September 2019 Update

Be aware that the market does not turn when it sees light at the end of the tunnel. It turns when all looks black, but just a subtle shade less black than the day before. - James Montier

The best thing that happens to us is when a great company gets into temporary trouble. We want to buy them when they’re on the operating table. – Warren Buffett

August brought a welcome change in the air. I’ve noticed the usual articles and news stories decrying the “death of value investing” changing their tone for the better. Investors are starting to recognize, and sentiment starting to lean towards the opportunities offered by cheap stocks today. Good news for us, and not a moment too soon.

I’ve noted here over the past how “value stocks” have gone from being simply cheap, to your-grandchildren-will-thank-you cheap, to once-in-a-lifetime-generationally cheap. They got this way because every other form of investing sounded and felt more exciting. After all, why buy a boring “old world” company if XYZ Corp is “changing the world”? Few investors stopped along the way to ask if the boring old companies are still worth anything, or if they might be paying too much for the glamorous new XYZ’s of the world.

In the stock market, its pretty much an iron clad rule that excitement is inversely proportional to prosperity. The most boring businesses, overlooked and unloved, tend to do a better job of that. In fact, a strategy of systematically buying cheap stocks with good cashflow has created the highest long run returns of any tested strategy through the market’s long history.

So could it be that now, finally, investors are returning one-by-one to actual investing? That is, paying attention to cashflow, valuation and growth?

The numbers have been squarely on our side for some time now. We’re in the midst of one of the greatest generational opportunities for cheap stocks ever. The missing piece, public interest, is just starting to click into gear. I think our faith and patience is about to be rewarded.

Recommended reading

Gain advantage by playing where no one else is playing: https://fs.blog/2018/10/long-game/

Proof that worrying is a waste of time: https://elemental.medium.com/most-things-you-worry-about-will-never-actually-happen-83bff850c5f9

A good summary of investing headspace: https://fs.blog/2015/03/carol-dweck-mindset/

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

August 2019 Update

In the realm of ideas everything depends on enthusiasm… in the real world all rests on perseverance. – Goethe

Our investments performed well in July. In the Growth Portfolio, Canadian energy stocks are showing increasing appeal as US oil production slows, bonds held steady in the Income Portfolio, supported by what looks to be an incoming recession, American Growth Portfolio stocks performed well as investors seek the protection of value stocks, and the Small Cap Value Portfolio excelled on a favourable turn higher for precious metals. While the catalysts in each of our portfolios may appear seemingly different, the driving force at the root of their success is common: cashflow.

By investing in companies showing high amounts of sustainable cashflow relative to their peers, and in those showing the greatest cashflow growth, our portfolios are constructed for long term, sustainable success. While it is true that over the last five years investing based on cashflow has produced worse results than investing based on more ephemeral factors such as popularity, we know that similar periods have occurred through history. Each time, cashflow won the performance race by the cycle’s end. When comparing returns over longer, more meaningful periods (10 year, 20 year, or 30 year spans let’s say), cashflow always wins, and by a large margin. I have utmost confidence that will continue, and that the numbers are on our side.

Recommended reading

The opportunity of a decade: https://www.bloomberg.com/news/articles/2019-07-23/value-stocks-haven-t-traded-this-low-in-nearly-half-a-century

Living legend Joel Greenblatt on investing: http://blog.validea.com/investing-insights-from-joel-greenblat/

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

July 2019 Update

If you buy stocks when they are out of favour and unloved, and sell them into strength when other investors recognize their merits, you’ll often go home with handsome gains. – John Neff

To us, ugly stocks were often beautiful. – John Neff

Being out of fashion ultimately enhances opportunities on the other side. – John Neff

This month’s quotes are from legendary investor, and recently departed, John Neff, who left behind one of the top investment track records of all time. How did he do it? Neff spent 31 years buying companies with solid fundamentals at 40-50% discounts to the market, taking advantage of stocks that were misunderstood, overlooked, and outright hated by most investors. This mantra should sound very familiar to clients and readers. When it comes to investing and human nature, it goes to show there’s nothing new under the sun. Tried and tested principles of buying cheap always prevails in time.

On that note, our Income Portfolio is doing well, earning a positive return that’s outperforming the market with low volatility. More people must be picking up on our ideas about slowing economic growth and the appeal of long term yields – I certainly get that sense by reading the newspaper these days. Recall we’re invested quite defensively here, and things will stay that way until data proves otherwise.

Across the equity portfolios our cashflow-growing companies are doing exceptionally well. I’m quite happy with the progress made by these companies over the last 9 months. However, we are still waiting for our value stocks to “pop into gear” before celebrating. Particularly, Canadian energy stocks – the deepest of deep value stocks I’ve ever seen -- keep holding us back while other holdings perform well. In time, these energy stocks will change from net detractors to net providers of investment return, and will do so with fury. Until then, patience.

In general terms, value stocks today remain the cheapest they’ve ever been in history, including the very bottom of the Great Depression. Historically, when investor appetite turns away from expensive glamour towards value, which is presently underway, value stocks become top performers for years to come. Through some periods in history, that strong rekindling of value outperformance has lasted over a decade. As this current rotation from glamour to value makes its way through the markets, I expect our value stock prices to appreciate materially.

Recommended reading

John Neff’s obituary: https://www.wsj.com/articles/john-neff-outperformed-the-stock-market-for-three-decades-11560453159

Value stocks are the cheapest they’ve ever been: https://www.marketwatch.com/story/value-stocks-are-trading-at-the-steepest-discount-in-history-2019-06-06?mod=mw_theo_homepage

Canada’s resource policy is out of step with the world: https://business.financialpost.com/opinion/jack-mintz-only-one-country-is-contemplating-destroying-its-own-resource-sector-canada

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

June 2019 Update

The sillier the market’s behaviour, the greater the opportunity for the business-like investor. – Ben Graham

The intelligent investor is a realist who sells to optimists and buys from pessimists. – Ben Graham

Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down. – Warren Buffett

I’m growing more optimistic by the day about the prospects for our Canadian oil and gas stocks, the largest weighting in our Growth Portfolio. The sector has been demolished (a highly technical term) over the last two years, and I’ve taken advantage of low prices by buying our fair share from the pessimists. And then buying more. What the pessimists are missing is that our companies have now demonstrated increasing cashflows over the last year, which is strongly supportive of future gains in stock prices. Several of the companies are earning so much cash over the next two years that they can buyout their entire public market cap and still have cash left over. I expect company buybacks, acquisitions, and perhaps even special cash dividends to be announced in the future. In all my investing experience, I’ve never seen anything so undervalued before.

Beyond their financial statements, over the past two months I’ve noticed the public narrative about Canadian oil and gas companies change for the positive. Misleading rhetoric coming from American-funded special interest groups operating in Canada is being replaced by a new air of cooperation and realism amongst Canadian provinces and our federal government. If Canada is to mitigate the economic effects of the coming recession, support of the Canadian oil and gas industry is imperative. Canada will need all the jobs it can muster to counter a real estate and banking slowdown in our population centres. This suggests to me that energy sector gains will come sooner rather than later, which will be a big help to our Growth Portfolio. A victory here would make for our hardest fought gain yet, but also our most rewarding by far. In my opinion, many of these companies can increase in price by a couple hundred percent, just to get back to “normal” value.

Also coming over the horizon now, and something all investors will need to be realistic about, is increasing inflation. The past ten years has seen low, docile, and benign price inflation, broadly supportive of North American consumer spending habits. However its hard not to notice consumer prices accelerating everywhere over the last several months -- at the gas pumps, grocery stores, retailers, phone and cable bills, education, rent/housing, and all things health care. While government statistics try to “manage down” the perception of these inflationary changes, the real effects are undeniably being felt by consumers. Particularly, middle class wages haven’t kept up with inflation, leaving the backbone of the North American economy in a debt-funded deficit. Inflation is now weighing on economic growth as I had expected several months ago. With the full effects of last year’s central bank hiking still ahead of us, I expect inflation to accelerate even more. On top of that, I would not be surprised to see inflation further accelerate over the next year as central banks now openly discuss coordinated efforts to boost inflation beyond their current 2% target.

To take advantage of this trend and protect our spending power, I’ve increased exposure to inflation-protected businesses, those that are able to raise prices and profit from inflationary times. Companies that sell the basic necessities of life such as grocery stores, telecom, rental housing, basic apparel, natural gas, and auto repair can increases prices, and consumers willingly pay because they must. In step with rising inflation, I also expect commodity prices to increase, which should further help our energy companies.

Recommended reading

Investing is mostly about behaviour management https://www.betterment.com/resources/reduce-stress-investing/

What does the return of inflation imply for value investing (hint: it’s good) https://www.fortunefinancialadvisors.com/blog/how-inflation-makes-the-value-factor-a-sector-bet/

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

May 2019 Update

Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard. – Warren Buffett

When everyone believes something is risky, their unwillingness to buy usually reduces it’s price to the point where it’s not risky at all. - Howard Marks

I am pleased to report continuing performance improvement for the Growth and Income portfolios. Firstly, we are benefiting from improving operating results of our businesses. Portfolio-level cashflows are growing. Secondly, investor sentiment is turning from negative to positive for our core sector holdings. Thirdly, the improvements made to our entry and exit timing system in November (the machine learning project) continue to bear fruit.
 
I am looking forward to the months ahead and urge clients to add additional capital to the portfolios. We are embarking on a new chapter of growth with a strategy that is unique, yet focussed on the fundamental principle of buying low and selling high.

Recommended reading

Experience is the best teacher https://www.collaborativefund.com/blog/you-have-to-live-it-to-believe-it/

An important consideration for today’s market https://www.thestreet.com/investing/stocks/will-the-real-pe-ratio-please-stand-up-14923577

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

April 2019 Update

Value investing is by its very nature contrarian. Out of favour securities may be undervalued; popular securities almost never are. – Seth Klarman

 

This matter of training oneself not to go with the crowd but to be able to zig when the crowd zags, in my opinion, is one of the most important fundamentals of investment success. - Phil Fisher

 

We continue to make solid progress over the first quarter, benefiting from improving operating results and improving investor sentiment towards our companies. The future for us looks brighter than the past, and so I expect material improvement of our results to continue through 2019 and 2020. Particularly, the new machine learning program I reported on late 2018 has already begun to yield substantially better buy signals. Value is still our biggest driver of expected return in the portfolios, which gives us a lot of runway ahead to remain more positive than usual. For our Canadian portfolios specifically, a number of catalysts are on the immediate horizon that will help realize this value. Our uniquely built and highly selective portfolios are within the lowest valuations in history, offering protection from record high valuations in the general market, and an opportunity to reward intelligent and patient investors.

Switching gears to the bond market, I continue to observe evidence that USA and Canada will see economic deceleration in the near to medium term. This is the most natural and obvious course following a years-long debt expansion, combining now with inflationary pressures. It was widely reported that the yield curve inverted in March, one signal (of many) that a recession is likely on the horizon. My view towards a slowing economy is one reason our Income Portfolio bonds keep appreciating in price. Bonds tend to benefit when investors look for safer harbours. I expect this to continue, as the slowing progresses.

Recommended reading

Persistence is more important than positivity https://fs.blog/2019/03/adversity/

90% of your happiness is up to you https://www.ted.com/talks/shawn_achor_the_happy_secret_to_better_work

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

March 2019 Update

The task is not so much to see what no one has yet seen; but to think what nobody has yet thought, about that which everybody sees. - Erwin Schrödinger

 

There are three types of people in the world: those who see, those who see once they are shown, and those who will never see. – Leonardo da Vinci

 

To achieve superior investment results, your insight into value has to be superior. Thus you must learn things others don’t, see things differently or do a better job of analyzing them – ideally all three.  - Howard Marks

February was a good month for our portfolios, with stock and bond prices moving higher. We benefited from good operating results and increasing guidance from our companies. Since December 31, Growth is up 10%, American Growth is up 20%, Income is up 3.2%, and Small Cap Value is up 2.5% as of this note going to press.

In Canada, the latest quarterly reporting shows our largest holdings, precious metals mining companies, are expanding their cashflows and reserves at a solid pace. Our second largest holdings, natural gas companies, too, are increasing cashflows and reserves rapidly. In fact, nearly every single one of our companies has grown cashflows at a healthy pace on a year over year basis. There is a similar focus on growing cashflows in the American Growth Portfolio.

As business owners first, growing cashflow is most pleasing news, as that cashflow belongs proportionately to each of us. As stock holders, that increasing cashflow serves to increase a stock’s intrinsic value, and thus our expectation for future return. This stands in stark contrast to the TSX Composite Index, where I estimate about 80% of the constituents are cashflow shrinking or negative.

How curious it is then, with all this growing cashflow, that the stock prices of many of our companies are still closer to their lows than their highs. It goes to show that over the short term, investor perception often overshadows real operating results. This is where superior insight into valuation comes into play - we take advantage of this gap between negative investor perception and positive real growing cashflow. In time, cashflow reality always wins out over investor perception. I therefore expect that growing cashflows, low purchase prices, and patience will see our share values move significantly higher. Our strategy is working.

Recommended reading

Howard Marks on earning a good return https://blogs.cfainstitute.org/investor/2019/02/19/howard-marks-cfa-getting-the-odds-on-your-side/  

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

February 2019 Update

In a turbulent sea of irrational behavior, the few who act rationally may well be the only survivors. In fact, the only antidote to emotion-driven misjudgment is rationality, especially when applied over the long haul with patient perseverance. - Robert Hagstrom

 

Mr. Market’s job is to provide you with prices; your job is to decide whether it is to your advantage to act on them. You do not have to trade with him just because he constantly begs you to. - Ben Graham

 

January was a good month for our portfolios, with stock and bond prices moving higher. The long term growth and value characteristics of our portfolios have never been better, save for the low prices seen late December 2018. Now is a good time to selectively take advantage of cheap prices for future growth.

It is my opinion that the general market has just passed through the popping phase of a bubble. For the last two years investors have stopped paying attention to valuations and important things like company debt, cashflow, and profit margins, etc. Instead, investors have played an expensive game of follow the leader, buying stocks because they’ve gone up in price. History tells us this type of momentum chasing, although exciting, never reaches a favourable end. Even with stock prices lower today than they were two months ago, valuations remain near the extreme peaks seen before the 1929 stock market crash and the dotcom crash.

So during this period, I’ve chosen to play a different game. Instead of chasing the most expensive stocks like everyone else, I’ve been purchasing the cheapest stocks of the most durable companies I could find. I have been preparing for the aftermath of over-valuation, with the goal of giving my clients long term protection of their money.

I did this by buying companies at exceptionally low valuations (between 4 and 5x cashflow in most cases) over the past two years. But unfortunately over the past year these shares went down instead of up. So depending on your point of view, either I look like an idiot (it’s possible), or these stocks now offer an even better deal, and therefore even more protection, than when I first bought them. In total, our portfolios today are valued at about 4x the cashflow that our businesses earn.

Is that good? What does that mean in a tangible sense?

For example, if I offered you a two bedroom condo in downtown Toronto with $2000 per month in rent net of expenses and taxes, that’s $24k a year of cashflow. Would you buy that condo for $120k? That’s 5x cashflow. Would you buy it for $96k, or 4x cashflow? What about $60k, or 2.5x? Some of our companies are that cheap – 2.5x cashflow.

My research shows the top performing stocks of the past couple years trade at about 40x cash flow right now. The average stock trades at about 20x cashflow. If I look back over history, I see that over the long term that average stocks trade at about 12x cashflow. Such lofty valuations imply 60% downside for the best performers from here, and 40% downside for the average stock. In contrast, the low valuation of our current holdings implies around 50% upside.

Having purchased durable businesses so cheaply, I have no doubt that we will realize on the implied upside, making our companies tremendously valuable investments for us. The simple thing about buying businesses so cheaply is you don’t have to be too smart to do it. One just needs a good sense of the obvious, and some patience for sentiment to correct so prices can move higher.

So if these businesses are so cheap, and all one needs is patience, then why doesn’t everyone do this?

When stocks go down most people get worried. The nervous system’s wiring overrides rational thought, causing investors to sell what’s been going down. With little sense of irony, these same investors usually then re-invest their proceeds into whatever has been going up – effectively doubling down on their misjudgements. This behaviour is most responsible for the market activity over the last two years. And it is precisely this emotional response that makes value investing difficult for most people, and yet creates opportunity for dedicated value investors in the first place.

But over the last two months there has been a change in market behaviour. The leadership of the market is now rotating away from the overpriced towards the cheap. My best guess is this mirrors the early 2000s, when the tech bubble popped catching most investors off guard. At that time, value investors, who had previously suffered material underperformance (Warren Buffett included), shone as boring, cheap, and profitable businesses regained popularity. The tech stocks previously considered safe on the way up proved anything but on the way down. In much the same way, I believe today’s exceptionally large gap between expensive and cheap securities has become its own catalyst. It’s been said before that the cure for low prices is low prices. Today, many old, boring, and profitable businesses are on the cusp of outperforming the shiny and new.

In my January note I wrote that now is the time to add capital to our portfolios to take advantage of cheap prices. I continue to believe that. In the spirit of Warren Buffett, it’s the most rational thing to do.

Recommended reading

Life isn’t about the hand we are dealt, it’s about how we play it https://ofdollarsanddata.com/fickle-fortune/

Keep your head when others are losing theirs https://fs.blog/2019/01/billion-dollar-ego/

The growing use of leverage in Canada will shift from tailwind to headwind https://betterdwelling.com/canadians-using-real-estate-for-personal-loans-accelerates-for-a-5th-month/

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

January 2019 Update

In bear markets, stocks return to their rightful owners. – JP Morgan

In strategy it is important to see distant things as if they were close and to take a distanced view of close things. – Miyamoto Musashi

There were heaps of these magic sixes. The magic sixes were companies that had 6% dividend yield, 6 times earnings and 60% of book value. – Peter Cundill

 

December created one of the largest opportunities for deep value investors in a decade. Some of you have inquired about adding capital to your portfolios to take advantage of low prices, and I applaud your rationality and conviction. Most stock prices are now down over 25% from their peaks, so the months ahead will see strategic buying of companies well below fair value. The long term growth and value characteristics of our portfolios have never been better.

Our largest positions in precious metals and bonds performed well, moving higher over the month. We took advantage of increasing momentum in precious metals companies to add new positions. Our utilities and consumer stocks held in better than average, while our natural gas companies declined to trade at an average of 2x cashflow, offering an astonishing 50% cashflow yield. One company even trades at 1x cashflow, a 100% cashflow yield. Such cheap valuations are simply irrational, and portend significant gains ahead.

Together, our companies are trading on average at 4x cashflow, delivering a 25% cashflow yield on purchase to investors. To put it another way, for every $100,000 invested today, our companies together will earn about $25,000 annually in cashflow. Four years from now, there will have been enough cashflow earned by the companies to cover totally the initial investment amount. Any growth in earnings over the next four years (which I believe is highly likely), plus even a small positive shift in sentiment, is a baseball-sized cherry on top. For comparison, the average stock trades at about 16x cashflow, almost four times more expensive (ie riskier) than our portfolios.

The balance of evidence suggests indices and popular stocks remain overvalued relative to cashflow and asset value fundamentals. I continue to believe we are in a bear market, characterized by swift rallies within the context of an overall downward trend for most stocks. While most investors will be focused on the largest popular stocks and indices, unquestionably, the best opportunities today are found amongst the most unpopular and unloved corners of the market – the areas we specialize in.

We will remain patient through inevitable periods of volatility so that we can reap the long term rewards of our strategy. Please be in touch if you wish to add capital.

Recommended reading

A secret pathway to find what no one in your sport or industry has ever found https://www.kapilguptamd.com/2018/10/28/a-secret-pathway-to-find-what-no-one-in-your-sport-or-industry-has-ever-found/

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

December 2018 Update

To buy when others are despondently selling and to sell when others are avidly buying requires the greatest of fortitude and pays the greatest ultimate rewards. – John Templeton

The stock market is a device for transferring money from the impatient to the patient. – Warren Buffett


Across each portfolio we took advantage of November’s volatility to replace some positions and add others at low prices. When it comes to investing, volatility is synonymous with opportunity, and we take advantage of every opportunity we can to improve the long term growth and value characteristics of our portfolios.
 
The balance of evidence still suggests popular stock indices are overvalued relative to cashflow and asset value fundamentals. While this overvaluation can continue for some time, and perhaps the market may even go higher, it is unlikely that investing in popular indices or the most popular stocks will produce lasting gains from current prices. Instead of following the herd, we’ve invested in unpopular, under-estimated, and outright cheap stocks that are much more likely to earn long term positive returns. We remain patient through inevitable periods of volatility so that we can reap the long term rewards. Following a value strategy has proven the best method of generating long term performance.
 
I’m happy to announce that a months-long research project has yielded positive results that will improve performance going forward. Harnessing the power of machine learning, I created a program that identifies common characteristics of losing trades. The program studied reams of data on every single losing trade in the portfolios since inception, in an effort to discover unanticipated, even hidden, areas for improvement. The program was successful in identifying several “hidden patterns” of losing trades before they turn into losers. What surprised me was that some of these patterns essentially camouflage themselves into promising looking opportunities – the types of things even the most seasoned of investors salivate over. I’ve added this new protection feature to our investment analysis process, screened all current investments against this new criterion, and very much look forward to the long term benefits.

Interesting links:
A wonderful list of the world’s most powerful ideas https://www.collaborativefund.com/blog/ideas-that-changed-my-life/

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

November 2018 Update

Equity markets are declining as expected, relieving some of their record over-valuation. The cause of October’s decline has been attributed to higher interest rates coupled with slower economic growth -- topics I have been writing about for some time now. By and large, the selloff so far has been orderly, without a sense of panic that traditionally marks a “bottom” in stock prices. Given the degree of over-valuation still remaining, and dwindling liquidity in daily trading, I expect that popular indices will continue lower over time until I observe more indicators of exhaustion. I expect to see many sharp and forceful rallies higher along the way, which is characteristic of bear markets. Also characteristic of bear markets is that these rallies progressively make lower highs, establishing a downtrend.
 
The goods news is that capital is flowing back from growth stocks to value stocks. This is what we should expect in a market that is becoming more rational in regard to valuation. This has helped our performance recently. Bonds are also doing much better relative to stocks. If I am correct in estimating that stock indices may only deliver a -2 to 2% annualized return over the next ten years, then owning a government bond yielding 3% annualized is a compelling offer, particularly for institutional investors.
 
In the 85 years since the first publication of Security Analysis by Graham and Dodd, value investing continues, unequivocally, to be the best style of investing when measuring the performance of long term returns. Sometimes the public loses track of the guiding principles of value, and becomes fooled into following short term fad investment styles such as high revenue growth, or naïve momentum. Each time that investors mis-calculate, it is value investing that returns to restore the function of markets and the credibility of market prices. As we proceed together through this bear market, it is important to keep in mind that this is the market’s way of correcting years-worth of prior excess, and restoring trust in capital allocation. In other words, value investors should welcome, and certainly not fear, bear markets, for they provide the breeding ground for future returns and rational investing.

Interesting links:
An in depth look at over-extended market valuation https://www.hussmanfunds.com/comment/mc181002/
Why government bond prices are likely to rise, and yields fall https://www.advisorperspectives.com/articles/2018/10/08/a-roadmap-for-the-upcoming-u-s-treasury-bull-market-1

Cordially,
 
Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

October 2018 Update

Popular stock indices are trading significantly above reasonable valuation, exceeding peak levels seen during the tech bubble of 2000 and before the Great Recession of 2008. The degree of over-valuation in some respects is now similar to levels last seen before the Great Crash in 1929. Market internals, as measured by advancing versus declining issues and new highs versus new lows, is showing significant deterioration in recent weeks. I believe popular stocks and indices are primed for material downside as they unwind from the riskiest level seen in our lifetime. The Growth and Income Portfolios are positioned in their most defensive allocations to date, designed to protect and benefit as unbridled investor euphoria returns to a more realistic level.
 
The Income Portfolio is fully allocated to government and high quality corporate bonds. With continued interest rate increases from central banks, along with the winding down of quantitative easing programs, I expect liquidity to tighten and economic growth to continue slowing across the globe. I expect stock market declines to result in a “flight to quality”, whereby investors will bid up the price of our defensive bonds as they seek safer harbours.
 
In the Growth Portfolio and Small Cap Value Portfolio, our largest equity holdings are deeply undervalued resource companies. As investors sell off overly-concentrated positions in the most popular stocks, I expect they will reposition capital towards such securities trading at much cheaper valuations with substantial upside potential. Generally speaking, purchasing securities trading at 3-4x cashflow, or under their net asset value, have provided significant profit opportunity with low downside risk. As an additional feature, many of our companies pay high dividends. In simpler terms, imagine being able to purchase a rental property for only 3.5x it’s annual rent, and below the cost it would take to re-construct the property from scratch. In our case, we can raise rent by 5-10% per year. Such conditions make for happy landlords.

Although psychologically it is not easy to buy or hold securities that have seen major price declines, it is precisely the emotionally charged price decline that lowers investment risk. As the price of a stock moves lower, investors pay less for the company in relation to its fair value. This lowers the risk of long term capital loss, and increases the potential of long term gain as the trading price eventually meets fair value. Low prices are what make stocks so initially valuable, and so eventually rewarding.
 
Coincidentally, the last time resource stocks were this cheap was the peak of the tech bubble. Resource stocks saw significant price appreciation as the rest of the market declined.
 
In our American Growth Portfolio we’ve seen significant price appreciation over the past years, matching that of the index. The big difference is we’ve done so by purchasing bargain priced securities, instead of chasing expensive stocks higher. Our American Portfolio features more diversity amongst sectors than our Canadian portfolio, but the same deep value principles apply to each stock: low cashflow multiples, discounts to book value, and rich dividends. I believe the deep value characteristics of our companies will allow us to see more upside, even in the face of major declines in the indices.

The evidence shows that value investing tends to underperform the most during the last stage of bull market euphoria as investors abandon fundamental valuation, and common sense. History also shows that value investing sees its greatest degree of outperformance directly after that euphoria phase comes to pass. In consideration of the evidence, I believe we are on the precipice of such a turn today, and it will be one of the largest of the past century.

Interesting links:
The different types of investor emotions https://www.collaborativefund.com/blog/concealed-emotions/
Are investors destined to repeat the same mistakes? https://www.collaborativefund.com/blog/fool-me-three-times-and-i-give-up/
Doing your research pays https://www.cnbc.com/2018/03/20/doing-your-homework-does-lead-to-better-investing-returns.html

Cordially,
 
Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

September 2018 Update

Imagine for a moment you could go back in time to March 2009, when the market was making its bottom after the Great Recession. With the full benefit of hindsight, what kind of stocks would you have bought if given the chance?
 
The biggest returns came from stocks that were down the most over the preceding year. These were stocks that, on average, were trading well below the value of the company’s assets. Many had fully funded dividends over 6%. They could be purchased for only 4 to 6 times earnings or cashflow, sometimes cheaper. People were selling these companies without doing the math, reacting emotionally to falling prices entirely disconnected from reality.
 
Over the following year some of these stocks were up 35%. Others up 50% to 70%. A few over 100%. Some went down before they went up. Some did very little for months before popping higher. But over a two year period just about all of them were up.
 
What if instead of treating these stocks in March 2009 as a singular event, you treated them as a pattern that could be identified regardless of what the overall market was doing. In other words, why not always look for stocks that are trading significantly lower, whose assets can be acquired at a discount, and whose earnings can be owned for a song? Forget about what the overall market is doing, just focus on the companies. It is no surprise that these types of companies earn higher than average returns over time, fairly consistently.
 
Now conversely, what happens if we repeat the experiment above but instead we start at the market top in 2007. With the benefit of hindsight, what kinds of stocks would you have avoided?
 
The biggest losses came from stocks that had significant sales growth with little earnings. These were high flying companies believed to be changing the future. On average they were trading over 30 times earnings, and had negative cash flow. All of them were widely followed by professionals and amateurs alike, and had consensus buy ratings from bank research departments and analysts. In short, trading prices fell tremendously, and some of these companies don’t exist anymore.
 
Today, when I look at the financial statements of individual companies making up the stock indices, I see a lot of high flyers, little or negative cashflow, and expensive multiples. Sadly, the average investor is making the same mistakes they made in 2007. They will receive a similar result.
 
The good news is there are a handful of stocks with highly desirable fundamentals that have already bottomed, can be purchased at a bargain price, and are turning higher. We’ve purchased these companies for 50 to 60 cents on the dollar, and with patience we’ll realize full value. These companies will be safe harbours while the most popular stocks and indices decline, much in the same way resource stocks protected investors while the tech bubble burst. I anticipate significant upside for our holdings.

Interesting links

Higher than average returns requires higher than average discipline https://alphaarchitect.com/2018/08/23/academic-factor-portfolios-are-extremely-painful-unless-you-are-an-alien/  

On increasing the hurdle for evidence https://fs.blog/2018/08/power-of-anecdotes/

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

August 2018 Update

Our value stocks performed well in July. Notable performers include Canadian natural gas companies and US pipelines, along with AGT Foods which received a management buyout offer only weeks after we purchased shares. At the same time, glamour stocks began to unwind from peak territory as I’ve been expecting for some time. Notably, Facebook and Netflix each sank over 20% after falling short of their earnings expectations.

With value stocks finally seeing positive momentum and glamour stocks missing their marks, I believe we are witnessing the beginning of the most important shift in investor psychology since 2008.

Over the last ten years, expensive glamour stocks have massively and uncharacteristically outperformed their cheap value counterparts by a wide margin. This stands in sharp contrast to market history and common sense, where the cheapest stocks earn the best return, not the most expensive. At this point the vast majority of investors have become enamoured with the glamour trade, making it ripe for a turn.

The principal catalyst for this turn, for value to outperform glamour going forward, is higher interest rates.

Glamour stocks have little cashflow today, with most of their cashflow anticipated in the future. Higher rates make glamour stocks less attractive because they shrink the value of all that future cashflow, causing a lot of pain for stock holders who must, in turn, lower their expectations.

For value stocks we observe the opposite. Since the cashflows and asset value of cheap value stocks is immediate and in the present, value stocks become relatively attractive and tend to produce strongly positive returns as investors seek out safer habours.

Cheap value stocks today are found in all the usual places: amongst the unloved, the ignored, the downtrodden, and the disappointed. Here we’ve purchased companies for 50 to 60 cents on the dollar including precious metals producers, energy producers, food processors and distributors, and bricks and mortar retail. With patience, we’ll realize full value on our companies and earn a good return for our efforts. But patience isn’t easy, if it was, it wouldn’t be so rewarding.

It goes without saying that I think the experience of glamour stock investors henceforth will be less rewarding – more akin to technology investors following the year 2000. Chasing trends without fundamental company research has never been a path to long term success.

In a world of glamour investors, value is the underdog. Growing up I always enjoyed rooting for the underdog, and still do. Not only was there more satisfaction in the win, but the payoff was always better too. Our portfolios are heavily aligned to benefit from our emerging value underdogs and I anticipate significant upside ahead for our holdings.

Interesting links

More on value versus growth investing https://www.marketwatch.com/story/after-a-decade-of-wins-the-end-may-be-near-for-one-of-wall-streets-best-stock-trades-2018-07-30

A look at global housing leverage https://latest.13d.com/boom-global-megacities-bust-contagion-economy-real-estate-30d0951e21bc

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth

July 2018 Update

The broad investment themes supporting our companies are playing out as expected. Low supply is driving up the cost of energy resources, inflation is starting to wake up precious metals and food prices, and global economic deceleration is pushing high quality bond prices higher. When appearing in concert as they do today, these elements point to a late stage in the economic cycle. Remember that the best economic news comes at the top of the cycle, while the worst economic news comes at the bottom.

Whereas exciting “growth” stocks have outperformed boring “value” stocks over the last decade, the reverse is more likely to be true going forward. Sentiment is shifting to favour the real economy over the digital, and higher short term interest rates are pinching lofty valuations. Our portfolios are heavily aligned to benefit from this emerging trend towards value and the return of real asset and resource investing. I anticipate significant upside ahead for our holdings.

Interesting links
Some investors says an “inverted yield curve” will predict the next recession. Not so. https://www.variantperception.com/2018/06/13/will-there-be-a-yield-curve-inversion-before-the-next-recession/
Economic news is best at the top http://www.kesslercompanies.com/last-time-unemployment-3-8/
Peeling back the layers of Canada’s subprime lending https://betterdwelling.com/canada-has-a-subprime-real-estate-problem-you-just-dont-know-it/
Deeper dive on the economy https://vintagevalueinvesting.com/is-the-economy-overheating/
Perception and placebos http://slatestarcodex.com/2018/01/31/powerless-placebos/

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor

June 2018 Update

Our largest portfolio positions continue to benefit as expected. Our energy companies received good news in May with the Canadian government’s support of the Trans Mountain Pipeline, along with improving natural gas and crude prices. Our precious metals companies benefited from increasing government support in their mining jurisdictions, along with support from higher commodity prices. Our bonds saw significant appreciation as global economic conditions decelerate, as I’ve been expecting for some time. In all cases, a combination of low purchase prices and low consensus expectations setup a promising foundation for our investments. I anticipate more upside ahead for our holdings.

The consensus investor today holds the largest position in growth stocks, high yield bonds, credit, and real estate in history, while holding the relatively smallest position in government bonds, gold, energy, and cash in history. This reflects the tendency of the public to invest by looking in the rear view mirror, chasing short term performance and naïve trend following instead of judging a security based on it’s intrinsic value. Our positions stand to benefit as the tide shifts back towards reality. 

Interesting links

Stocks aren’t the only inefficient market: https://www.bloomberg.com/news/features/2018-05-03/the-gambler-who-cracked-the-horse-racing-code

There will be stories for decades: https://betterdwelling.com/boc-8-of-canadian-households-owe-more-than-20-of-the-2-1-trillion-in-debt/

Value stocks emerging as the new heroes: http://eastwestfunds.com/research/value-vs-growth-a-decade-long-pause-provides-great-entry/

What do google search trends tell us about the health of the economy?  https://twitter.com/jessefelder/status/999307524674392064/photo/1

The next big market mistake: https://latest.13d.com/liquidity-new-leverage-regulation-algorithmic-investing-qt-bond-equity-markets-7b7f97c57cc5

Cordially,

Ben W. Kizemchuk
Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth
www.growthandincome.ca
www.wellington-altus.ca

(416) 369-3024

55 Yonge Street, Suite 1100
Toronto, Ontario
M5E 1J4

May 2018 Update

April was one of our best months on record for the Growth Portfolio. Our largest holdings, gold and energy producers, saw significant price appreciation. A combination of low purchase prices and low consensus expectations setup a promising foundation for our investments, so when several pieces of good news came out in April, buying interest sparked up quickly. Consensus expectations for our companies are still far too low, so I anticipate more upside ahead.

In regards to our defensive bond position, the economic slowdown that I’ve been anticipating is taking hold. Short term interest rates have been rising, making loans more expensive for borrowers. Consumer loan delinquencies are rising, including credit card receivables, auto loans, and some lines of credit. Applications for consumer proposals are now rising. Historically, once these types of loans start experiencing trouble after a long period of calm, recession is not far away. The Income Portfolio’s bonds protect and benefit as the economy slows.

Most people believe interest rates are rising because of economic growth. What they misunderstand is that rates are rising in spite of a slowing real economy. What looks like economic growth and inflation to the general public is tomorrow’s consumption being pulled forward to today by debt-fueled spending. When tomorrow’s dollars are borrowed and spent today, there is less demand left for tomorrow. If we net-out the effects of tax-cut deficit spending by the US government, economic activity is meager at best. Therefore, hiking interest rates will likely weaken conditions into a recession faster than expected.

Such was the case in 2007, when central banks hiked rates to combat what they thought was inflation at the time, all the while steering the economy into recession.

While rising interest rates garner most of the attention in the news, few investors notice there are even more meaningful central bank policy actions on the horizon. Central banks are now slowing their purchase programs of stocks, bonds and mortgages (called “quantitative easing”). These programs have been in place since 2009 to help support economic recovery by providing liquidity. By this time next year, central banks will have started to sell off those stocks, bonds and mortgages, withdrawing liquidity from the economy. This amounts to a coordinated and synchronized global deflation.

Most investors are not adequately prepared for this outcome. The consensus investor today holds the largest position in stocks and real estate in history, while holding the relatively smallest position in government bonds, gold, energy, and cash in history. This reflects the tendency of the public to invest by looking in the rear view mirror, impressed by short term outcomes and naive speculation. Whereas they characteristically ignore the warning signs of excess, we are prepared to benefit from what comes ahead.

Interesting links
Good news for energy stocks: http://blog.knowledgeleaderscapital.com/?p=14069
Consumer proposals are on the rise: https://betterdwelling.com/canadians-seeking-early-intervention-from-bankruptcy-spikes-to-a-new-january-record/
Canada’s housing market dominos: https://www.thestar.com/business/2018/04/04/they-bought-their-prebuilt-homes-at-the-markets-peak-now-they-face-financial-ruin.html
The risk hidden inside today’s most popular investment strategy: https://latest.13d.com/big-tech-passive-algorithmic-investing-more-pain-market-action-threats-8e25503fd1e4
Hunter S Thompson on leading a good life: https://www.fs.blog/2014/05/hunter-s-thompson-to-hume-logan/

Cordially,

Ben W. Kizemchuk

Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth
www.growthandincome.ca
www.altusinvest.ca
(416) 369-3024

55 Yonge Street, Suite 1100
Toronto, Ontario
M5E 1J4

All opinions and estimates contained in this report constitute the judgement of Ben W Kizemchuk of Wellington-Altus Private Wealth as of the date of this report and are subject to change without notice. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.

April 2018 Update

We continue to maintain a defensive position across our portfolios. We are holding a larger than usual amount of cash, government bonds, and commodity producers, with a reduced exposure to equities.

The five charts below illustrate my thoughts about the market, and how we are positioned to take advantage.

The first chart measures stock market valuation -- how much investors are willing to pay for $1 of corporate earnings. Valuations match levels seen only before the Great Crash of 1929 (stock market then fell 90%), and the DotCom Crash of 2001 (stock market fell 46%). The average stock is too expensive, hence risky. That makes the best performing stocks of the last year even riskier. Hence, I view the market and consensus growth expectations with a fair amount of skepticism and caution.

The second chart measures investor euphoria – how excited investors are about owning stocks. We can measure this by observing the amount of cash in US brokerage accounts relative to the size of the stock market. When the blue line is low, there is less cash because investors have spent it on stocks. Today’s current level of excitement has coincided with investors going “all-in” at past stock market peaks. As a countermeasure against this euphoria, 30% of our Canadian Growth Portfolio is in cash, 12% of our American Growth Portfolio is in cash, and 22% of our Small Cap Value Portfolio is in cash.

The markets are expensive, and investors can’t seem to own enough stock – a perfect recipe for a tidal wave of risk in my opinion.

When it comes to stocks, not all of them are expensive, just most of them. We always want to be defensive with our stocks by owning what’s cheap. The third chart below shows the relative value between stocks and commodities. When the blue line is low, commodities are relatively cheap, and when the blue line is high, stocks are relatively cheap. The chart shows that commodities are at their cheapest value since 2000, and match the early 1970s before that. I expect commodities to significantly increase in price as they did after both prior occasions. Our Canadian stock portfolios own large interests in gold, silver, oil, and natural gas producers to take the advantage.

The fourth chart below highlights our particular interest in precious metals, with an emphasis on silver. The high price of gold bullion relative to silver bullion has reliably marked the start of strong periods of outperformance by precious metals. Our largest individual position in the Canadian Growth Portfolio is a silver miner.

Our fifth chart shows another place to find shelter. This chart measures investor sentiment for 10-year government treasury bonds, which tend to act as a safe haven in times of market turmoil. When the blue line is high, treasury bonds are unpopular and cheap, and when the blue line is low, treasury bonds are popular and expensive. The chart shows bonds haven’t been this unpopular and cheap since the mid 2000s. Most of our Income Portfolio holds long term government bonds, which I expect to increase in price. Of note, we hold zero so-called “blue chip” dividend stocks – they are too risky at this time due to excessive valuation, as per the first chart.

The final bonus chart is the most important of all. Investing obeys two of life’s core principles: there is no growth without pain, and everything moves in cycles. With commodity stocks and bonds so cheap and out of favour, our portfolios are at the point of maximum financial opportunity for intelligent investors.

Interesting links

Higher interest rates are slowing the economy: http://business.financialpost.com/personal-finance/debt/these-charts-show-higher-canadian-rates-are-starting-to-bite

Canada has too much debt to escape a major recession: https://www.bloomberg.com/news/articles/2018-03-13/consumer-debt-binge-draws-moody-s-warning-for-canadian-banks

Detachment from the outcome is a key attribute of successful investors: https://intelligentfanatics.com/forums/topic/the-power-of-detachment/

A list of powerful ideas: http://www.collaborativefund.com/blog/ideas-that-changed-my-life/

Cordially,

Ben W. Kizemchuk

Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth
www.growthandincome.ca
www.altusinvest.ca
(416) 369-3024

55 Yonge Street, Suite 1100
Toronto, Ontario
M5E 1J4

All opinions and estimates contained in this report constitute the judgement of Ben W Kizemchuk of Wellington-Altus Private Wealth as of the date of this report and are subject to change without notice. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.

March 2018 Update

We continue to maintain a defensive position across our portfolios. We are holding a larger than usual amount of cash, government bonds, and commodity producers, with a reduced exposure to equities.

Warren Buffett’s company Berkshire Hathaway released their annual shareholder letter last weekend to the delight of many value investors. Buffett mentioned that he was a net buyer of securities throughout the year, but expressed a cautious tone about today’s valuations. I agree with his perspective that while there are many well run companies, their trading prices are generally too high to ensure an adequate margin of safety. In other words, higher prices have increased risk. At present, Berkshire’s portfolio is invested about $191 Billion in stocks and $116 Billion in cash, a roughly similar composition to our Growth Portfolio’s 30% cash position. And like Buffett, I too await lower prices so we can make lower risk purchases.

As illustrated in the graph below, stock prices relative to earnings match levels seen only before the Great Crash of 1929 and the DotCom Crash of 2001. With nine years since the last major downcycle in stocks, it bears reminding that all markets are cyclical, and sticking to defensive principles is the only way to win the long game. In the short run when prices are elevated as they are today, that means we underperform because we will not do the risky things everyone else believes are normal. In the long run, it means we survive and protect capital.

In early February we saw the first signs of a large (and anticipated) increase in market volatility. Investors should remember that the market is here to serve us, not guide us. Often times market prices over and under-react to various news items, and we will take advantage of that volatility to buy companies with strong operations and valuable assets at a cheap price. Just because someone is willing to sell us a share of a business at a low price doesn’t necessarily mean that’s what the share is actually worth to a more prudent long term buyer. We should be quite happy to see more volatility, because it allows us to deploy our cash into bargain purchases, investing for the long term.

Interesting links

More of today’s best investors raising cash: http://business.financialpost.com/news/fp-street/brookfield-selling-assets-to-build-war-chest-for-next-downturn

Investor discipline and sticking to your style: http://mebfaber.com/2016/01/05/how-to-beat-98-of-all-mutual-funds/

Stop reading the news: https://www.fs.blog/2013/12/stop-reading-news/

Natural gas bull market: https://latest.13d.com/natural-gas-longest-bear-markets-greatest-over-supply-always-leads-long-bull-markets-2a5e8e85f1ad

Toronto is not even close to running out of land: https://betterdwelling.com/city/toronto/researchers-destroy-narrative-greater-toronto-running-land/

Cordially,

Ben W. Kizemchuk

Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth
www.growthandincome.ca
www.altusinvest.ca
(416) 369-3024

55 Yonge Street, Suite 1100
Toronto, Ontario
M5E 1J4

All opinions and estimates contained in this report constitute the judgement of Ben W Kizemchuk of Wellington-Altus Private Wealth as of the date of this report and are subject to change without notice. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.

February 2018 Update

We continue to maintain a defensive position across our portfolios. We are holding a larger than usual amount of cash, government bonds, and commodity producers, with a reduced exposure to equities.

Incoming data suggests the Canadian and US economies will grow, but at a slower pace than consensus estimates. With market valuations now stretched to levels beyond historic comparison, slower than anticipated growth poses a significant risk to the popular rosy outlook for stocks. Although stock prices may continue higher, I believe the short-term reward of chasing such gains is not worth risking capital. My focus remains on protecting capital by reducing the risk of permanent loss, and secondly on maintaining upside potential through holding undervalued securities.

Over the past year we recorded a 25% gain in the American Growth Portfolio, while the Canadian Growth Portfolio was flat. On the topic of relative performance, one client asked me a good question that illuminates an important aspect of our value investing strategy: how could two exactly similar strategies (apart from a Canadian versus US focus) deliver such different results in a year?

In the short term, any investment outcome is the product of many factors that we cannot control. In other words, luck plays a big part in which stocks move up or down in a year. In fact, most often when we establish a new position in an out-of-favour stock, it moves down before it moves up. However if we measure over longer periods of time, we know that various short term factors lose influence, and a stock’s price reflects the long term growth earned by the business. In our strategy, I focus only on the factors that I can control, such as only buying businesses with steadily growing profits, or businesses with valuable assets, or businesses mispriced by emotional investors. By concentrating on factors under our control, our view is necessarily on the long term, which allows us to earn above average long term returns.

While most investors form a judgement about a stock or fund based on what it did over the last 365 days, I believe the growth prospects of a company have nothing to do with arbitrary astrological timing, and everything to do with that company’s intrinsic value. Sometimes that value is realized within one year, sometimes longer. In any case, we can rest assured that the availability of one year performance numbers has no bearing on a sound investment process.

This means that our Canadian and American Portfolios will produce yearly variations in performance (as demonstrated in 2017). Over longer periods these variations will average out to the long term growth rates of the businesses we own. If we do a good job in our business valuation, and buy our businesses for less than they’re worth, we have a good idea of what the long term results are likely to be -- only we don’t know when those results will be delivered. We know the destination, but not how fast we’ll get there.

If all of our businesses reached their estimated fair value tomorrow, the Canadian Growth Portfolio, American Growth, and Small Cap Value would each be up healthy double digits. Therefore, what’s more important than measuring the ebbs and flows of short term performance, is to condition and accept that we must be patient for the process to work in its own time. This is what Warren Buffett’s partner, Charlie Munger, refers to when he talks about “sit on your a** investing”. Do good valuation work, buy the company at a discount to what its worth, and then wait.

Interesting links:

“Expected value” will change your life: https://www.fs.blog/2018/01/expected-value/

Management insights from Jeff Bezos: https://www.youtube.com/watch?v=fpDUiDQigO8

More from the incomparable Charlie Munger: https://youtu.be/BLctqhNClqY?t=19m5s

 

Cordially,

Ben W. Kizemchuk

Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth
www.growthandincome.ca
www.altusinvest.ca
(416) 369-3024

55 Yonge Street, Suite 1100
Toronto, Ontario
M5E 1J4

All opinions and estimates contained in this report constitute the judgement of Ben W Kizemchuk of Wellington-Altus Private Wealth as of the date of this report and are subject to change without notice. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.