben Graham's words of "price is what you pay,
value is what you get". <o:p></o:p></span></div>
Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com10tag:blogger.com,1999:blog-5042705291735134971.post-9099382742317946612013-11-25T15:02:00.001-08:002014-01-24T20:36:03.543-08:00A Stock Market Bubble?<div style="text-align: justify;">
There has been a lot of talk of a stock bubble in the financial media. One of the cover story for the weekly Barron's magazine was "<a href="http://online.barrons.com/article/SB50001424053111904227604579194121510134080.html?mod=BOL_archive_twm_ls#articleTabs_article%3D0">Bubble Trouble?</a>" (subscription required to read). Also, there was another good <a href="http://online.wsj.com/news/articles/SB10001424052702304791704579210273629381340">WSJ story</a> that used Robert Shiller's favoured Cyclical Adjusted P/E (CAPE) ratio to argue stock valuations are getting frothy. The CAPE, which divides the S&P500 price by a 10-year average real earnings number, is near 25.1 compared to the 130 year average of 16. With the S&P500 rallying over 27% this year, NASDAQ over 30% and Dow Jones Industrial 22%, it definitely looks like a stock market bubble is building. However, I should caution investors not to call a top based on the YTD performance or the fact that the S&P500 is up over 170% since its low in March, 2009. </div>
<br />
<b>The Frothy Side:</b><br />
<br />
<div style="text-align: justify;">
Let's not forget the cause of the market rally this year. The key reason is that low interest rates, caused by ultra loose monetary policies like QE, pushed many investors up the risk curve. Some fixed income yields, namely short term treasuries, were negative after adjusting for inflation (real yield) which forced investors to seek higher yielding assets in either corporate bonds, high yields or even conservative blue chip stocks. The key measure that determined whether investors prefer bonds or stocks is spread between the earnings yield (E/P or inverse of the P/E ratio) and the bond yield. At the start of the year, the 10-year US treasury yield was near 1.8% and the S&P500 earnings yield was 7.5% or almost 4 times higher! It's a no-brainer why stocks rallied. The fact pension funds and mutual funds had low equity exposure also fueled the equity rally as those "big players" re-entered the market. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Despite a small correction in the summer due to the taper tantrum, stocks kept on rallying. The current earnings yield of the S&P500 is about 6% while the 10-year US treasury is yielding near 3%, which reduced the attractiveness of stocks by 50%. The S&P500 is trading at 16.5X trailing earnings and 15.1X forward earnings. Those measures are slightly higher than historical averages but well short of the P/E north of 20X in the dotcom boom and 17-18X at the height of the 2007 bull market. This means that stocks can still rally further. Mutual fund asset levels are still low compare to 2007 and many pension funds are still under-weighing equities. Therefore, don't be surprised if stocks move higher. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
However, what worries me is that the equity rally is mostly due to P/E multiple expansion. Recall changes in price is the product of changes in earnings multiplied by changes in the P/E ratio. Given the aggregate S&P500 earnings is foretasted to increase only 6% in 2013<b>, the 27% rally in the index was caused mostly by a 20% expansion in the P/E ratio</b>. P/E doesn't expand forever and the fact earnings growth is unlikely to pick up is a cause for concern. </div>
<br />
<br />
<b>The Problem of Calling a Top: </b><br />
<b><br /></b>
<br />
<div style="text-align: justify;">
In December 1996, former Fed Chair Alan Greenspan made his famous "irrational exuberance" speech questioning the valuation of equities at that time. Some investors agreed with Greenspan and started shorting equities. The fact the stock market advanced 31% in 1997, 26% in 1998, and 20% in 1999 proved many of those skeptics wrong. The point I want to make here is that calling a top is extremely hard. Many should not even waste the time or effort to because it is hard to get both the timing and thesis correct. </div>
<br />
<br />
<b>So, What to Do? </b><br />
<br />
<div style="text-align: justify;">
Bonds are still yielding close to nothing (after adjusting for inflation) while stocks may be in bubble territory. <b>My opinion is that stocks should be preferred to bonds.</b></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Reasons: </div>
<br />
<ul>
<li style="text-align: justify;">Earnings yield of 6% is still 2 times higher than long term treasury yield and higher than most fixed income yields (including junk bonds that are yielding near 5%) </li>
<li style="text-align: justify;">Stocks provide investors with great long term performance despite short term troubles. Let's not forget that in the 20th century, the Dow Jones returned 5.1% compounded annually. For those who are not aware, the market experienced several large drops greater than 50% with the Dow losing 90% from 1929-1933. That period also included 2 World Wars, the Great Depression, a Cold War, a decade of super high inflation etc. </li>
</ul>
<div style="text-align: justify;">
For the average Joe investor, a bubbly market should not deter them from a conservative dollar cost averaging strategy where one sets aside a fixed amount to put into an index fund every month or quarter. For more active investors, there are still bargain stocks available especially in the mining space. Trying to call a market top is foolish because no one has a perfect crystal ball. Investors should adhere to strict investment rules such as buying stocks at reasonable valuations (i.e. significantly below intrinsic value) in order to provide them with a margin of safety. Timing the market appears to be simple and easiest strategy to make money but its application is hard in practice. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
I<b>n short, although I worry about a stock market bubble, I'm still long stocks in my portfolio because they still provide the best risk-adjusted potential return. I use the margin of safety principle advocated by Ben Graham to help protect my downside by buying stocks with low valuations, healthy balance sheets and high future earnings power. I tried calling market tops and bottoms in the past but learned it's better to admit you can't. Many times, you get the thesis right, but the wrong timing can kill you. As Keynes famously said: "The market can stay irrational longer than you can solvent". </b></div>
<br />
<div style="text-align: justify;">
<b><br /></b></div>
<br />Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com2tag:blogger.com,1999:blog-5042705291735134971.post-40975544864647857412013-11-06T14:23:00.000-08:002014-03-14T15:49:20.529-07:00Are Share Buybacks Really Meaningful?After my article on stock splits, I believe I should discuss my thoughts on share buybacks, another important topic in corporate finance. I will write about other topics such as dividend payout policy, M&A, executive compensation etc in the future.<br />
<br />
<u><i>What are Share Buybacks?</i></u><br />
<br />
Share buybacks, also know as share repurchases, are methods of returning cash back to shareholders. The net effect of repurchasing shares will result in less shares outstanding, which increase the ownership of shareholders who decide to maintain their stake. Companies usually purchase their shares on the open-market, although a tender offer can also be used. In Canada, an open market share buyback program is called Normal Course Issuer Bid (NCIB).<br />
<br />
<div style="text-align: justify;">
<u><i>Rationale Behind Share Repurchases: Returning Free Cash Flow</i></u></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Basically there are 3 main uses of free cash flow (often defined as operating cash flow minus capital expenditures): (1) pay down debt (2) make an acquisition (3) return it back to shareholders via dividends or share buybacks. Most executives hate option 1 because they want to maintain an "optimal structure" of debt and equity. In my own opinion, it may be prudent to reduce debt levels when excessive free cash flow exists since high cash levels usually build near the height of an economic boom, which implies a recession may be on the horizon. Reducing debt levels in good times prepares the company for bad times such as a recession or economic slowdown. Also, it leaves excessive capacity to take on more debt in recessionary times when interest rates are much lower. Option 2 was popular but CEOs are now more cautions when it comes to acquisitions especially after the disastrous outcomes of serial acquirers like Tyco, Worldcom, or Citigroup. Accounting treatment is also less favourable with FASB and IASB abolishing the pooling of interests method. Option 3 is the most commonly used method of returning free cash flow and most executives prefer stock repurchases just because it is "tax-efficient" over dividends. Although the argument is valid, purchasing shares above intrinsic value is value destroying (see example below) despite being a little tax efficient If the shares do trade above intrinsic value and the company has excessive cash, it should consider boosting its dividend instead.</div>
<div style="text-align: justify;">
<br /></div>
<i><u>Example:</u></i><br />
<br />
<div style="text-align: justify;">
Stock X is trading at $150, has 100 million shares outstanding, and earns $500 million a year. This implies a market capitalization of $15 billion and EPS of $5. Let's assume that the true intrinsic value (hidden from the public but can be roughly estimated by the intelligent investor) is only $10 billion or $100 per share, which implies the stock is 50% overvalued. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
If the company decides to repurchase 5% of its outstanding shares (5 million shares) at $150 and still makes $500 million a year, EPS would increase from $5 to $5.26, a magical 5.2% increase. However, if the share price corrects to the actual $10 billion (in the long run, the market is a weighing machine and will be efficient) , the high purchases made at $150 are clearly value destroying. If the company did not conduct the share repurchase, intrinsic value would still be $100 per share (10 billion value divided by 100 million shares). If they did the share repurchase, they would destroy $250 million of value by buying shares for $750 million when intrinsic value of those shares is only $500 million. Thus, intrinsic value of the company after the repurchase is 9.25 billion or $97.37 per share. ([$10 billion - 0.75 billion]/ 95 million shares). Well congratulations shareholders of company X, it just destroyed $2.63 of value on a per share basis. The company may had good intentions, such as returning cash to shareholders, but buying back shares above intrinsic value is dumb. Many would argue against me by stating there is no exact method of determining the intrinsic value. Nonetheless, I believe experienced managers who is familiar with industry trends and the company's financials should have a rough idea on the company's intrinsic value. Academic studies have shown that following the insiders (after they disclose a purchase or sale) can earn abnormal returns. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
If the shares was 300% overvalued, this transaction would destroy over $11.50 of value on a per share basis. The prior examples are typical in the real world. Why? This is because corporations usually have large cash hoards in boom times or just before a recession hits, which also corresponds to when their share prices are often overvalued in the market. Many corporate executives are often pressured to return cash to shareholders and believe buybacks are the most efficient method. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<u><i>Rationale Behind Share Repurchases: Growing EPS or Offset Share Dilution </i></u></div>
<div style="text-align: justify;">
<b><br /></b></div>
<div style="text-align: justify;">
Short term earnings accretion get the attention of analysts and the financial press, but prudent investors should look for underlying value creation, not earnings accretion. As the example above shows, there is earnings accretion with EPS growing 5.2%. However, the actual intrinsic value of the business, on a per share basis, is lower as a result of repurchasing shares above intrinsic value. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Another common argument is that companies often issue stock options and exercising those options could dilute existing common shareholders. The problem of offsetting that dilution with share repurchases is that buying shares above intrinsic value would destroy more value than merely letting its shares outstanding increase. Let's go back to the prior example. If there is 5 million of options, the shares outstanding would increase to 105 million and EPS decreases to $4.76. Most executives doesn't like that lower EPS so they decide to repurchase shares. If the company doesn't do anything, intrinsic value reduces to $95.24 ($10 billion/ 105 million shares) or $4.76 lower. If the company decides to repurchases 5 million shares at $150 (greater than $100 intrinsic value) to offset the 5 million share dilution, intrinsic value is reduced to $92.50 ([10 billion - 750 million] / 100 million shares) or $7.50 lower. Clearly $95.24 > $92.50, so repurchasing shares when the shares are overvalued is a dumb idea. Buying loonies for tonnies is plain silly (For non-Canadian readers, loonies = $1 while tonnies = $2) </div>
<div style="text-align: justify;">
<br /></div>
<br />
<i><u>Share Buyback Lesson from the Oracle of Omaha:</u></i><br />
<br />
<div style="text-align: justify;">
We pay so much tuition to learn finance in University but the best source, Buffett's Annual Letters to shareholders, is available on the Berkshire Hathway's site for free. Regarding share buybacks, Buffett's clearly explained his position in his <a href="http://www.berkshirehathaway.com/letters/2011ltr.pdf">2011 Annual Letter</a> (see the section on "Share Repurchases" on page 6-7). Here is a quote taken from the letter:</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
"Charlie and I favor repurchases when two conditions are met:
<b>first, a company has ample funds to take care of the operational and liquidity
needs of its business; second, its stock is selling at a material discount to
the company’s intrinsic business value, conservatively calculated</b>"</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Buffett explains how CEOs, even the honest and hardworking ones, fail the second test miserably. A CEO may think his company's share price is cheap no matter what price it is selling at. Even the honest executive is led to believe that returning excessive free cash flow is necessary. Buffett argues that this is not true. There is no point of a share repurchase UNLESS the you can repurchase the shares below intrinsic value, hopefully conservatively calculated as Buffett suggests. Notice Buffett never mentions earnings accretion or returning excessive free cash flow as criteria when deciding a share repurchase.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Here is another interesting thought from Buffett: "When Berkshire buys stock in a company that is repurchasing
shares, we hope for two events: First, we have the normal hope that earnings of
the business will increase at a good clip for a long time to come; and<b> second,
we also hope that the stock UNDERPERFORMS in the market for a long time as well ." </b></div>
<br />
<div style="text-align: justify;">
<span style="font-weight: bold;"><br /></span></div>
<div style="text-align: justify;">
Wait, what? Did Buffett just say he hopes the share price would underperform the market for a long time? This is not a typo. The logic is a simple one, but often not well understood. If the share price underperforms, the company can purchase more shares and the remaining shareholders would own more of the company (and receive more share of the company's long term earnings as well). If IBM's share price remains at $200 for the next 5 years, Berkshire's 5.5% stake in the company would indirectly increase to 7% through the ~$50 billion share buyback program. But if IBM averaged $300 in the same period, then Berkshire's stake would only increase to 6.5%. The 0.5% may seem small but it makes a big difference in the long run. If net income is $20 billion for IBM per year, then Berkshire will get an additional $100 million share of that income. IBM's stock price is in fact languishing right now as expected and sell-side analysts are cutting their price targets like crazy. While analysts criticize IBM for poor share performance, Buffett must love the lower share price right now. It's hard to think long term but let's not forget the moral behind the turquoise vs. hare story. </div>
<br />
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
If the company is pursuing a large buyback program, shareholders should cheer when the stock price languishes. As Buffett says: "The logic is simple: <b>If you are going to be a net buyer of
stocks in the future, either directly with your own money or indirectly
(through your ownership of a company that is repurchasing shares), you are hurt
when stocks rise</b>. You benefit when stocks swoon. Emotions, however, too often
complicate the matter: Most people, including those who will be net buyers in
the future, take comfort in seeing stock prices advance. <b>These shareholders
resemble a commuter who rejoices after the price of gas increases, simply
because his tank contains a day’s supply.</b>" Very well said Mr.Buffett, I thank you for sharing this point many people miss. </div>
<div style="text-align: justify;">
<br /></div>
<br />
<u><i>Conclusion:</i></u><br />
<br />
<div style="text-align: justify;">
To answer the question in the title, share buybacks is definitely meaningful method of returning capital to shareholder only if the company can repurchase shares under intrinsic value, conservatively calculated. Investors should be cautious when CEOs announce buybacks because their intent is to offset share dilution or increase EPS growth. If CEOs announce buybacks because they want to return free cash flow, carefully assess the company's intrinsic value. If the company's shares are trading below intrinsic value, you should applaud the move and give a big thumbs up. If it is not (especially if it is significantly above your estimate of intrinsic value), you should re-consider your investment thesis in the company. No matter how great a business may be, investors should not invest in the company if the CEO makes poor capital allocation decisions because those decisions can lead to a lot of value destruction. (An exception would a net-net special situation but I'll again save this topic for next time)</div>
Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com3tag:blogger.com,1999:blog-5042705291735134971.post-67231478392587158382013-11-05T18:13:00.003-08:002014-04-03T08:28:21.735-07:00Some Real Thoughts On Stock Splits <div style="text-align: justify;">
Another post inspired by a WSJ CFO Journal article. (The article is found <a href="http://blogs.wsj.com/cfo/2013/11/05/stock-splits-rekindle-a-polarizing-debate/?mod=djemCFO_h">here</a>. My prior article inspired by WSJ was on non-GAAP measures, which is <a href="http://kennyyang91.blogspot.ca/2013/07/financial-reporting-and-use-of-non-gaap.html">here</a>). The WSJ article discuss how corporations should consider revisiting stock splits. The author claims that academic studies have shown that the companies who split their stock will outperform the market. It is clearly the author supports the idea that a stock split will create value for its shareholders. However, my own opinion on share splits is quite the opposite: <b>It's distracting </b><b>tactic that management use to boost the stock price in the short term and does not create any value at all. </b>Why would management want to boost short term share performance? The answer is simple: stock options grants (I'll save the topic of executive compensation for another day).</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
For those who are not familiar with the concept, a stock-split is a transaction that increases the company's shares outstanding by a specific multiple (usually 2 times or 3 times) and reduces the trading price of the stock by the same multiple. Here is an example to illustrate a stock-split: stock X is trading at $100 and has 1 million shares outstanding. If it announces a 2:1 stock-split, the number of shares outstanding doubles to 2 million and the stock's trading price would halved to $50. The company's market capitalization remains at $100 million (market capitalization is the market value of equity calculated by multiplying shares outstanding by the share price). No matter how you slice and dice it - i.e. $50 x 2 million, $33.33 x 3 million, $20 x 5 million -, the market capitalization is still $100 million. The famous Yogi Bear once said to the waiter after he ordered a pie: "Please cut it in 4 pieces instead of 8 because I can't eat 8 pieces". It doesn't matter how the pie is cut, Yogi Bear will still eat one whole pie. The fact he thinks he is eating less because he ate less pieces is plain silly.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
This quote from the article made me laugh:<span style="font-family: inherit;"> "<span style="line-height: 22.5px;">Kenneth Fisher, Noble Energy’s CFO, says the company’s research indicates companies that split outperform their peers by 2% to 3% in the near term.". The </span></span><span style="line-height: 22.5px;">emphasis</span><span style="font-family: inherit;"><span style="line-height: 22.5px;"> in that quote </span></span><span style="line-height: 22.5px;">should</span><span style="font-family: inherit;"><span style="line-height: 22.5px;"> be on the last two words in his sentence: NEAR TERM. </span></span></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
If stock splits do create value, then companies with the high trading prices should be less attractive to investors. History suggest otherwise. Lets take the three highest priced stocks in the S&P500 which had no stock split in the last 10-years and look at their performance. The three companies with the highest trading prices are Berkshire Hathaway (at $171,700), Priceline.com (at $1080), and Google (at $1020). In the past 10 years (November 2003-present), the S&P500 only returned 60%. What about those stocks with the highest trading prices? Berkshire returned 120%, Priceline returned 5000% and Google returned 800% in the same period. Granted, although Priceline and Google were trading at prices below $100 in 2003, their executives never considered a stock split when their shares soared above $100 like most other S&P500 chiefs. Thus, the evidence suggests that high trading prices do not hurt share performance at all. So why do most CEOs want a stock split? </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Most S&P500 CEOs usually do a 2:1 or 3:1 split when the price of the company's shares soar above $100 because they believe they can create value by lowering the share's trading price. By lowering the trading price, CEOs think they can psychologically impact investors' perception of value just because the price per share is lower or liquidity in the stock has increased.<b> While I agree most companies may experience short-term outperformance after a share split, the long term costs of the share split is negative for shareholders. Stock splits increase administrative and market listing costs because the shares traded more often (more turnover)</b>. Also, stock-splits generally attract more short-term oriented investors and increase management's incentive to try to meet quarterly earnings forecasts as the shareholder base becomes increasingly short-term oriented. <b>There is nothing more value destroying in the long run than management trying to play the earnings beat game</b>. Management may try various schemes to meet short term earnings expectations such as cutting expenses (instead of growing revenue), focusing on short term payback projects (instead of projects with the highest NPV), or doing ridiculously high priced acquisitions (which maximize short term earnings accretion but hurt long term value because they often overpay or issue undervalued stock to finance such acquisitions).</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Therefore, <b>stock-splits add zero value and it's just a short term tactic aimed at boosting investor's short term enthusiasm</b>. If you hear a CEO talk about the benefits of a stock split, ask him/her whether 1 x 10 = 2 x 5 If he/she says yes, then you should reply why consider a stock split in the first place when the left hand side of the prior equation is equal to the right hand side. Actually the equation should be 2 x 5 - costs < 1 x 10 because stock splits will increase costs. Long term shareholder value can only be created if management focuses on building the underlying business (invest in positive NPV projects, return excessive free cash flow, and allocate capital efficiently) and generate a high return on capital. As Buffett famously said: "If the business does well, the stock will follow". If a CEO thinks his/her company should consider a stock split because the trading price is too high, he/she is spending way too much time looking at the company's stock price and not enough time building the underlying business. </div>
Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com1tag:blogger.com,1999:blog-5042705291735134971.post-9070286895656123242013-10-25T18:03:00.003-07:002014-01-25T07:17:44.972-08:00 Why Investors Should Invest In Canada And Its Second Largest Bank<a href="http://seekingalpha.com/article/1775342-why-investors-should-invest-in-canada-and-its-second-largest-bank">Please see the full article on the Seeking Alpha site</a><br />
<br />
Update: I wrote a very detailed analysis of TD after Q4/2013 earnings also on Seeking Alpha.(<a href="http://seekingalpha.com/article/1885491-toronto-dominion-banks-surprise-dividend-increase-is-overlooked-by-investors">Link</a>)Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com1tag:blogger.com,1999:blog-5042705291735134971.post-59930096653287931872013-10-25T18:02:00.003-07:002013-10-25T18:02:47.281-07:00Manulife: A Canadian Insurer With Compelling Growth Potential And Yield<a href="http://seekingalpha.com/article/1775252-manulife-a-canadian-insurer-with-compelling-growth-potential-and-yield">Please see the full article on the Seeking Alpha site</a>Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com0tag:blogger.com,1999:blog-5042705291735134971.post-76312293808255463012013-10-24T09:19:00.003-07:002013-10-24T09:19:49.578-07:00The Outlook For Equities After The September Jobs Report<a href="http://seekingalpha.com/article/1762902-the-outlook-for-equities-after-the-september-jobs-report">Please see the full article on Seeking Alpha's Site: </a><br />
<br />Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com1tag:blogger.com,1999:blog-5042705291735134971.post-54047535447108771712013-10-20T19:35:00.001-07:002013-10-21T17:00:18.596-07:00With Debt Ceiling Debate Out of Way..What's Next For the Market? (An Investment Strategy Update)<div style="text-align: justify;">
Perhaps I was too pessimistic in my prior post to expect a market correction. Stocks hardly experienced a correction at all! The S&P500 and TSX both reached new 52-week highs of 1745 and 13,150 respectively. Investors are cheering over the fact there was a temporary kick the can down the road solution that avoided a U.S. default. Yes, a disastrous default was avoided, but the fight will come up again. Let's all hope Santa gives politicians a merry Christmas so they all can maintain their rationality in the new budget/debt ceiling negotiations in the new year. </div>
<div style="text-align: justify;">
<br /></div>
<b>A 11th Deal...Again:</b><br />
<b><br /></b>
<br />
<div style="text-align: justify;">
The Reid-McConnell dual did it again. Once again, it was up to the Senate to break the stalemate given the House cannot formulate any reasonable bill. The deal was extremely favourable for the Democrats given the bipartisan bill re-open the government and provides funding until January 15th without any large changes to the Affordable Care Act (Obamacare) that conservative GOP lawmakers demanded. Also the bill suspends the nation's debt ceiling to February 7th, giving lawmakers a small breathing room of 4 month to come up with a credible deficit reduction plan. A bipartisan committee is set up to negotiate over the budget, trying to bridge the differences between the House budget and the Senate budget. The deadline is to present a proposal to congress by December 13. </div>
<i><br /></i>
<b>Damage of Political Bickering:</b><br />
<br />
<div style="text-align: justify;">
The GOP's strategy of combining the Obamacare debate into the debt ceiling negotiation backfired. Even senior GOP members like McConnell admitted the strategy was "flawed" in the beginning. Unfortunately, the biggest losers are not those adamant conservative GOP lawmakers. The real losers of the 16-day government shutdown are actually the ordinary Americans that depended on the government. Most economists estimate that there was a direct 0.2% GDP hit because the loss wage income of the 400,000 furloughed government workers. There could be another 0.3-0.4% GDP hit in the fourth quarter because of indirect impacts, i.e. tourism/travel businesses saw a huge decline in customers due to the shutdown of many national parks and government sites. Adding both the direct and indirect impacts, there could be a 0.5-0.6% drag on the fourth quarter GDP. Prior to the government shutdown, the U.S. economy was expected to grow at 2.6% in Q4 (Q1 growth of 1.1% and Q2 growth of 2.5%). Therefore, the 16-day government shutdown would reduce Q4 GDP to approximately 2%. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Here is a million dollar question: If the economy just experienced a slowdown, why is the equity market rallying to new highs? The simply answer is the Fed. Given a 0.5-0.6% cut in GDP in Q4 and the fact that the Fed policymakers are literally flying blind (important data such as non-farm payrolls, inflation, industrial production, housing reports were all suspended due to the government shutdown), it is likely there may not be any further tapering talks for the remainder of the year. According to a <a href="http://www.bloomberg.com/news/2013-10-18/fed-qe-taper-seen-delayed-to-march-as-shutdown-bites.html">Bloomberg survey</a> of Wall Street economists, the Fed is not expected to taper until March next year, a complete change in opinion since August when the Fed was expected to taper last month but did not. The expected path of QE3 is completed altered and additional stimulus is likely to provide further boost prices of risky assets. As former Citigroup CEO Chuck Prince used to say, "as long as the music is playing, you gotta get up and dance"</div>
<br />
<b>Equity Outlook:</b><br />
<br />
<div style="text-align: justify;">
The outlook for equities is positive for the next few months (up to New Years Day), although the author is still slightly cautious given current valuation. The S&P500 is valued at 16.6X trailing earnings and 14.5X forward earnings. The long term average for trailing earnings is 16.4X (50 year) and 14X (20 year) for forward earnings according to Bloomberg data. Although valuation may look high, there is no doubt that the current least path of resistance for equities is up, meaning further gains ahead. Moreover, equities tend to gain from late-October to December based on historical seasonal trends with December being the best month for stocks. Finally, stocks current have positive price momentum and that will trigger further buying to support the current advance. A combination of seasonality, positive momentum, and monetary stimulus all point to a positive outlook for equities for the remainder of the year. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<a href="https://docs.google.com/file/d/0B4Tpbylx1OfvZFFqeVRYQlRPTUE/edit?usp=sharing">In my July Investment outlook report</a>, I expected the S&P500 to finish 2013 at ~1625. Because tapering is delayed and the debt ceiling problem is avoided,<b> I now expect the index to finish around 1720-1770, a valuation based on expected earnings of $122 in 2014 and a 14-14.5X forward multiple.</b> Although the multiple is slightly higher than the average 14X, I expect the positive investor sentiment and the high level of monetary stimulus to justify recent multiple expansion. The index rally this year was 70% attributable to multiple expansion and only 30% to actual earnings growth. Given earnings is expected to grow only 8% while revenue is only expected to grow 5% this year, a 24% rally (YTD) in the index is not justified purely on fundamentals alone. The search for yield has force many investors, small or large, to invest in riskier assets like equities in order to fulfill their expected returns requirements. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Nonetheless, there are slight positives that can at least maintain the current price momentum to year-end. First, <a href="http://www.factset.com/websitefiles/PDFs/earningsinsight/earningsinsight_10.18.13">according to Factset</a>, out of the 97 S&P500 companies that reported Q3/2013 earnings, 53% reported sales above consensus estimates. That is slightly better than 40-50% rate in prior earnings seasons. Top line sales growth is paramount to further earnings growth. In addition, profit margins is near 2007 highs.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Sector-wise, I still favour cyclical sectors like <b>financials </b>(banks benefit from steeper yield curve and insurers can benefit from higher interest environment. Author likes MFC and IAG), <b>industrials </b>(GM, F, UNP), <b>energy </b>(downstream refiners like VLO looks attractive given the low crack spreads), and <b>technology </b>(look for the cash cows and good ROIC like CSCO). Despite putting a underweight outlook on materials in July, the author feels many names in this space are becoming undervalued such as AGU and YRI/AUY. </div>
<br />
<b><br /></b>
<b>FICC Asset Outlook: </b><br />
<b><br /></b>
The outlook FICC (Fixed Income, Currencies and Commodities) remains relatively unchanged since <a href="https://docs.google.com/file/d/0B4Tpbylx1OfvZFFqeVRYQlRPTUE/edit?usp=sharing">my July Investment Outlook Report</a>. I am keeping most of the expected price targeted unchanged such as the year-end target for 10-year treasuries at 2.8%-3.0% (despite a huge change in tapering expectation!). A slight change would be a less favourable outlook for the U.S. dollar given delayed tapering, which is positive for commodity currencies like the CAD and AUD.<br />
<br />
<br />
<b><span style="font-size: x-small;">Disclaimer: </span></b><br />
<span style="font-size: x-small;">This piece is for information purposes only. The list of stocks suggestions provided only serve to provide readers with ideas that they can further conduct research on. The author is not responsible for any losses readers incur by buying any names suggested. </span><br />
<span style="font-size: x-small;"><br /></span>
<span style="font-size: x-small;">Out of the names suggested, the author owns a large stake in MFC</span>Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com2tag:blogger.com,1999:blog-5042705291735134971.post-7771262893324628902013-10-07T16:13:00.000-07:002013-10-11T18:12:31.704-07:00The Debt Ceiling Debate: A Possible Repeat of 2011? <div style="text-align: justify;">
In this piece, I will update everyone on the current situation in Washington regarding the government shutdown and the debt ceiling debate. Given both parties are publicly attacking each other and negotiations to re-open the government failed to yield any results, investors should not be expecting a smooth negotiation to raise the $16.7 trillion debt ceiling. Treasury Secretary Jack Lew already stated that by October 17th, the Treasury would only have $30 billion to pay claims including interests on debt. </div>
<div style="text-align: justify;">
<br /></div>
<b><u>One party Zigs, other Zags:</u></b><br />
<br />
<div style="text-align: justify;">
Because of political differences, the U.S. government had to shutdown last Tuesday because of the U.S. congress's inability to pass a funding bill to fund the government for the new fiscal 2014 year. (U.S. government has fiscal year ending September 30). Republicans insisted on delaying the implementation of Obama's Affordable Health Care Act (Obamacare) as a condition to pass a funding bill. Democrats did not yield to Republican's demands and merely blamed Republicans for the cause of the shutdown. It is clear that each party is using this opportunity (government shutdown & debt ceiling debate) to try to lay blame on the other party and to seize some political gains for the upcoming election (mid-year election next year for the house/senate and 2016 Presidential election). Furthermore, Republicans already conceded too much in the last budget debate on New Year's eve that led to the sequester. Therefore, Republicans wanted to act tougher this time to force the Democrats to concede more during this round of budget debate. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Given the hard stance taken by the two parties publicly, it is difficult to reconcile the two parities and form an agreement to open the government. Also, the vote to increase the debt ceiling appears more difficult given politicians can't even agree to end the government shutdown. The political game of chicken is starting to look awfully similar to 2011 and may have similar consequences. </div>
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<b><u>U.S. Won't Default, But That is Not What Investors Should Worry About: </u></b><br />
<br />
<div style="text-align: justify;">
Yes,<b> I can safely assure investors that U.S. won't default on its debt</b>. Given U.S. treasury yields are used as benchmark yields for almost every financial instrument and the U.S. dollar is also the reserve currency, politicians know they can't risk a default, no matter how small it is. The effects of such a default would be unimaginable. For those who are curious, yields on treasuries would soar (not a safe haven anymore!), stocks prices would tumble and foreign investors may attempt to exit their U.S. investments. The consequences of these actions will trigger a long recession or even depression if policymakers do not act quickly. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Let's move away from the doomsday scenario to a more realistic scenario. The U.S. will not default, but politicians will continue to avoid making progress on discussions until the last minute regarding the debt ceiling. <b>As the October 17th deadline date approaches, investor confidence will slowly erode to reflect a rising probability that politicians may fail to reach an agreement by the 11th hour. The erosion of confidence will be detrimental to the financial market</b>s. Stocks will face some short term headwinds and bonds yields will decline due to the safe haven trade. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Current investor sentiment is high because of the Fed's commitment to keep rates low (accommodative monetary policy) and the continuation of its asset purchase program (QE3). Nonetheless, history has provided many evidences where confidence can erode quickly. As investors saw in 2011, the debt ceiling debate suddenly went sour 2 days before the deadline and investors quickly dumped all risky assets (such as stocks) to avoid a potential U.S. default. <b>When investors are nervous, emotions will take over. This means that anxious investors will sell everything because they only care about the return OF their capital rather than return ON their capital. Investors must realize that they are creatures of emotion, not creatures of logic especially in times of uncertainty. </b>T-bill investors are already anxious enough to push the yield on T-bills due in late October from 0% to 0.13%. The CDS market is also showing some signs of stress with the cost of U.S. CDS rose to 64 bps from 30 bps. </div>
<div style="text-align: justify;">
<b><br /></b></div>
<br />
<b><u>Investment Strategy:</u></b><br />
<b><u><br /></u></b>
<br />
<div style="text-align: justify;">
In times of uncertainty, cash is king. Keeping some cash on hand is wise especially if markets will react negatively if negotiations continue up to the 11th hour of the debt ceiling deadline. Markets are not worried now because they assumed the debt ceiling will be raised and the agreement would be amicable. However, the final agreement on the debt ceiling would be far from amicable and investors' anxiety will increase with each passing day. More anxiety will likely lead to a market correction in the short term despite the U.S. congress will eventually raise the debt ceiling.<br />
<br />
While it is possible for a debt ceiling agreement without creating too much investor anxiety, markets would hardly respond at all to a positive outcome because it has already been "priced in". However, markets will decline if negotiations become too hostile. Hence caution is warranted for now. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Going back to the question I proposed in my title, it is quite possible for a repeat of 2011. However, equity market declines are likely to be much smaller than the 19% experienced in 2011 because of the Fed's stimulus and better economic conditions<b>. Nevertheless, if the U.S. congress fail to raise the ceiling by the deadline, a 5-10% equity decline is definitely possible. Market declines are actually good for investors because they allow prudent long term investors to add to their positions when prices are down. Unlike most investors, I welcome market declines -especially large ones like 50%- so I can buy additional shares of the companies I own. If everyone likes big discounts when they go shopping, they should learn to appreciate market declines the same way. </b></div>
Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com2tag:blogger.com,1999:blog-5042705291735134971.post-62872261248892722442013-10-02T07:24:00.001-07:002013-10-02T12:51:52.866-07:00BlackBerry Q2 MD&A: More Bad News But Not All Negative <div style="text-align: justify;">
Quietly on a Tuesday afternoon, BlackBerry released its full Q2 report on EDGAR. I had the opportunity to skim through the filing and found some interesting data points. Readers are welcome to read my analysis, but could skip to the conclusion if they want to a quick read on what is the outlook for BlackBerry's shares. The financial media quickly pointed at all the negatives in the report without painting a full picture of the company. That being said, the Q2 report was more negative so I'll start of with the negatives. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<b>The Negatives:</b></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<i>(1) Hardware Fiasco:</i></div>
<div style="text-align: justify;">
<i><br /></i></div>
<div style="text-align: justify;">
According to dictionary.com, the word fiasco is defined as "A Complete and Ignominious Failure" and those words describe perfectly the performance of BlackBerry's hardware division in Q2/2014. We already knew from the pre-announcement on September 20th that hardware had a 50% decline year-over-year but new details are also very disappointing (see chart below). Quarter-over-quarter, the region that saw the hardest decline was Latam and EMEA (Europe, Middle East, Africa). Weakness was wide-spread in all of the regions, even in emerging markets such as EMEA and Latam where the BlackBerry brand was favoured . </div>
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<i><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">$ in millions<o:p></o:p></span></i></div>
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<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">Q2/14<o:p></o:p></span></b></div>
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<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">Q1/14<o:p></o:p></span></b></div>
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<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">Q2/13<o:p></o:p></span></b></div>
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<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">Y/Y<o:p></o:p></span></b></div>
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<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">Q/Q<o:p></o:p></span></b></div>
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<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">Canada<o:p></o:p></span></div>
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<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">91<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 59.0pt;" valign="bottom" width="79"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">263<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">227<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">-59.9%<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">-65.4%<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 12.75pt; mso-yfti-irow: 3;">
<td nowrap="" style="border-top: none; border: solid windowtext 1.0pt; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 74.0pt;" valign="bottom" width="99"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">U.S. <o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">323<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 59.0pt;" valign="bottom" width="79"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">498<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">641<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">-49.6%<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">-35.1%<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 12.75pt; mso-yfti-irow: 4;">
<td nowrap="" style="border-top: none; border: solid windowtext 1.0pt; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 74.0pt;" valign="bottom" width="99"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">North America<o:p></o:p></span></b></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">414<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 59.0pt;" valign="bottom" width="79"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">761<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">868<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">-52.3%<o:p></o:p></span></b></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">-45.6%<o:p></o:p></span></b></div>
</td>
</tr>
<tr style="height: 12.75pt; mso-yfti-irow: 5;">
<td nowrap="" style="border-top: none; border: solid windowtext 1.0pt; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 74.0pt;" valign="bottom" width="99"></td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"></td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 59.0pt;" valign="bottom" width="79"></td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"></td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"></td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"></td>
</tr>
<tr style="height: 12.75pt; mso-yfti-irow: 6;">
<td nowrap="" style="border-top: none; border: solid windowtext 1.0pt; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 74.0pt;" valign="bottom" width="99"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">EMEA<o:p></o:p></span></b></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">686<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 59.0pt;" valign="bottom" width="79"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">1343<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">1087<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">-36.9%<o:p></o:p></span></b></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">-48.9%<o:p></o:p></span></b></div>
</td>
</tr>
<tr style="height: 12.75pt; mso-yfti-irow: 7;">
<td nowrap="" style="border-top: none; border: solid windowtext 1.0pt; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 74.0pt;" valign="bottom" width="99"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">Latam<o:p></o:p></span></b></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">196<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 59.0pt;" valign="bottom" width="79"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">449<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">520<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">-62.3%<o:p></o:p></span></b></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">-56.3%<o:p></o:p></span></b></div>
</td>
</tr>
<tr style="height: 12.75pt; mso-yfti-irow: 8; mso-yfti-lastrow: yes;">
<td nowrap="" style="border-top: none; border: solid windowtext 1.0pt; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 74.0pt;" valign="bottom" width="99"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">Asia Pac<o:p></o:p></span></b></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">277<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 59.0pt;" valign="bottom" width="79"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">518<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">383<o:p></o:p></span></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">-27.7%<o:p></o:p></span></b></div>
</td>
<td nowrap="" style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 12.75pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 48.0pt;" valign="bottom" width="64"><div align="center" class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: center;">
<b><span style="font-family: "Arial","sans-serif"; font-size: 10.0pt; mso-fareast-font-family: "Times New Roman";">-46.5%<o:p></o:p></span></b></div>
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</tbody></table>
<br />
<div style="text-align: justify;">
Another confusion in the quarter was the accounting for BB10 devices. According to the quarterly report, the company did NOT change its revenue recognition policy. However, BB10 devices did not meet the company's revenue recognition criteria. Under U.S. GAAP (BlackBerry reports under U.S. GAAP), one of the revenue criteria is for the price to be fixed and measurable. Given BlackBerry must deduct estimated return returns and sales incentives (marketing, rebates) to estimate net revenue, the final price is not fixed if return rates or sales incentives cannot be measured reasonably. BlackBerry had trouble selling its BB10 devices and cannot accurately forecast the return rates/sales incentives in order to book the BB10 revenue. Due to the low sell-through rates and additional sales incentives needed, the company decided to not book revenue on BB10 devices until they are sold in the channel as described below: </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<span style="background-color: white;"><i>"Where a right of return cannot be reasonably and reliably estimated, the Company recognizes revenue when the product sells through to an end user or the return period lapses.</i></span><span style="background-color: white;"><i>For shipments where the Company recognizes revenue when the product is sold through to an end user, the Company determines the point at which that happens based upon internally generated reporting indicating when the devices are activated on the Company’s relay infrastructure.</i></span><i>"</i></div>
<div style="text-align: justify;">
<i><br /></i></div>
<div style="text-align: justify;">
Nevertheless, the company expected the change in BB10 revenue recognition did not "materially" impact revenue and they merely deferred the BB10 revenue. As I stated in my prior post, the big $500 million jump in deferred revenue could account for some of the deferred BB10 revenue. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
The future outlook for the hardware division is not encouraging. Device sales may continue to decline and BB10 sales are not picking up. Based on the company's provided BB10 sell-through rates, I estimate around 3 million BB10 devices have sold through to end-users vs. company's old expectation for "tens of million" units. The company needs to re-position its devices to attack specific markets it wants to target. The decision to make Z10 a low-cost devices could boost near-term sales as the high selling price on Z10 was main factor why many consumers decided to buy Android phones or iPhones. The Q5 also needs further price reduction in order for the company to remain competitive in emerging markets. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<i>(2) Services Businesses Still in Decline:</i></div>
<div style="text-align: justify;">
<i><br /></i></div>
<div style="text-align: justify;">
Service revenue declined 8.8% quarter-over-quarter from $794 million last quarter to $724 million this quarter. However, both quarter included service revenue deferrals due to the currency crisis in Venezuela ($72 million last quarter and $67 million this quarter). Without the Venezuela currency impact, service revenue actually declined 11.5%. Going forward, the company project a 12% quarter-over-quarter decline in Q3/2014, which is much higher than the single-digit decline projected in prior quarters. The faster than expected decline in service revenue is attributable to lower device sales and the migration to BB10 devices which receive lower service revenue than older BB7 devices. </div>
<br />
<div style="text-align: justify;">
<span style="font-style: italic;"><br /></span></div>
<div style="text-align: justify;">
<i>(3) The Restructuring Process is Costly:</i></div>
<br />
<div style="text-align: justify;">
<i><br /></i></div>
<div style="text-align: justify;">
The company already announced a planed reduction of 4500 employees. In the Q2 report, the company further elaborated that this plan will cost $400 million ($0.76/share) over the next three quarters. To help alleviate the financial strain, the company is putting up $122 million ($0.23/share) of assets up for sale immediately. </div>
<br />
<br />
<b>The Positives: </b><br />
<br />
<i>(1) Ample of Liquidity:</i><br />
<i><br /></i>
<br />
<div style="text-align: justify;">
The company burned $500 million cash in the quarter; however, the cash burn rate should decrease after the company cut expenses and cash is received from selling its massive inventory. Z10 devices are now worthless on the company's books (thanks to the $934 million inventory charge) and could be sold at very low prices to protect its market share and increase BlackBerry's cash flow. With nearly $2.5 billion of cash on hand and a $500 million tax refund in Q1/2015, BlackBerry does not face a liquidity problem and could survive for the next few quarters. However, if it does quickly restructure its businesses, the long-term survival of the company could be at risk. </div>
<br />
<div style="text-align: justify;">
<span style="font-style: italic;"><br /></span></div>
<div style="text-align: justify;">
<i>(2) Purchase Obligation Less of a Drag on Valuation: </i></div>
<br />
<div style="text-align: justify;">
<i><br /></i></div>
<div style="text-align: justify;">
BlackBerry bears like to point at the $5.3 billion purchase obligation stated in the Q1/2014 report as drag on the company's valuation. In its new Q2 report, purchase obligation decreased significantly to only $3.1 billion and could be reduced further as the company further re-align its purchase obligation with expected demand for its products. </div>
<br />
<div style="text-align: justify;">
<span style="font-style: italic;"><br /></span></div>
<div style="text-align: justify;">
<i>(3) Lost Service Revenue can partially recover:</i></div>
<div style="text-align: justify;">
<i><br /></i></div>
<div style="text-align: justify;">
The company deferred $72 million of service revenues in Q1 and $67 million in Q2. Of the $72 million deferred last quarter, $25 million has now been collected and the company expect further payments. Therefore, the lost service revenue could partially recover although it may be difficult to recovery the full amount. </div>
<div style="text-align: justify;">
<span style="font-style: italic;"><br /></span></div>
<div style="text-align: justify;">
<i>(4) Channel Inventory is Reduced: </i></div>
<br />
<div style="text-align: justify;">
Sell through this quarter was 5.9 million units vs. shipment of 3.7 million units, which decreased channel inventory by 2.2 million units. Usually shipments increase after channel inventory is decreased significantly, a slight positive for the next quarter. </div>
<br />
<div style="text-align: justify;">
<b>Conclusion: </b></div>
<div style="text-align: justify;">
<b><br /></b></div>
<div style="text-align: justify;">
Overall, the Q2 report revealed a more negative picture but there are also some positives as well. The $9 preliminary offer from Fairfax is discounted by the market because Prem Watsa is still seeking financing. Nonetheless, investors should not doubt his 28-year track record at closing deals and making good on his promises despite negative developments. He will keep his word and the $9 offer will be finalized. Other bidders may emerged but the $9 offer price still represents a 16% gain from today's market price of $7.75. The headlines may not be friendly to BlackBerry and the future prospects of the company is not 100% positive, but it looks like the maximum point of pessimism has been reached on the stock.<br />
<br />
UPDATE( 1:00pm EST), Dow Jones reported that there are "other parties" interested in BlackBerry including Cerberus Capital Management. It is more likely than not that maximum point of pessimism has been reached.<br />
<br />
Source: <a href="http://ca.blackberry.com/content/dam/bbCompany/Desktop/Global/PDF/Investors/Documents/2013/Q2FY14_Final_Filing.pdf">BlackBerry Q2 Report </a></div>
<br />Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com1tag:blogger.com,1999:blog-5042705291735134971.post-20084374736432298482013-09-27T08:02:00.000-07:002013-10-02T07:31:47.193-07:00BlackBerry's Q2 Press Release: No Surprises But There Are More Data Points <div style="text-align: justify;">
After BlackBerry's terrible pre-announcement last Friday, the earnings release today is almost a non-event. The main financial drivers were in-line with the pre-announcement so there were no real surprises to shareholders and analysts, although the media is still using the bad financials to create fancy headlines such as "BlackBerry loses $1 billion". </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<b><u>Key Results:</u></b></div>
<ul>
<li style="text-align: justify;">Revenue was $1,573 million, slight below the guided $1.6 billion in the pre-announcement</li>
<li style="text-align: justify;">Adjusted gross margin of 36.2%, slight above the mid-range of guided 35-37% in the pre-announcement. Adjusted gross margin adds back the $10 million restructuring charge and $934 million non-cash inventory/supplier commitment charge. Both were included in the Cost of Sales line on the Income Statement </li>
<li style="text-align: justify;">GAAP loss of $965 million (guided $950-995 million) or $0.47/share (guided $0.47-0.51)</li>
<li style="text-align: justify;">Ending cash (plus investments) balance of $2,569 million at Q2/2014 vs. $3,071 million at Q1/2014</li>
</ul>
<div style="text-align: justify;">
The figures did not surprise anyone but the press release today provided the latest financial statements. There are some interesting conclusion one can make based on them.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
<b><u>Q2 Income Statement:</u></b></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
The pre-announcement already warned everyone about terrible loss number for Q2. Nevertheless, there are some slight positive points about this bad quarter. I believe Prem Watsa understand these points as well when made his $9 offer. </div>
<div>
<ul>
<li style="text-align: justify;">The 50% quarter-over-quarter (q/q) decrease in revenue is surprising. However, BB10 device sales are not recognized until they are sold to end-customers (the sell-through model vs. BlackBerry's old sell-in model). Deferred revenue had a big jump of $500 million q/q on the balance sheet. If one assumes (this is a big assumption) that the $500 million reflected potential BB10 sales, then the revenue decline would have been 33% q/q vs. the 50%. BB10 sales could have been greater than $500 million but I am using the $500 million jump in deferred revenue as a rough guide</li>
<li style="text-align: justify;">Adjusted gross margin of 36.2% was 2.3% higher than last quarter's 33.9%, despite most of sales came from older BB7 devices. This implies that management was heavily discounting BB7 in previous quarter to drive BB10 sales. Now with BB10 sales slowing, removing those heavy BB7 discounts actually resulted in higher gross margin. Most corporations still order BB7 devices because BES 10 (the company's mobile device management service) lacks full backward integration to support BB7 devices. Removing BB7 discounts was actually a good idea</li>
<li style="text-align: justify;">The Cost of Sales line contained a $934 million inventory charge. An inventory charge also reduces the carrying cost of inventory. If BlackBerry can sell those worthless inventory in the future, it will help boost revenue and cash flow. Taking a big bath this quarter is shifting future expenses up-front</li>
<li style="text-align: justify;">The most interesting point I saw was if we adjust the one-time items and apply the guided 50% cut in operating expenses going forward, the company can money. i.e. take earnings before tax of -$1,438 million, add the $934 million inventory charge, add the $72 million restructuring charge and add the $450 million potential reduction in operating expense. The adjusted earnings before tax becomes $18 million. Therefore, BlackBerry can make money in the future if it downsizes significantly and become a niche player. The 13% reduction in operating expenses did little to offset the 50% decline in revenue this quarter. </li>
</ul>
<div style="text-align: justify;">
Given BlackBerry's financial performance, the company's ability to generate future earnings is questionable. Therefore, looking at the balance sheet is important because the valuation of the company is heavily dependent on what resources it owns. </div>
<div style="text-align: justify;">
<br /></div>
</div>
<div style="text-align: justify;">
<b><u>Q2 Balance Sheet:</u></b></div>
<div>
<ul>
<li style="text-align: justify;">Despite the $934 million charge, the ending inventory is $941 million, which is higher than last quarter's! Thus, most of the $934 million charge was related to the $5.3 billion off-balance sheet supply commitment. BlackBerry may have to take additional inventory charge in future quarters </li>
<li style="text-align: justify;">The increase in income tax receivable to $462 million from $33 million is positive given this will be a future cash-inflow once collected</li>
<li style="text-align: justify;">Working capital management appears poor with cash conversion cycle at 94 days (highest in the past 8 quarters), but this number is likely to decrease based historical trend. The company's working capital position improved after it booked a $400 million charge relating to its PlayBook tablet</li>
<li style="text-align: justify;">Book Value reduced to $16.06 and Tangible Book reduced to $9.38. Looks like Prem's offer is just slightly below Tangible Book</li>
</ul>
</div>
<div style="text-align: justify;">
The current value of BlackBerry is balance sheet dependent. The balance sheet contains cash at $2,569 million, PP&E booked at $2,119 million and intangible assets (patents) at $3,505 million. The market value of patents, a key valuation input for BlackBerry, is quoted from $1-3 billion. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
As I stated in my prior post, I valued BlackBerry at $11.50 based on the Q1 balance sheet and gave no consideration for future earnings power (the ability to generate future earnings). After seeing the updated Q2 balance sheet, I will revised the figure down to ~$11. However, this valuation does not matter if no one wants to pay for it. Shareholders only have one offer at $9 on the table and it may be the best offer. </div>
<div style="text-align: justify;">
<b><u><br /></u></b></div>
<div style="text-align: justify;">
<b><u>Prem Watsa's $9 Conditional Offer:</u></b></div>
<div style="text-align: justify;">
<b><u><br /></u></b></div>
<div style="text-align: justify;">
The shares are trading almost $1 below the $9 offer price, implying the market is betting the deal may not go through. A 12.5% risk-arb spread looks too good to be true. Nonetheless, there was a 30% risk-arb spread on the Progress Energy deal and a 20% risk-arb spread on the Nexen deal because of uncertainty regarding government approval. Investors should remember that both deals were completed and risk arbitrageurs got their double digit returns.</div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Some analysts predict Prem may lower his $9 offer to squeeze existing shareholders. That could definitely happen, but there are some negative implications for him as well. If he does lower his offer, his reputation and credibility will be damaged. Prem and Fairfax need that good reputation and credibility for future deal making so trading a good reputation for money is foolish. As Buffett famously said: "Lose money, I'll be understanding. Lose a shred of reputation, I will be ruthless." I think Prem understand what Buffett meant and put his reputation on the line when he announced that the takeover would be led by Fairfax (his firm). </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Therefore,I think the $9 is creditable despite the uncertainty. Looking at the balance sheet, it is less healthier than I expected so a higher offer is unlikely at this point, although a higher bid could emerge.<br />
<br />
<br />
Source: <a href="http://www.sec.gov/Archives/edgar/data/1070235/000134100413000997/form6-k.htm">BlackBerry 6-K filing</a> </div>
Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com1tag:blogger.com,1999:blog-5042705291735134971.post-67235453182927278312013-09-23T12:28:00.001-07:002013-09-27T10:45:39.562-07:00BlackBerry's Deal with Fairfax Financial <div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span style="font-family: 'Times New Roman', serif; font-size: 12pt;">One has to wonder why BlackBerry pre-announced
its fiscal Q2 results last Friday when its scheduled quarterly announcement
is less than a week away. Shareholders got an answer in today's press release
when BlackBerry signed a letter of intent with a consortium led by Fairfax
Financial. The letter of intent contemplates a transaction in which BlackBerry
shareholders would receive US$9.00 in cash for shares not owned by Fairfax
(Fairfax owns 10% of the company). This transaction would value the company at
US$4.7 billion, a fraction of the value the market gave it back in 2008 when it
was worth US$80 billion. <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span style="font-family: 'Times New Roman', serif; font-size: 12pt;">The parties will try to reach a definitive
transaction agreement by end of November 4,2013. BlackBerry is allowed to enter
into "alternative transactions" with another party during the due
diligence period (now till November 4,2013). <o:p></o:p></span></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<b><span style="font-family: 'Times New Roman', serif; font-size: 12pt;">My Opinion:</span></b><span style="font-family: 'Times New Roman', serif; font-size: 12pt;"><o:p></o:p></span></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span style="font-family: 'Times New Roman', serif;"><span style="font-size: small;">It shouldn't be surprising that Fairfax, being
the buyer, would offer a low price of US$9. Being a shareholder, I believe this
undervalues the company, but I acknowledge the company is facing more headwinds than I
anticipated. The low offer price for BlackBerry almost reminds me of </span>Bear Stearns<span style="font-size: small;"> when it
was first offered $2 per share on March 14, 2008. Jamie Dimon stated that
"buying a house and buying a house on fire is not the same". Ultimately,
Dimon had to concede to shareholders by offering $10 per share. In case of
BlackBerry, I</span><b style="font-size: 12pt;"> don't expect the final transaction price to be significantly
higher than the current pre-announced US$9 offer price. Nonetheless,</b><span style="font-size: small;"> </span><b style="font-size: 12pt;">it is more likely than not that the final transaction price
will be higher than the current US$9. Therefore, I am holding my shares for now especially given the shares are trading below US$9 (BBRY) preliminary offer price.
The final transaction may be slightly higher at $9.50-$10.50. </b><span style="font-size: 12pt;"> The announcement today does buy time for the company to find another buyer as it temporarily puts a floor to the stock price and will limit additional negative rumors on the company. The key point is that Fairfax has provided confidence to BlackBerry 's customers that the company will survive. </span></span></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span style="font-family: 'Times New Roman', serif; font-size: 12pt;">Because of today's announcement, the stock has
become a special situation and a pure risk arbitrage play. Taking the playbook
from <a href="http://www.berkshirehathaway.com/letters/1988.html">Buffett's 1988 annual letter</a> on how to evaluate this situation:<o:p></o:p></span></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span style="font-family: 'Times New Roman', serif; font-size: 12pt;"><i>To evaluate arbitrage situations you must answer
the four questions: <o:p></o:p></i></span></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span style="font-family: 'Times New Roman', serif; font-size: 12pt;"><i>(1) How likely is it that the promised event
will indeed occur? (2) How long will your money be tied up? (3) What
chance is there that something still better will transpire - a competing
takeover bid, for example? (4) What will happen if the event
does not take place because of anti-trust action, financing glitches, etc.?</i><o:p></o:p></span><br />
<br /></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span style="font-family: 'Times New Roman', serif;"><span style="font-size: small;">The probability of (1) happening is high given
Prem's track record of closing deals. Looking at criteria (2), the timing on
this arbitrage trade appears to be 6 weeks. As for criteria (3), there is a
chance of a better offer from another bidder or another a group of buyers
teaming up to buy BlackBerry and </span><span style="font-size: small;">carve out the operations. I think there is definitely a chance for a higher offer price than $9.50-10.50 but investors should keep their expectation low for now. Getting a better outcome than expected is never a bad thing! Finally, I think
the chances for criteria (4) is less likely given I feel BlackBerry's
management has already took the big bath in order to help Prem Watsa. A possible glitch is the financing because the Fairfax group has not finalized the financing yet. Nonetheless, chances are low that Prem cannot find the necessary financing for a $2.1 billion ($4.7 billion less $2.6 cash) bid. <o:p></o:p></span></span></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span style="font-family: 'Times New Roman', serif;"><span style="font-size: small;">With cash of $2.6 billion, patent value estimated at
roughly $2 billion (could be high as $3-4 billion), and value of services/other
infrastructure at $1.5 billion, BlackBerry should be worth ~$11.60 conservatively
valued. Of course, Fairfax, being the buyer, will not pay that price even if the
$11.60/share is a conservative value. However, Fairfax may raise the price
slightly to $9.50 or $10 to appease shareholders just like JP Morgan did in its
deal with </span>Bear Stearns<span style="font-size: small;">. There is still value in the company even if they flop
the hardware side. The delay in its global BBM launch was disappointing but BBM
will still ultimately attract millions of users, which the company can monetize
through advertising etc. <o:p></o:p></span></span></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<br /></div>
<div class="MsoNormal" style="margin-bottom: 0.0001pt; text-align: justify;">
<span style="font-family: 'Times New Roman', serif; font-size: 12pt;">The next 6 weeks will be interesting. The
earnings report on Friday September 26 will offer more colour on the financial
health and future of BlackBerry. <o:p></o:p></span></div>
<br />
Source:<a href="http://finance.yahoo.com/news/blackberry-enters-letter-intent-consortium-173000552.html">http://finance.yahoo.com/news/blackberry-enters-letter-intent-consortium-173000552.html</a><br />
<br />
<br />Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com2tag:blogger.com,1999:blog-5042705291735134971.post-79475120797501571712013-09-18T18:09:00.000-07:002013-09-19T20:19:57.881-07:00No Tapering...For Now<div style="text-align: justify;">
Market participants were quite surprised at the FOMC's decision to not taper its asset purchase program today. The consensus among many analysts and economists was for the FOMC to taper or reduce the size of its asset purchase program in the range of $10-$15 billion. The reaction to the announcement was quite volatile. The S&P500 rallied to an all time high of 1725, the 10-year treasury yield decrease 15 basis points (bps) to 2.70%, precious metals rallied and the U.S. Dollar depreciated against the majors. </div>
<br />
<b><u>Why Not Taper?</u></b><br />
<br />
<div style="text-align: justify;">
During Bernanke's press conference, there was a question phased as "Why not taper now given that the Fed has already signaled to the market that it will taper in September?". The Fed Chairman's answer was simple: the reduction of QE is heavily data dependent and financial conditions have tighten considerably to pose a risk to the economic recovery. Bernanke reiterated his stance that there is no "pre-set course" on ending the asset purchase program (QE3) and market participants were wrong to bet on a September taper. The Fed will consider reducing QE in the "coming meetings" depending on incoming data. Nonetheless, Bernanke's tone in the press conference was more cautious and suggest that the Fed may wait longer before tapering QE; the following statement from the FOMC illustrates this point:<span style="font-family: inherit;"> "...<b>the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases"</b></span></div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Bernanke clearly explained that the labour market must improve "substantially" and the outlook for the labour market must be equally solid to justify a reduction of QE. The labour market improved since last September, but the improvement was not "substantial".</div>
<ul>
<li style="text-align: justify;">The 6 month average non-farm payrolls did improve from 140K last August to the 155K currently. Many FOMC members stated in their public speeches that a run-rate of 200K or above defines a solid labour market. Because the rolling 6-month average payroll number is still below the 200K level, a September taper does make sense especially due to the Fed's mandate of maximum employment</li>
<li style="text-align: justify;">The unemployment rate decreased from 8.1% in August 2012 to 7.3% currently. Although the 0.8% reduction in unemployment rate is encouraging, part of the decrease is attributable to the 0.3% decrease in the labour participation rate during the same period, which is definitely not positive. As Bernanke stated in the press conference, the 0.8% decrease should be partially discounted because it ignores decline in the participation rate </li>
</ul>
<div style="text-align: justify;">
There are also other reasons, as outlined below, that explain why the Fed did not taper:</div>
<ul>
<li style="text-align: justify;">The recent spike in interest rates was a major concern as outlined in today's FOMC statement <b style="font-family: inherit;">"</b><span style="text-align: justify;"><b style="font-family: inherit;">the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market". </b><span style="font-family: inherit;">It was obvious that FOMC members realize that market participants perceived tapering as </span>tightening. Given that interest rates have increased significantly since June, FOMC members wanted to let interest rates fall slightly in order to stimulate economic activity, especially in the housing sector. i.e. recent weekly mortgage applications have been decreasing at double digit percentage rates. This is attributable to the 120 bps rise in the 30-year mortgage rate from 3.5% to 4.7% in less than 3 months</span></li>
<li style="text-align: justify;">The recent run-up in rates has partially alleviated the Fed's concern about financial stability. Higher interest rates and speculation regarding a September taper helped to reduce the excessive levered positions taken by speculators. With less concerns regarding financial stability, the Fed decided to continue QE as risks to the recovery still remains</li>
<li style="text-align: justify;">Fiscal problems, such as the potential debt ceiling debate later this month and a possibility of a government shutdown, may slow the recovery. A repeat of 2011 would be disastrous for the financial markets and the Fed is just being cautious ahead of the negotiations </li>
</ul>
<br />
<div style="text-align: justify;">
In the final analysis, all of the points above explain why the Fed decided to keep the size of its asset purchase program at $85 billion and did not taper QE. Also, it is interesting to note that FOMC members lowered their GDP forecast for 2013 to 2.0-2.3% from 2.3%-2.6%. </div>
<div style="text-align: justify;">
<br /></div>
<b><u>When Will the Fed Taper?</u></b><br />
<b><u><br /></u></b>
<i>Don't count on the 7.0% and 6.5% thresholds:</i><br />
<br />
<div style="text-align: justify;">
Many analysts thought Bernanke was giving specific guidance when he indicated that the QE program will end by the time the unemployment rate hit 7.0% and a first hike will occur when the unemployment rate hit 6.5%. Because the Fed chairman uses words like "depends", "subject to", and "data dependent" when explaining Fed policy, investors should rely less on the numbers provided and more on the chairman's qualitative descriptions. He made it clear in today's press conference that the numbers provided were used as illustrations to describe potential exit strategies. Also, the 7.0% and 6.5% are used as thresholds, not as triggers. QE does not necessarily end when the unemployment rate drops below 7.0%. By the same token, a rate hike is not automatically considered if the unemployment rate drops below 6.5%. Investors must remember that the Fed has a dual mandate of maximum employment and price stability. Whether QE is a good policy tool or not is debatable, but FOMC members are simply doing their job by promoting maximum employment when they decided to not taper today. </div>
<br />
<i>The Fed will taper when the labour market has improved "substantially":</i><br />
<i><br /></i>
As discussed above, the Fed will taper QE when the labour market improve substantially. A substantial improvement can be defined when all the conditions below are satisfied:<br />
<ul>
<li>When the 6 month average payrolls number is near or above the 200K level </li>
<li>Unemployment is below 7% AND the labour participation rate shows some improvement from current levels</li>
<li>Wage growth is at or above the current 2% level</li>
<li>Improvement in other labour market statistics: lower longer term unemployment, lower number of discouraged workers and higher private payrolls</li>
</ul>
<i><br /></i>
<i>The actual timing is difficult to ascertain but the Fed will eventually taper: </i><br />
<br />
<div style="text-align: justify;">
In my opinion, predicting when the Fed will taper is a pure gamble. Because the FOMC hinted at the possibility of tapering in the "coming meetings" in today's statement, investors should expect a taper announcement either in the October or December meeting depending on the incoming economic data. Investors are making a mistake if they think the Fed will continue its easy monetary policy. Generally, the economy is on a better footing compared to last year, so less monetary stimulus is justified. The Fed needs to communicate clearly to the market on how it will reduce QE over time when it begins to taper QE. Overreactions in the financial markets, such as the rate shock in June, can spill over to the real economy and damage the underlying recovery. </div>
<div style="text-align: justify;">
<b><u><br /></u></b></div>
<b><u>Implication for Investments:</u></b><br />
<br />
<div style="text-align: justify;">
Today's Fed announcement did not change my long term investment outlook. Investors are facing a rising interest rate environment in the long run and chasing after yields is a bad strategy. Short to intermediate term bonds are better choices than long term bonds, although the long-end of the curve may outperform in the short term. As for equities, valuations are no longer attractive and caution is warranted given that lower interest rate (the driver of lower discount rates) won't be around forever. However, equities are not terribly overpriced either, so betting against stocks is also not a good strategy. I am maintaining all my long equity positions, although I may sell into large rallies in the upcoming months. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
The energy and materials sectors will benefit from today's Fed announcement and will outperform in the short term. Because these two sectors were the laggard this year, investors may benefit from overweight energy and materials stocks relatively to other sectors. Nonetheless, individual stock selection is important given that not all stocks in the energy or materials sectors are attractive. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
There will always be opportunities to take advantage of one-sided expectations. As described in my prior posts, the 10-year treasury with a 3% yield is too high because higher rates will eventually cripple the recovery. After today's rate announcement, the yield decreased to 2.7%. If the yield drops below 2.3% in the upcoming month, a short rates trade may look attractive. The 2.3% was the yield before Bernanke laid out the framework for tapering QE in the June 19th FOMC press conference. The Fed will taper eventually so any large drop in rates, especially within a short time period, provides a good opportunity to short rates. <br />
<br />
All in all, investors should remember this: financial assets (stocks or rates) don't grow to the sky, nor do they fall to the floor. </div>
<div style="text-align: justify;">
<br /></div>
-----<br />
<u><b>Appendix: FOMC policy statement [1], bolded sentences are important.</b></u><br />
<br />
<div style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 13px; text-align: justify;">
Information received since the Federal Open Market Committee met in July suggests that economic activity has been expanding at a moderate pace. Some indicators of labor market conditions have shown further improvement in recent months, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has been strengthening,<b> but mortgage rates have risen further and fiscal policy is restraining economic growth</b>. Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee's longer-run objective, <b>but longer-term inflation expectations have remained stable</b>.</div>
<div style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 13px; text-align: justify;">
<br /></div>
<div style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 13px; text-align: justify;">
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, <b>but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market</b>. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.</div>
<div style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 13px; text-align: justify;">
<br /></div>
<div style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 13px; text-align: justify;">
Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy<b>. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.</b> Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.</div>
<div style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 13px; text-align: justify;">
<br /></div>
<div style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 13px; text-align: justify;">
<b>The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. In judging when to moderate the pace of asset purchases, the Committee will, at its coming meetings, assess whether incoming information continues to support the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective. </b>Asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's economic outlook as well as its assessment of the likely efficacy and costs of such purchases.</div>
<div style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 13px; text-align: justify;">
<br /></div>
<div style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 13px; text-align: justify;">
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that <b>a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.</b> In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.</div>
<div style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 13px; text-align: justify;">
<br /></div>
<div style="background-color: white; font-family: Arial, Helvetica, sans-serif; font-size: 13px; text-align: justify;">
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Charles L. Evans; Jerome H. Powell; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations</div>
<br />
<br />
Source:<br />
[1] FOMC Statement <a href="http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm">http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm</a><br />
[2] FOMC Projects <a href="http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130918.pdf">http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130918.pdf</a><br />
[3] FOMC Press Conference <a href="http://www.ustream.tv/federalreserve">http://www.ustream.tv/federalreserve</a>Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com2tag:blogger.com,1999:blog-5042705291735134971.post-35671292893658253512013-09-10T12:10:00.003-07:002013-09-16T06:49:23.494-07:00A Big Change in the Dow Jones Industrial Average <div style="text-align: justify;">
For passive investors who invests in diamonds, cubes and spiders (see footnote if you don't get this) , the announcement today made by S&P Dow Jones indices should have caught your attention. The index provider has announced that Goldman Sachs (GS), Nike (NKE) and Visa (V) will replace Hewlett Packard (HPQ), Alcoa (AA), and Bank of America (BAC) in the Dow Jones Industrial Average after the close of September 20th. This is a major component change for the Dow Jones index since 2011. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Just a brief history on the index, the Dow Jones Industrial Average was created in 1896 when Charles Dow compiled the prices of 12 leading industrial stocks to create a barometer for general business conditions. The index's components increased to 30 by the end of 1928 and numerous revisions were made to the index on a periodic basis. Companies are removed if they no longer considered a leading blue chip company and S&P Dow Jones indices has several methodologies on deciding which company should be added or removed. Out of the 12 original Dow components, GE is the only one that remains. </div>
<br />
What is noticeable about today's change is the addition of two high priced stocks, namely Goldman and Visa. These high priced stock may have a significant influence on how future performance of the Dow Jones Index is calculated given it is a price-weighted index. I have provided a discussion below on price-weighted vs. market-weighted (sometimes called value weighted) indices.<br />
<br />
<b><u>The difference between a price weighted index and market-weighted index:</u></b><br />
<br />
<br />
<u>Price Weighted Example:</u><br />
<div class="MsoNormal">
<o:p><br /></o:p></div>
<div class="MsoNormal">
<o:p>A price weighted index is calculated by adding the share price of all the stocks in the index and dividing the sum by the number of components as shown below: </o:p></div>
<div class="MsoNormal">
<o:p><br /></o:p></div>
<br />
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<br /></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Stock Price Time
t=0<o:p></o:p></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Stock Price Time
t=1 <o:p></o:p></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Return <o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Stock A<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">10<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">15<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">+50%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Stock B<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">20<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">10<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">-50%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Index <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">15 (average
A&B price)<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">12.5</span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 119.7pt;" valign="top" width="160"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">-16.7%<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<br />
<div style="text-align: justify;">
Despite the average return of the two stocks is 0%, the price weighted index suffered a remarkable 16.7% decline because stock B, the more heavily weighted one, dropped 50%. The weakness of a price-weighted index is that the performance of higher priced stocks can have a huge impact on the overall index performance. </div>
<br />
<br />
<u>Market-Weighted Example (price assume same at t=0 and t=1 as last table)</u>:<br />
<br />
<br />
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184; width: 638px;">
<tbody>
<tr>
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.05pt;" valign="top" width="73"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<br /></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Shares
Outstanding<o:p></o:p></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 4.0cm;" valign="top" width="151"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Market Cap t=0 (shares x price) <o:p></o:p></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 129.5pt;" valign="top" width="173"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Market Cap Time
t=1 <o:p></o:p></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 95.75pt;" valign="top" width="128"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Return <o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.05pt;" valign="top" width="73"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Stock A<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">10<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 4.0cm;" valign="top" width="151"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">100 <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 129.5pt;" valign="top" width="173"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">150<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 95.75pt;" valign="top" width="128"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">+50%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.05pt;" valign="top" width="73"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Stock B<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">5<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 4.0cm;" valign="top" width="151"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">100<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 129.5pt;" valign="top" width="173"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">50<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 95.75pt;" valign="top" width="128"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">-50%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.05pt;" valign="top" width="73"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">Index <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 3.0cm;" valign="top" width="113"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<br /></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 4.0cm;" valign="top" width="151"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">200 (sum A+B)<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 129.5pt;" valign="top" width="173"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">200 (<o:p></o:p></span><span style="font-family: 'Times New Roman', serif;">sum A+B)</span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 95.75pt;" valign="top" width="128"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: "Times New Roman","serif";">0%<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<br />
<div style="text-align: justify;">
With a market-weighted index, the result is completely different than the price-weighted index. The index returned 0%, which is the average return of stock A and B (given they have same market-cap). In a market-weighted index, the individual weights for any stock depends on its market capitalization (share price times shares outstanding) rather than its absolute share price. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
The examples above show the weakness of price-weighted indices. The performance of those indices is highly dependent on the returns of the higher priced stocks. For example, the Dow Jones's highest priced stock is IBM (current at $200), but many Dow components' share price are below $100. Adding higher priced stocks like Goldman Sachs (at $165) and Visa (at $184) to the Dow Jones will skew the index's performance as more weight is given to these new components. The problem with large stock prices is the main reason why blue chip giants Apple (currently priced at $500) and Google (current priced at $900) are not added to the Dow Jones index despite they clearly represent leading blue chip companies. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
Not many major world market indices are price-weighted. For those who are curious, the only other major stock index that is priced weighted is Japan's Nikkei 225 index. The S&P500 and the TSX Composite are all market-weighted indices. </div>
<br />
<b><u>Implications for the Dow Jones Index going forward:</u></b><br />
<br />
<div style="text-align: justify;">
In the long run, the effect of this change is minor but this change is significant. Goldman and Visa together will represent 15% the Dow's returns, which could distort future price returns of the overall index. Passive investors investing in ETFs such as DIA, should realize that their investment is now more concentrated in the financial sector given that 2 financial companies are added and only one was removed. Also, given the extraordinary high share prices of Goldman and Visa, passive investors are over-weighting financials due to the price-weighted nature of the Dow Index. This is something to keep in mind for passive investors when constructing a portfolio or re-balance their current ones. In addition, for traders using the Dow Theory to predict future prices, the components change will likely alter price patterns of the index and traders need to make the necessary adjustments to minimize price fluctuations due to this components change. </div>
<div style="text-align: justify;">
<br /></div>
<div style="text-align: justify;">
---------</div>
<br />
<b>Source: </b><a href="http://press.djindexes.com/index.php/goldman-sachs-visa-nike-set-to-join-the-dow-jones-industrial-average/">http://press.djindexes.com/index.php/goldman-sachs-visa-nike-set-to-join-the-dow-jones-industrial-average/</a><br />
<br />
<div style="text-align: justify;">
<b>Footnote:</b> Diamonds, cubes and spiders refer to the classes of Exchange Traded Funds (ETFs) that track the three biggest indices. Diamonds refers to the DIA which tracks the Dow Jones Industrial Average. Cubes refers to the QQQ which tracks the NASDAQ 100. Spiders refers to SPY which tracks the S&P500. ETFs are exchanged traded instruments that is designed to track an underlying index like the Dow Jones or S&P500. ETFs are often lower cost investment products compared to a traditional mutual funds. </div>
Anonymoushttp://www.blogger.com/profile/10345713816107253844noreply@blogger.com1tag:blogger.com,1999:blog-5042705291735134971.post-40010484662004863282013-08-29T17:29:00.001-07:002013-09-02T14:44:21.269-07:00 Review Canadian Banks after Q3 Earnings<div style="text-align: justify;">
<i><span style="font-family: inherit;">Please note I use stock symbols to refer to the banks. BMO and TD are self explanatory. RY refers to RBC, BNS refers to Scotiabank, and CM refers to CIBC. The financial data were all taken from the company's respective websites. I cannot guarantee 100% accuracy but all numbers should be correct. </span></i></div>
<div style="text-align: justify;">
<i><span style="font-family: inherit;"><br /></span></i></div>
<div style="text-align: justify;">
<i><span style="font-family: inherit;">I have provided a glossary of key banking terms at the end of the article </span></i></div>
<span style="font-family: inherit;">-----</span><br />
<span style="font-family: inherit;"><br /></span>
<span style="text-align: justify;">I will provide a quick overview of the Q3 earnings and then I will explain why I believe TD and BNS will outperform vs. their peers in the next 6-12 months. </span><br />
<div>
<br /></div>
<b><span style="font-family: inherit;"><u>General Overview: </u></span></b><br />
<b><span style="font-family: inherit;"><br /></span></b>
<span style="font-family: inherit;">
</span>
<br />
<div style="text-align: justify;">
<span style="font-family: inherit;">Q3 Canadian bank earnings were definitely better than street consensus. Analysts were modeling for a softer quarter as they assumed that slower housing activities in Canada and lower Canadian GDP growth affected the banks' Canadian divisions. Nonetheless, the big five banks showed exceptional operational excellence by dealing with the difficult operating environment. Share price reactions, after the announcements, were limited with the exception of TD and CM, which saw gains of 2% after reporting earnings that blew past analysts' estimates. </span></div>
<div style="text-align: justify;">
<span style="font-family: inherit;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: inherit;"><u>Some general trend in the Q3 reports:</u></span></div>
<ul>
<li style="text-align: justify;"><span style="font-family: inherit;">Canadian banking (P&C) is still the main driver of overall earnings. The average contribution from the Canadian banking segment for the big five is 52.4% and that segment experienced a 10.0% year-over-year (Y/Y) increase in earnings, in-line with the average Y/Y increase of 10.2% in overall earnings for the big five banks</span></li>
<li style="text-align: justify;"><span style="font-family: inherit;">The higher interest rate environment will limit declines in net interest margin or NIM (a key profit ratio). Most banks expect their NIMs to remain relatively flat, which is good news considering many banks have guided investors in the past that NIMs will steadily decline. Table 3 shows that despite NIMs being down 4 bps (-0.04%) on average Y/Y, they are up 2 bps (+0.02%) Q/Q </span></li>
<li style="text-align: justify;"><span style="font-family: inherit;">The credit environment is definitely improving. PCL ratios are slightly lower than historical averages for each bank respectively. </span></li>
<li style="text-align: justify;"><span style="font-family: inherit;">The banks' capital levels are strong even on a Basel III basis. Tier 1 common equity ratio averaged 9.1% among the big five banks. That is significantly higher than the Basel Committee's 7% proposal. Higher capital levels provide a safety cushion and allow banks the flexibility to return excessive capital back to shareholders or re-invest them back into their businesses. Most banks have Normal Course Issuer Bids (NCIB) to repurchase shares. CM announced a new NCIB program in their Q3 results</span></li>
<li style="text-align: justify;"><span style="font-family: inherit;">BNS, TD and RY increased dividends this quarter to align their payout ratios near the targeted 40-50%. </span></li>
</ul>
<span style="font-family: inherit;"><br /></span>
<i><span style="font-family: inherit;">Table 1: Quarterly comparison of adjusted EPS (adjusted EPS excluding one-time items and amortization of intangibles): </span></i><br />
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Bank<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Q3/2012<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Q2/2013<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Q3/2013<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Y/Y Change**<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Q/Q Change***<o:p></o:p></span></b></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">BMO<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$1.49<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$1.46<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$1.68<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">12.8%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">15.1%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">BNS<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$1.16<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$1.27<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$1.24<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">6.9%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">-2.4%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">CM<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$2.12<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$2.06<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$2.29<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">8.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">11.2%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">RY<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$1.29<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$1.29<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$1.46<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">13.2%
<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">13.2%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">TD*<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$1.91<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$1.90<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$2.10<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">9.9%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">10.5%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><br /></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><br /></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><br /></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Average:<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">10.2%<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 79.8pt;" valign="top" width="106"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>9.5%</b><o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<span style="font-family: inherit; line-height: 115%;">*TD exclude an after-tax charge of $418 million ($0.45/share) relating to severe weather</span><br />
<div class="MsoNormal">
<span style="font-family: inherit; line-height: 115%;">** Y/Y change is percentage year-over-year change in earnings </span></div>
<div class="MsoNormal">
<span style="font-family: inherit; line-height: 115%;">*** Q/Q change is percentage quarter-over-quarter change in earnings <o:p></o:p></span><br />
<span style="font-family: inherit;"><span style="line-height: 115%;"><br /></span></span>
<br />
<span style="font-family: inherit;"><span style="line-height: 115%;"><br /></span></span>
<br />
<div style="text-align: justify;">
<span style="font-family: inherit; line-height: 115%;">RY and BMO experienced a stellar quarter with double digit Y/Y and Q/Q percentage increases while BNS experienced the lowest growth due to challenges in its emerging market businesses. Looking ahead, BNS's poor performance is likely to reverse since emerging market volatility has decreased since July. BMO's growth is likely to slow in Q4 because its Q3 earnings were driven by some one-time factors such as recoveries on impaired loans. Overall, the earnings trend looks favourable for TD and RY. Nevertheless, the reversal of BNS's poor Q3 performance may also imply a positive earnings outlook for BNS as well. </span></div>
<br />
<br /></div>
<i><span style="font-family: inherit;">Table 2: General comparison of key ratios of the big five banks</span></i><br />
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><br /></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">BMO<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">BNS<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">CM<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">RY<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">TD<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Avg.<o:p></o:p></span></b></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Tier
1 Common Ratio (Basel III)<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">9.6%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">8.6%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">9.3%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">9.2%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">8.9%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">9.1%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">ROE
(to common) <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">15.6%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">16.2%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">21.6%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">20.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">13.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">17.3%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Total efficiency ratio<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">62.8%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">53.3%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">55.6%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">55.4%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">62.5%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">57.9%<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<span style="font-family: inherit;"><br /></span><span style="font-family: inherit;"><br /></span>
<b><u><span style="font-family: inherit;">Canadian P&C Banking Results:</span></u></b><br />
<span style="font-family: inherit;"><i><br /></i>
<i>Table 3: Canadian banking results among the big five </i></span><br />
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><i>$ in millions</i><o:p></o:p></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>BMO<o:p></o:p></b></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>BNS<o:p></o:p></b></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>CM<o:p></o:p></b></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>RY<o:p></o:p></b></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>TD<o:p></o:p></b></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>Avg.</b><o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Canadian
P&C earnings<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$500<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$590<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$654<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$1163<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$973<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">N/A<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"> As % of total earnings <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">44.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">33.0%
<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">69.2%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">52.5%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">63.2%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">52.4%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"> Y/Y % change
in earnings <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">8.2%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">13.5%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">9.7%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">7.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">12.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">10.0%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Loan growth Y/Y <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">10.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">6.6%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">7.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">5.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">4.4%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">6.6%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Loan growth Q/Q<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">3.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">0.7%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.2%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.3%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.4%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Deposit growth Y/Y<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">8.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">3.1%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.9%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">7.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">4.2%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">4.8%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Deposit growth Q/Q<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">3.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.1%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">0.6%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.4%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.4%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">∆
NIM Y/Y <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">-18
bps<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">-4 bps<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">+6
bps<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">-2
bps<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">-3
bps<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">-4
bps<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">∆
NIM Q/Q<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">- 1bps<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">+3 bps<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">-1
bps<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">+6
bps<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">+3
bps<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">+2
bps<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Efficiency ratio <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">50.6%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">49.6%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">48.9%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">44.2%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">44.5%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">47.6%<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<span style="font-family: inherit;"><i><br /></i>
</span><br />
<div style="text-align: justify;">
<span style="font-family: inherit;">Canadian banking divisions of the big 5 are still showing strong growth despite a tough operating environment. Earnings growth of 10% Y/Y is very impressive, partly due to higher volume growth ( + 6.6% Y/Y in loan growth) and lower efficiency ratios </span>obtained<span style="font-family: inherit;"> through positive operating leverage. RY and TD's efficiency ratios reached record lows due to cost cutting initiatives. Bank executives acknowledged on the conference calls that high earnings growth will be difficult to achieve for the next few quarters. Thus, investors may have to lower their earnings growth expectations from the current 10% run-rate, although earnings will not fall off a cliff as some suggested. With lower earnings growth in the Canadian P&C divisions, investors should favour banks with the highest operating leverage and lowest efficiency ratio like TD or RY. Also, the trend for NIMs are more favourable for TD and RY than the other three banks. The success of this division is key to potential share price appreciation.</span><br />
<span style="font-family: inherit;"><br /></span>
<span style="font-family: inherit;"><br /></span>
<span style="font-family: inherit;"><br /></span></div>
<b><u><span style="font-family: inherit;">Credit Analysis:</span></u></b><br />
<span style="font-family: inherit;"><b><u><br /></u></b>
<i>Table 4: Provision for Credit Losses (PCL) of big 5 banks:</i></span><br />
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<i><span style="font-family: inherit;">$ in millions <o:p></o:p></span></i></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">BMO<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">BNS<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">CM<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">RY<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">TD<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>Avg.</b><o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
PCL</div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$77<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$314<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$320
<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$267<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$477<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">N/A<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"> PCL Ratio (%)<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">0.11<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">0.31<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">0.45
<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">0.26<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">0.43<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">0.31<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<span style="font-family: inherit;"><b><u><br /></u></b>
</span><br />
<div style="text-align: justify;">
<span style="font-family: inherit;">Overall credit remains strong at the big five banks. BMO's PCL of $77 million looks low relatively to its historical $150 million run-rate averaged in the past few quarters. The low number was due to a huge recovery on M&I's (a U.S. bank BMO acquired in 2011) impaired loan portfolios. </span></div>
<span style="font-family: inherit;"><br /></span>
<br />
<span style="font-family: inherit;"><br /></span>
<br />
<div style="text-align: justify;">
<span style="font-family: inherit;"><br /></span></div>
<u><b><span style="font-family: inherit;">Capital Markets and Wealth Management:</span></b></u><br />
<span style="font-family: inherit;"><br /></span>
<i><span style="font-family: inherit;">Table 5: Capital market earnings of big five banks: </span></i><br />
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><i>$ in millions</i><o:p></o:p></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">BMO<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">BNS<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">CM<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">RY<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">TD<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Avg.<o:p></o:p></span></b></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Capital
Market Earnings<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">281<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$361<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$175<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$388<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$147<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">N/A<o:p></o:p></span></div>
</td>
</tr>
<tr style="height: 2.8pt; mso-yfti-irow: 2; mso-yfti-lastrow: yes;">
<td style="border-top: none; border: solid windowtext 1.0pt; height: 2.8pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"> As % of total Earnings<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 2.8pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">24.7%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 2.8pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">20.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 2.8pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">18.6%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 2.8pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">21.0%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 2.8pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">9.3%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; height: 2.8pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">18.7%<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<span style="font-family: inherit;"><br /></span>
<br />
<div style="text-align: justify;">
<span style="font-family: inherit;">Capital market divisions of the big five performed well in light of the market volatility sparked by the Fed's </span>tapering <span style="font-family: inherit;">announcement. Bank executives stated that fixed income trading remains challenging as spreads widened and long term rates rose. Earnings from capital markets divisions </span>can fluctuate significantly quarter-over-quarter and large earnings growth in this segment does not necessarily translate into solid long term <span style="font-family: inherit;">earnings growth. The increased volatility in fixed income and equity markets in August may lower trading revenues in the 4th quarter. G</span>iven that capital market conditions appear less favourable in the next quarter,<span style="font-family: inherit;"> investors should favour a bank like TD, which has the lowest contribution from its capital market business. </span><br />
<span style="font-family: inherit;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: inherit;">Wealth management remains a bright spot for most banks. As fee-based accounts increase, fee income from this division will provide stable earnings and can offset potential profit decline in capital market divisions. BNS and RY are best positioned for growth in the wealth management space. Both spent billions growing their wealth businesses via large </span>acquisitions<span style="font-family: inherit;"> in the past two years. Canadian banks are grabbing market share from independent fund companies at a rapid pace because smaller dealers are unable to compete with the big five's large distribution channels and economies of scale. </span></div>
<span style="font-family: inherit;"><b><u><br /></u></b>
<b><u>Dividends:</u></b></span><br />
<span style="font-family: inherit;"><b><u><br /></u></b>
</span><br />
<i><span style="font-family: inherit;">Table 6: Dividend data of big five banks: </span></i><br />
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><br /></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">BMO<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">BNS<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">CM<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">RY<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">TD<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Avg.<o:p></o:p></span></b></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">TTM earnings <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$6.30<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$5.04<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$8.60<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$5.36<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$7.38<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">N/A<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Targeted payout ratio <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">40-50%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">40-50%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">40-50%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">40-50%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">40-50%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">40-50%<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2013 dividends <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$2.94<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$2.39<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$3.82<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$2.53<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$3.24<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">N/A<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"> Implied payout ratio <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">46.6%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">47.4%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">44.4%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">47.2%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">43.9%<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">45.9%<o:p></o:p></span></div>
</td>
</tr>
</tbody></table>
<span style="font-family: inherit;">*TTM = Trailing Twelve Months</span><br />
<span style="font-family: inherit;"><br /></span>
<br />
<div style="text-align: justify;">
<span style="font-family: inherit;">Most banks are near the mid-range of their targeted 40-50% payout ratio. TD is the furthest away from the middle of that range. Dividend investors should prefer TD since it has the best potential to increase its dividend. Given the pattern of dividend hikes every 2 quarters from TD, RY and BNS, expect a dividend hike in Q1/2014 from those three banks. BMO and CM are not regular dividend hikers but prefer to return more capital via buybacks.</span></div>
<span style="font-family: inherit;"><br /></span>
<span style="font-family: inherit;"><br /></span>
<b><u><span style="font-family: inherit;">Current Valuation Levels of Canadian Banks:</span></u></b><br />
<span style="font-family: inherit;"><b><u><br /></u></b>
<i>Table 7: Market and Valuation Data </i></span><br />
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;"><tbody>
<tr><td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<i><span style="font-family: inherit;">As of Aug.29<o:p></o:p></span></i></div>
</td><td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">BMO<o:p></o:p></span></b></div>
</td><td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">BNS<o:p></o:p></span></b></div>
</td><td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">CM<o:p></o:p></span></b></div>
</td><td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">RY<o:p></o:p></span></b></div>
</td><td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">TD<o:p></o:p></span></b></div>
</td><td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>Avg.</b><o:p></o:p></span></div>
</td></tr>
<tr><td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Price<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$66.88<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$58.33<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$82.66<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$65.24<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$89.93<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">N/A<o:p></o:p></span></div>
</td></tr>
<tr><td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Dividend Recent Quarterly Annualized<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$2.96<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$2.48<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$3.84<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$2.68<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$3.40<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">N/A<o:p></o:p></span></div>
</td></tr>
<tr><td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Dividend Yield<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">4.4%<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">4.3%<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">4.6%<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">4.1%<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">3.8%<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">4.2%<o:p></o:p></span></div>
</td></tr>
<tr><td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Earnings (TTM)<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$6.30<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$5.04<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$8.60<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$5.36<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$7.38<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">N/A<o:p></o:p></span></div>
</td></tr>
<tr><td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">P/E (TTM)<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">10.6X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">11.6X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">9.6X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">12.2X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">12.2X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">11.2X<o:p></o:p></span></div>
</td></tr>
<tr><td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Book Value<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$42.38<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$32.51<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$40.11<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$29.59<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$50.04<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">N/A<o:p></o:p></span></div>
</td></tr>
<tr><td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">P/BV<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.6X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.8X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.1X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.2X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.8X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.9X<o:p></o:p></span></div>
</td></tr>
<tr><td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Tangible Book<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$34.08<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$23.71<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$34.00<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$21.96<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$33.06<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">N/A<o:p></o:p></span></div>
</td></tr>
<tr><td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">P/TBV<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.0X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.5X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.4X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">3.0X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.7X<o:p></o:p></span></div>
</td><td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.75pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.5X<o:p></o:p></span></div>
</td></tr>
</tbody></table>
<b style="font-family: inherit;"><u><br /></u></b><span style="font-family: inherit;"> </span><a href="https://docs.google.com/file/d/0B4Tpbylx1OfvR0ZlUUM0RnNCd0k/edit?usp=sharing" style="font-family: inherit;">ATTACHED is a link graphs of historical Price-to-Book Ratios </a><span style="font-family: inherit;">. Please click the link on the left to view a PDF document of the charts. </span><span style="font-family: inherit;">Canadian banks are still trading at reasonable multiples compared to the past 12 years. Also, the graphs show that BNS is trading below the peer average, compared to its past history of trading at a premium compared to the peer average. BNS also has the highest differential between its current book multiple and its 12-year average multiple compared to the other 4 banks. </span><br />
<span style="font-family: inherit;"><br /></span>
<br />
<div style="text-align: justify;">
<span style="font-family: inherit;">As table 7 illustrates, Canadian banks are trading at 11.2X trailing earnings and 1.9X book. Compared to the big 4 American banks (BAC, C, WFC, JPM), which trade at 16.4X trailing earnings and 1.1X book, Canadian banks look slightly more expensive but the valuation gap has definitely narrowed after U.S. bank stocks gained over 20% YTD. On an earnings basis, Canadian banks are slightly cheaper especially looking at the average 10.8X forward P/E ratio. Accounting for the 4.2% average dividend yield, total annual share returns for the banks should be around the 10% level. </span><br />
<br />
<div style="text-align: start;">
<b><u><span style="font-family: inherit;">A Sample Price-to-Book Multiple Analysis:</span></u></b></div>
</div>
<div style="text-align: justify;">
<span style="font-family: inherit;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: inherit;">The table 8 provides a sample valuation based on 3-year average price-to-book ratios. I chose 3-year (August 2010-August 2013) because it represents the average of the post financial crisis era. This valuation method is crude but it does provide a rough guideline on which bank have the potential to outperform relatively vs. its peers because banks exhibit a strong pattern of mean reversion. The analysis below shows that BNS and CM provide good potential to outperform vs. their peers although this analysis does not take into account multiple expansions or contractions due to fundamental factors. The table below is purely a mechanical exercise and serves as a rough guide to see which banks look relatively undervalued vs. peers.</span></div>
<span style="font-family: inherit;"><b><u><br /></u></b>
<i>Table 8: Sample Book Value Valuation </i></span><br />
<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0cm 5.4pt 0cm 5.4pt; mso-yfti-tbllook: 1184;">
<tbody>
<tr>
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><br /></span></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">BMO<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">BNS<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">CM<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">RY<o:p></o:p></span></b></div>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>TD</b><o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Book value<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">$42.38<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">$32.51<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">$40.11<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">$29.59<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>$50.04</b><o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">3-year
average multiple<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.63X<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.16X<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.26X<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.22X<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">1.75X<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Price forecast average book multiple
(A) <o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$69.08<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$68.27<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$90.64<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$65.69<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$87.57<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td colspan="6" style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 422.05pt;" valign="top" width="563"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><br /></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">Tangible
book <o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">$34.08<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">$23.71<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">$34.00<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">$21.96<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>$33.06</b><o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">3-year
average multiple<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.0X<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">3.05X<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.75X<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">3.05X<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">2.82X<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Price forecast average tangible book
(B)<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$68.16<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$72.32<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$93.50<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$66.98<o:p></o:p></span></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;">$93.23<o:p></o:p></span></div>
</td>
</tr>
<tr>
<td colspan="6" style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 422.05pt;" valign="top" width="563"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><br /></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">Average (A) & (B)<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">$66.46<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">$70.30<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">$92.07<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<b><span style="font-family: inherit;">$66.34<o:p></o:p></span></b></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<span style="font-family: inherit;"><b>$90.40</b><o:p></o:p></span></div>
</td>
</tr>
<tr>
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 134.1pt;" valign="top" width="179"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<i><span style="font-family: inherit;">Implied % gain from current market price<o:p></o:p></span></i></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 58.25pt;" valign="top" width="78"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<i><span style="font-family: inherit;">-0.6%<o:p></o:p></span></i></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 57.35pt;" valign="top" width="76"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<i><span style="font-family: inherit;">+20.5%<o:p></o:p></span></i></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 56.3pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<i><span style="font-family: inherit;">+11.4%<o:p></o:p></span></i></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 55.9pt;" valign="top" width="75"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<i><span style="font-family: inherit;">+1.7%<o:p></o:p></span></i></div>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0cm 5.4pt 0cm 5.4pt; width: 60.15pt;" valign="top" width="80"><div class="MsoNormal" style="margin-bottom: 0.0001pt;">
<i><span style="font-family: inherit;">+0.5%</span></i></div>
</td></tr>
</tbody></table>
<span style="font-family: inherit;"><br /></span>
<span style="font-family: inherit;"><b><u><br /></u></b>
<b><u>Conclusion: Which Bank is a Better Investment?</u></b></span><br />
<span style="font-family: inherit;"><br /></span>
<br />
<div style="text-align: justify;">
<span style="font-family: inherit;">At the start of the year, I liked RY and TD with BNS ranking 3rd, CM ranking 4th and BMO ranking 5th. I liked RY because of its strategic positioning in its capital markets businesses, which benefited from QE3. RY's rapid growth in wealth management and excellent efficiency in Canadian banking were also positives. I liked TD because of its attractive U.S. growth profile and solid Canadian banking operations. Now with recent changes in share prices and business developments, I like BNS now and still like TD with CM ranking 3rd, RY ranking 4th and BMO ranking 5th. </span></div>
<div style="text-align: justify;">
<span style="font-family: inherit;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: inherit;">The recent decline in BNS's share price from its February highs is hard to ignore. Given it is trading below the average price-to-book of 1.9X, it is undervalued. BNS rarely traded below the peer average for the last 5 years. BNS investors caught the taper tantrum as emerging markets experienced significant volatility in the past two months after the Fed hinted at tapering QE. Although the volatility may continue, BNS's share price already reflects this risk and higher prices are on the horizon in the next 6-12 month. The price-to-book of 1.75 is very low for a bank that provided consistent earnings growth in the past 5 years and BNS possess an excellent business mix. Retail banking, wholesale banking (capital markets) and wealth management </span>each <span style="font-family: inherit;">contribute 1/3 to earnings , providing a very balanced business mix for the bank. BNS's price-to-book averaged near 2 excluding recent months. Therefore, a multiple expansion to 2X book imply that its shares should trade near $65, up 11% from today's price. </span></div>
<div style="text-align: justify;">
<span style="font-family: inherit;"><br /></span></div>
<div style="text-align: justify;">
<span style="font-family: inherit;">Despite the outperformance of TD in the most recent 6 months, it will continue to perform well in the next few quarters. The average price-to-book for TD was significantly above 2 prior to 2008 crisis. Now with a growing U.S. P&C division. which was acquired after the financial crisis, TD should trade at a multiple of at least 2X book. Thus, implying a share price of ~$100 in the next 6-12 months. The $100 target implies a 11% gain from today's price. Also, investors should not forget that TD has the best potential to increase dividends down the road, one of the most important factor to consider as bank investors. </span></div>
<div style="text-align: justify;">
<br /></div>
<div style="-webkit-text-stroke-width: 0px; color: black; font-family: 'Times New Roman'; font-size: medium; font-style: normal; font-variant: normal; font-weight: normal; letter-spacing: normal; line-height: normal; orphans: auto; text-align: justify; text-indent: 0px; text-transform: none; white-space: normal; widows: auto; word-spacing: 0px;">
<div style="margin: 0px;">
<div style="text-align: justify;">
<span style="font-family: inherit;">As for CM, there is an potential for share price appreciation once the discussion with Aimia regarding the Aeroplan credit card is finished. Since talks are still ongoing, CM shares may still lag in the short term but the potential for gains is there. Its shares underpeformed its peers in the past few months due to the uncertainty regarding the Aimia discussions, pushing CM's valuation to the lowest since 2009. Thus, a reversal of the recent price decline is possible in the months ahead. </span><br />
<span style="font-family: inherit;"><br /></span>
<span style="font-family: inherit;">RY's multiples, both on book and earnings basis, are trading </span>significantly<span style="font-family: inherit;"> higher than the peer average and fully justify the </span>better <span style="font-family: inherit;">underlying fundamentals of the company. RY is trading at 2.2X book vs. the peer average of 1.9X and 12.1X earnings vs. the peer average of 10.5X. I expect RY's share price to be flat or slightly higher over the 6-12 month. </span><br />
<span style="font-family: inherit;"><br /></span>
<span style="font-family: inherit;">BMO is still facing headwinds despite a good quarter in Q3. BMO's poor track record at lowering the efficiency ratio and failure to attain a sizable positive operating leverage will cause its share price to lag peers, although probably not significantly given Canadian bank stocks usually trend in the same direction. </span></div>
</div>
<div style="margin: 0px;">
<div style="text-align: justify;">
<span style="font-family: inherit;"><br /></span></div>
</div>
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<div style="text-align: justify;">
<span style="font-family: inherit;">All in all, TD and BNS will outperform their peer group while RY and BMO are likely to underperform. BNS's international franchise is currently undervalued because of short term volatility in emerging markets. This is temporary in nature and its emerging market exposure will be beneficial for long term earnings growth. As for TD, it can leverage its U.S. franchise to deliver additional earnings growth by benefiting from a recovering U.S. economy and increasing its economies of scale in its U.S. business. For dividend investors, TD also provides the highest 10-year dividend growth rate with compounded annual growth rate of 10% and the best potential to increase dividends down the road due to its low payout ratio. </span></div>
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<b><u><span style="font-family: inherit;">Glossary:</span></u></b><br />
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<span style="font-family: inherit;">This glossary intents to provide a short list of brief explanations of banking terminology for those readers that want a better understanding of these key terms</span></div>
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<span style="font-family: inherit;"><b>Adjusted or Cash EPS: </b>An EPS measure commonly cited by sell-side bank analysts when analyzing Canadian bank results. The cash EPS exclude amortization of intangibles, other non-cash items and one time items </span></div>
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<span style="font-family: inherit;"><b>Book Value: </b>Book value is an important measure when analyzing banks. Because banks hold securities that are mostly marked to market, most investors analyze banks by applying a simple price-to-book ratio calculated as by dividing the share price by the most recent book value per share. Book value per share for banks is calculated as equity to common shareholders divided by shares outstanding at end of period. Note that equity for common shareholders exclude non-controlling interests and preferred shares.</span></div>
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<span style="font-family: inherit;"><b style="line-height: 115%;">Efficiency Ratio: </b><span style="font-size: small;"><span style="line-height: 115%;">An expense ratio for banks which is calculated as non-interest expenses divided by total revenue. Non-interest expenses are all the fixed expenses of running the bank, which exclude interest expenses. A lower efficiency ratio shows that the bank is better at </span></span><span style="line-height: 18px;">controlling</span><span style="font-size: small;"><span style="line-height: 115%;"> expenses </span></span></span></div>
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<span style="font-family: inherit;"><b>NIM: </b>Abbreviation for Net interest margin. Net interest margin is net interest income divided by average earning assets. Net interest income is the difference between interest income (received from bank's borrowers) and interest expense (paid to bank's lenders). Total earning assets are sum of all the asset that can generate interest income. </span></div>
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<span style="font-family: inherit;"><b>Operating Leverage: </b>Operating leverage, for banks, is the difference between growth rate of revenue and growth rate of non-interests expense. For example, if a bank grew revenue by 5% while non-interest expense grew only 3%, the operating leverage is 2%. Bank investors want the bank with best operating leverage as higher growth rate in sales vs. expenses will lead to better bottom line results.</span></div>
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<span style="font-family: inherit;"><b>PCL: </b>Abbreviation for Provision for Credit Losses. This is the amount set aside every reporting period as reserve to cover potential loan losses or losses on impaired loans. This is like a bad debt expense learned in an accounting 101 class. PCL can be expressed as a ratio which compares the dollar PCL amount to the average of loans and acceptances number.</span></div>
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<span style="font-family: inherit;"><b>Tangible Book Value: </b> Adjusted book value to exclude goodwill and other intangibles</span><br />
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<span style="font-family: inherit;"><b>Tier 1 Common Equity Ratio: </b>This is the main capital ratio under the new Basel III rules which Canadian banks are already forced to comply by OSFI (Canada's banking regulator). It compares Tier 1 common equity to a bank's Risk Weighted Assets (RWA). Tier 1 common equity includes common stock and retained earnings, which are the most reliable form of capital for the bank. RWA is an subjective figure calculating by adjusting various bank assets to reflect the risks. For example, a $100 million government bond may only be $10 million under the RWA measure while a more risker $100 million corporate bond may be $80 million under RWA. Also, RWA includes some off-balance exposures as well. </span></div>
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