Episode #5 - The Stock Market, an Investor's Guide: Portfolio Building From the Ground Up
Announcer: Welcome to The Money Clip podcast series from The Vault, Scotiabank’s online guide to helping Canadians get ahead financially. Listen in to gain a deeper understanding of your personal finances and find out how a few small changes to the way you manage your money can make a big difference.Michael Seaton: Thank you for joining us on our second Money Clip podcast series from Scotiabank. I’m Michael Seaton, Editor of The Vault program, which provides Canadians with a deeper understanding of personal finance and money related matters. Back with us today is Fred Ketchen, Director of Stock Trading for ScotiaMcLeod, who is here to discuss the ins and outs of the stock market. This is Part 2 of 3, and in this second segment, Fred will help us understand how to invest in the stock market and some of the choices investors should be aware of. Before we begin, we’d love to hear from you, our listener. Information on how to reach us with questions and comments will be provided at the end of the show. So welcome back, Fred, and thanks again for speaking with us. I’d like to start with a really basic question: How does someone go about buying a stock?
Fred Ketchen: Well, presumably, if you have intended to become an investor and you want to buy a stock, first thing you need to have is you have to have an account that is open at an investment dealer or a brokerage organization. Once that account has been properly opened and all of the information has been supplied that is required, now you have to decide what it is that you’re going to buy. You have to do your homework, however, first of all, and I think it’s extremely important that people take the time to understand, first of all, the workings of the stock market, know why you’re investing and know some of the attributes of investing. You know, all stocks don’t go up; some of them go down. Understand your risk tolerance so that you know what kind of issues that you’re going to invest in. The ones where you can go home at night, have a good night’s sleep, and be able to come back the next day and do it all over again. So do your homework, talk to your advisor, if you have an advisor. But in this business, you always have a choice: you have the choice of a full-service dealer, where you can go and have conversations with advisors, get information, leadership from that individual; or, you can go to the discount side of the operation where, of course, you make up your own mind, and you do, basically, your own trading almost, by doing it all online. So decide what it is that you want to do, how you want to do it, what you want to buy—go ahead and do it.
Michael Seaton: Excellent. So I’ve opened up my account now, I’m ready to start investing. How do I go about researching a company? What should I be looking for in my research—key indicators? And are there any sure-fire ways to show that a company is fundamentally sound for the long haul?
Fred Ketchen: Well, first of all, in the full-service brokerage business—investment business—you do have huge research departments that provide a lot of research on individual companies that advisors have access to, and they use that and pass that on to their clients. On the other hand, there are still ways where you can look for your own research. A whole lot of stuff is on the Internet. The whole history of an awful lot of companies is all there, including where they started, what year they started, their growth pattern. You can see their financial statements, you can see their discussions that they have with their investors in the investor community. And, for goodness sake, read the market pages in our newspapers and listen to radio and watch the television sets, because there is more business news available now than has ever been available before. You just have to be able to sift through it and decide what applies to you and what doesn’t. So when it comes to a particular company, I think the first thing you do is you look at that company’s history. Look at its successes, look at its challenges. Consider the knowledge and the ability of a company’s management. Consider their position in the industry in which they are located. Look at the industry itself. You know, some industries have risen in popularity and profit, some industries have fallen in popularity and, certainly, in profit. So know the position of the industry in our economy. Other things you need to know is—very, very important question—is this company that you’re looking at—is it profitable? And, if it’s important to you, does it pay dividends? In other words, you want to become a shareholder, does this company share its profits with you as a shareholder? Because, after all, as a shareholder, you own part of the company. A lot of work to do. It can be interesting and extremely rewarding.
Michael Seaton: And is it better—you touched on this a moment ago in the first question—in your opinion, is it better to work with a broker or to do it on your own?
Fred Ketchen: I think it very much depends upon your level of understanding of the stock market and how much time you want to spend on it. If you have little understanding and you need some direction, in my opinion, it’s better to have an advisor, but you’ve got to look for a good advisor. I mean, there are lots of them around, but we all have different relationships with different people. Some people are all very nice but I have trouble getting along with them for some particular reason; we just don’t see eye-to-eye on some things. So you search around. Talk to your friends, find out who they might use as a full-service advisor. “How do they get along with that person? What kind of advice has that person given to you? Has it been successful for you or has it not?” And I think you put all those things together, and you can decide for yourself whether that person is the one you need or whether you really have all the knowledge you now want by reading, listening, observing, and you can go off and do it your own way.
Michael Seaton: Excellent. So, with growth investing and value investing being tossed around in the business pages, what is the key difference between these two areas of growth and value, and which is the better style?
Fred Ketchen: Well, I’m not sure there is a better style. Sometimes you can combine these styles. If you’re looking at growth investing, you invest for growth, naturally; usually a non-dividend paying common stock of a company with expansion or with growth potential. The portion of the company’s profits that might have been paid as dividends to you is, in fact, put back into the company to finance that growth; thus, a growth company. You would buy growth stocks for their potential to provide capital gains rather than providing income in the form of dividends. Now then, for value investing, you try to find companies that are undervalued. Hopefully, they are good, solid businesses, whose shares have been overlooked by a raft of investors. You can help identify these opportunities by examining their financial history. And take a look at their price earnings ratio. Their price-to-earnings ratio, in other words, if they earned a dollar a share and the price of the stock is ten dollars, the P/E ration would be ten. Now, lots of companies have P/E ratios in the area of fifteen, eighteen; maybe that’s okay. But if you find a price-to-earnings ratio of, say, 33 or 50, as is sometimes the case, now that raises the flag, and you’ve got to know why is that price earnings ratio as high as it is. So, if it’s in a good industry, it’s a well-run company, and it has a lower P/E ratio than most other companies within that industry, it warrants a second look because this may provide exceptional opportunities. So that’s the value. Of course, then there is the other one, which is growth, value, and income investing, and that combines all of these things. And if you’re looking at those kinds of things, you know, you’d look at utilities, for instance, you’d look at bank shares, where you’d get growth, you get value, you get income.
Michael Seaton: Excellent. And aside from an individual stock, exchange traded funds have been in the news lately. What exactly is an ETF, as they’re called…
Fred Ketchen: Yes.
Michael Seaton: …and how do they work?
Fred Ketchen: Well, ETFs, exchange traded funds, are something like index mutual funds. Exchange traded funds are more immediate, however, because they trade just like stocks all session long, whereas index mutual funds, as with other mutual funds, are priced just once a day, and that pricing takes place at the market close. ETFs are based on, say, the S&P/TSX composite index, or it can be based on a certain market sector; maybe the gold group, maybe the energy group, could be the financial services sector. You pay a commission if you buy or sell an ETF, just as though it were an ordinary stock that you might buy on the market. You can sell it short, but you can’t sell a mutual fund short, of course. So, these are the aspects of exchange traded funds: they’re immediate, they’re like a mutual fund; but they have different attributes than what we would look at as a normal mutual fund. And a lot of people find them to be very, very attractive.
Michael Seaton: There’s a lot of talk of them in the news. There’s also a lot of talk—a very hot topic this week—of income trusts. And many companies have been converting to income trusts, but the recent announcement from the federal government has sort of shaken things up a bit. Can you help listeners understand the basics of an income trust, and how they work? And are they still a good investment in light of the changes recently announced?
Fred Ketchen: Well, an income trust is like a regular company. Let’s suppose you’ve got the regular company that you might want to go out and buy its shares. An income trust, basically, is just another type of a company, but it’s formulated a little differently. Where a regular listed company, like the Bank of Nova Scotia and its shares—the Bank of Nova Scotia pays taxes. When you look at an income trust, the difference is that an income trust has formed itself into a trust where the assets of the business are put in trust for all of the unit holders. Trusts, basically, are non-taxable. And so you’re buying one of those companies non-taxable, but all of the revenues—or the majority of revenues that that income trust receives over a period of time—the majority of that revenue is distributed to their unit holders. A lot of income trusts dispense that money on a monthly basis. If you ever wanted to know what it was like to receive the old age pension, you know, this is just like—it comes in every month, and it just comes in automatically; it’s kind of attractive. Now, if you’re looking at an income trust, would you buy it? Well, I would say this: if you wouldn’t buy it when it was a stock-traded company, a tax-paying company, you ought not to buy it just because it’s an income trust. But, like everything else, it’s a segment of the market. There are good opportunities, and there are not-so-good opportunities. So income trusts are no different. You’ve got to do your research on an income trust. Know its history, know its successes, know what kind of an industry it is in, and I would think that those kinds of opportunities will exist. Don’t forget, when Finance Minister Flaherty announced his change to the tax regime as it applies to income trusts, he said they’ve got time to adjust. This will not take place until 2011. No, there won’t be any more income trusts, but the ones that are there will have that kind of time, and the holders of those income trusts will have that kind of time to adjust to the new environment. But do your homework. Opportunities are still there, but make sure that you understand where the challenges and the dangers are.
Michael Seaton: And specific to those challenges and dangers, is there a different way that we, as individuals, can research income trusts? Are we looking for different things, or is it fairly the same course to chart with an individual company or stock?
Fred Ketchen: I wouldn’t separate an income trust from a tax-paying corporation. I think that the route to determine whether it’s a good investment or whether it is not a good investment is exactly the same, no matter what kind of an instrument it might be, when it comes to those two in particular.
Michael Seaton: Excellent. In your experience—we’ll break out to a more general question out of different sector type investing—what are some of the most common mistakes that an individual can make when investing?
Fred Ketchen: I think the first mistake that people make is that they think this is the route to sudden riches. It isn’t. It takes a lot of homework, and I think homework in this whole business is extremely important. Not following your investment plan. I’ve always said, you know, if you’re going to become an investor, you need to have an investment plan. Know where you are, where you want to be, and what kind of money you want to have by the time you get to where you want to be. And so you can do that if you have a proper plan and then follow the plan. I have met far too many people that have come in to speak to their investment advisors, and they have sat down and they have formulated this lovely looking plan that is going to take you from when you’re 30 to when you’re 65, and you’re going to have this much if all things work out well. And they take the plan home and they put it in the bureau drawer and never bother to look at it again. Mistake number two: look at it and don’t forget that as life changes, your plan needs to be changed. You may be a newly married couple. Maybe three years down the road, you’ve got a family suddenly. Your situation has changed. Your child goes off to university, your situation changes. So you’ve got to adjust your plan to all of these changes that do take place. And then, of course, I think that the one mistake that people have a tendency to make sometimes is by listening to other folks in the subway, or around the corner, or their neighbours, or whatever else, and they’re always chasing the hot stock of the day. Don’t chase that hot stock of the day because, most times, it just doesn’t pay off. Realize your risk tolerance. I mentioned that a while ago and in another portion of this program. And I think that you understand how much risk you’re willing to accept and how much risk you’re not willing to accept. And stick by that, and don’t be stubborn.
Michael Seaton: I wish you were around when I made some rather questionable investment choices a few years ago.
Fred Ketchen: I think we’ve all done that.
Michael Seaton: One final question for this segment, Fred. If you had to give investors one piece of advice, what would it be?
Fred Ketchen: Well, you know, there’s a little bit of advice you can give to all these people, and certainly, I start off with—I mentioned about having a plan, because I think you need it. And I say that in order to invest wisely, you must do your homework. But for goodness sake, don’t be short term. People who make the majority of money in markets are the long term, patient investors. So, invest wisely, invest for the long term, and learn to have patience.
Michael Seaton: Excellent. That’s great. Thank you, Fred. That will wrap-up Part 2 in our series on the stock market. We appreciate, again, your insights and advice and we look forward to next time in Part 3. Thank you to our listeners for joining us on The Money Clip podcast series from The Vault at Scotiabank. And we hope you will join us next time.
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