October 2008: by Darrell Nordstrom

Where's today's smart money?

The movie, "Forrest Gump" has a scene where Forrest and his war veteran lieutenant are on their shrimp boat in the middle of a turbulent ocean, doing their best to weather a vicious storm.

All the other boats stayed on shore, the perceived place of safety, only to be washed up on shore and completely destroyed. As the only surviving vessel, Forrest and his partner went on to catch all the shrimp and develop a highly successful fleet of boats.

It's an interesting and spellbinding movie that might have a lot to say about what's happening in today's stock market.

Clearly, most investors have chosen to retreat to their perceived place of safety - treasury bills - by selling their holdings and thereby driving down the price of those same stocks. The amount of money temporarily parked in T-bills is at historically high levels and the rate of return is at all-time low levels.

Assuming an investor placed $1 million in a T-bill account and this individual required $50,000 per year to cover basic living expenses, the T-bill account may become a destructive investment vehicle for three reasons.

1. $1M at 3% produces $30,000 yearly income, a shortfall of 20,000.

2. Interest income is fully taxable which results in approximately $5,000 of tax at Saskatchewan's lowest tax rates.

3. Inflation at 3% erodes the value of the $1M principle by another $30,000.

To summarize, the $1 million of capital is eroded by $25,000 because of the shortfall of income and by another $30,000 due to inflation. The total loss for the year is $55,000 and the loss will increase every year due to the erosion of the capital base. The "safe haven" obviously destroys capital and will not work as a long-term solution.

Warren Buffett, the "Oracle of Omaha," is regarded as one of the world's best investors. He is famous for his many quotes, one of which is "... Be fearful when others are greedy and be greedy when others are fearful." True to his words, with current investor fears running extremely high, Buffett purchased $5 billion of preferred shares of Goldman Sachs on Sept. 24.

The current market melt down has produced a large number of quality-based, high-value, blue chip equities at very attractive prices. These corporations have outstanding investment potential for many reasons such as strong management teams, low levels of debt, strong cash positions, steadily increasing sales, steadily increasing profits, consistently increasing dividends and limited competition.

All the fundamentals of these companies are particularly strong and their prices are discounted by 30 to 50 per cent or more. When considering the purchase of shares in a multibillion-dollar, well-run business that has an enviable long-term track record and consistently maintains its strong financial fundamentals, there is a price point at which there is no logical reason for not buying.

Two stocks with well-known names have an interesting story to tell. Power Corp, a Canadian stock that includes Great West Life, Canada Life, London Life, Investors Group and Mackenzie Financial shows revenue of $26 billion, $28 billion, $29 billion the past three calendar years and $42 billion the past 12 months.

Its earnings over the same time period have increased from $3.7 billion to $4.3 billion. Earnings per share have increased from $2.28 to $3 to $3.13 to $3.81. The dividend per share has increased from $.65 to $.76 to $.92 and is $1.16 for thepast 12 months. Arguably, this appears to be very good performance. The stock; however, is down 20 per cent.*

Another well-known example from south of the border is General Electric, one of the world's largest and oldest companies. It shows a similar pattern with revenue increasing from $149 billion to $163 billion to $172 billion in the past three years and earnings growing consistently from $37 billion to $43 billion to $50 billion.

Again, dividends have consistently increased as have earnings per share. This company is producing consistently improving results. Its share price, due to the fear in the market is down 39 per cent. Businesses should be purchased based on what their true value is and not necessarily the price set by the market on any particular day. To quote Buffett again, "...if a business does well the stock (price) eventually follows."

There are numerous quotes from Buffett that give wise advice resulting in tremendous stock market success. Google "Warren Buffett Quotes" and learn where today's smart money resides.

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About the author
Darrell Nordstrom, CFP, RFP, CLU, CHFC, is a Senior Financial Advisor with Regency Advisory Corporation. He can be reached at 1-800-465-2100 or 665-3244, or click to email Darrell Nordstrom.

Disclaimer
Please contact a professional advisor to discuss your particular circumstances prior to acting on the information above. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd.

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