FAQ

At KeyStone Financial, we have a very specific mandate. All of the companies we recommend, whether in the Income Stock or Small Cap Reports, are all profitable companies, which are financially healthy and are trading at attractive prices. In the ISR, we take this mandate further and only recommend companies that are paying a generous income yield. Typically, we try to find companies that are yielding at least 4%, although in some cases we will consider companies that produce a lower yield. While the mandate is to find income stocks, what we are looking to discover are income growth stocks. These are companies that provide investors with a sustainable yield, but also have the ability to grow their income distributions over time, thus increasing the income yield. In our research, we utilize numeric and non-numeric methods of determining the sustainability of the current income distribution, how much it can grow, how exposed a company is to the changing economy, and the relative attractiveness of the current share price.

As part of our research service, we categorize each of our recommendations into 3 model portfolios classified by risk – conservative, moderate, and aggressive. In our Conservative Portfolio, you will find larger, well established companies that have relatively low volatility in earnings and cash flow from year-to-year. These companies are easily categorized into sectors like utilities, banking, and telecom. In periods of economic recession, we expect these to be the types of companies that are impacted the least. While these companies are less risky, they also tend to yield lower returns. In some short-term markets this may not be the case, but over time there is usually an inverse correlation between risk and return. In our Aggressive Portfolio, you will find smaller and typically higher-growth companies. These stocks are not so easily categorized into specific industries. They are, in many cases, a collection of smaller unknown niche or specialty businesses. Our Aggressive companies will be more impacted by events in the overall economy and we would expect earnings and cash flow (and potentially income distributions) to be more volatile. While we use the term aggressive to describe them, they are not speculative stocks (at least by our definition). Each of these companies must still pass through our extensive criteria of profitability and overall financial health, and many of them are very resilient to negative events in the economy. Our Moderate Portfolio, quite simply put, consists of companies that fall in between the conservative and aggressive risk classes.

In terms of what portfolio is best for you, it all depends on your specific situation, which includes (but is not limited to) your age, your income, whether or not you have dependents, what other kinds of assets you have, and how important your investment portfolio is to your overall well being (financially and otherwise). It also depends on how willing you are to bear risk from a purely emotional perspective. As an example, if you are a retired pensioner who relies on your portfolio to maintain your lifestyle, then you have a very low risk tolerance. In that case, you should probably focus almost exclusively on conservative stocks and your total portfolio must consist of a wide range of safer investments, including bonds or bond funds and market ETFs (exchange traded funds). If you are relatively young and have a few decades of earning power left, your risk tolerance can be quite high and you can invest in almost anything you want.

It is important to note that these examples were provided for illustrative purposes only. Determining your risk tolerance is a very important and sometimes complex task and if you are not comfortable determining it yourself, then you need to consult a registered and competent financial advisor to assist you. The services of a financial advisor can be easily coupled with those of KeyStone’s research service.

The first thing you have to do is determine your risk tolerance and decide how much capital you are going to allocate to your ISR portfolio. We already provided a brief discussion on risk tolerance, so we don’t need to reiterate those points. Determining the amount of capital that you will allocate to this portfolio is very similar to determining risk tolerance; it depends completely on your specific financial situation.

However, assuming you have those two items addressed, you can move forward with building an income stock portfolio. What we usually suggest is that subscribers couple our service with that of a discount brokerage. For those that don’t know, a discount brokerage is a stock brokerage that will execute your trades, but does not provide you with advice. The benefit is that it is much cheaper than a conventional full service brokerage.

The commissions you pay per trade depend on which discount broker you are using, the size of your account, and how often you trade. The absolute most you should ever pay for a trade is about $35, but you can get them for far less. Through our research, we have found that the most simple and attractively priced service is from Questrade. They offer a flat $7.99 per trade commission structure for accounts of all sizes.

Now that you have your trading account set up, the next step is to start constructing your portfolio. As discussed, we categorize each of our recommendations into 3 model portfolios – conservative, moderate, and aggressive. Depending on what you determined as your risk tolerance, simply go to that portfolio, read the initial report and the most recent update report for each individual recommendation and start buying the stocks. You have the choice of either following only one of the 3 portfolios or you can break your portfolio up and buy a few companies from each of the 3.

Our suggestion is that your ISR portfolio should consist of about 8 to 10 stocks; this number may change as you are selling or buying new companies. For those that want to diversify across each of the portfolios, we also have our newly created Hybrid Portfolio (currently consisting of 8 recommendations and can fluctuate between 6-12 stocks over the course of time). Once you have your portfolio constructed, you just have to follow the update reports that we send out on a regular basis. Within each report is valuable information that will advise you on when and at what price to BUY or SELL each of the respective companies.

When we recommend a new company, our expectation is that over time, the stock price will appreciate and provide strong returns for our subscribers. While this is great for investors who already own the company, it does not do much for new subscribers that did not have the opportunity to purchase the companies close to the initial recommendation price. If the recommendation is currently rated a HOLD (Short and Long Term) or if the stock price has appreciated beyond the fair value assessment, we do not advise that you take a new position in the company. What we do advise is for you to remain patient. Start with the companies that are currently rated as BUY and where the fair value assessments are comfortably above the stock prices. If you are intending on building an 8 stock portfolio and there are only 4 current BUY recommendations in your portfolio of choice, start with those. There is nothing wrong with keeping some capital available on the sidelines to capitalize on new opportunities. Over the coming months, new recommendations will be made or existing ratings will be revised upwards and you will have the opportunity to fill your portfolio to its desired size. Another option is to venture outside of your preferred portfolio and purchase 1 or 2 recommendations from the neighb ouring portfolios. Advising patience may be of little comfort to people paying for financial advice; however, it must be understood that the stock market does not provide an infinite number of quality opportunities at all points in time.

Recommending companies simply for the sake of filling portfolios will almost certainly cause problems for your portfolio long term. Beyond the companies that are currently recommended in our portfolios, we also follow dozens of other companies that are close to meeting our criteria and where a specific event will move them from our MONITOR list to our list of recommended companies. It often takes time to build a solid portfolio, but your chances in the market will be dramatically increased if you exercise patience and avoid restlessness.

The fair value figures listed in each of the company reports is our assessment of the maximum price we are comfortable paying for a stock. This is the maximum price that we believe we can buy the stock and still generate a reasonable return over time. In special cases, we will discuss the fair value assessment in the conclusion of the report and may perhaps advise buying below or slightly above this value. Really, this assessment should not be taken too seriously as it is very subjective.

Nobody knows with certainty where a stock price is going to be 12 months in the future as there are plenty of events, both foreseeable and unforeseeable, that will alter this value assessment. It is, simply put, a tool that helps users gain an understanding of the relative value of each individual recommendation. There are a number of other factors including risk, which determine the overall investment merit of a particular company.

This rating is used for companies where we are optimistic of long-term potential (two to five years), but we believe there is a possibility of short term weakness. Sometimes this is due to operational issues with the company and sometimes it is because the stock price has appreciated to the fair value and we don’t see much more short-term growth. It might be logical to assume that a company with this rating possesses lower investment merit than a company rated BUY. This is not necessarily the case. An example is Ag Growth International. Ag was reduced from a BUY to Short Term: HOLD/Long Term: BUY on July 16th, 2010, at a price of $34.22 (originally recommended at $31.79 in November of 2009). The company was facing some short-term difficulties, but in spite of them, generated a strong quarter of results and raised the dividend. Within a few months, the company traded at $46.92. We liked the company and the sector long term and we expected the market to take longer to discover this; that was clearly not the case. The key here is that our recommendations are designed to perform in the long term, trying to time a stock in the short term is often a fool’s game.

When we talk about a company’s valuation, we are referring to how cheap the stock is relative to the value of the underlying business. Our mandate is to discover companies that are trading at a discount relative to the actual value of the company. This is what we are referring to when we say a company has an attractive valuation. There are a number of numeric and non-numeric methods that we use to determine valuation and it is by no means an exact science. To put it simply, if the sustainable earnings and cash flow per share are high and the share price is low, the valuation is most likely attractive. We want to pay as little as possible for a quality company with the hope that eventually the market will recognize this quality and the share price (and valuation) will grow in tandem.

The balance sheet is a list of a company’s assets and liabilities (debts and obligations) and it is used to determine the financial health of the company. It’s really quite simple because everybody has a balance sheet. If you were to construct a list of all your assets (cash, investments, house, car, etc.) and a list of all your liabilities (mortgage, credit card debt, line of credit, car loan, etc.), you will have created a personal balance sheet. When you take your assets and subtract your liabilities, you arrive at your net asset value. It is the same for a company. We look for companies with large balances of quality assets like cash and tangible assets that are generating a high return on investment. We also look for companies with low levels of debt or preferable no debt. Low debt typically means less interest to pay and the less likelihood of the company experiencing financial difficulties if the economy declines. It also means that a company is better positioned to take advantage of opportunities if and when they present themselves. So when we say strong balance sheet, we are referring to the balance between assets and liabilities.

Our advice is to be patient and follow the research on the company. We don’t recommend companies with an intention to hold them for only a few months. Our initial intention is to hold them for years, collect dividend cheques, and benefit from capital gains long term. Sometimes a company’s shares will appreciate faster than we expected, but investing means that we are prepared to hold the stock and allow it to grow with the company. One of the primary benefits of income investing is that we are receiving an income yield and can therefore afford to be more patient.

A slip in the stock price does not necessarily mean that it is a bad company. As fundamental investors, we separate a company’s market, or stock price, from the actual intrinsic value of the underlying business. In the short term, the stock price will move up and down based on a number of factors, many of which have nothing to do with the company. Unless you are planning on selling the company in the short term, the current share price is largely irrelevant. What is relevant is that you are receiving your distribution or dividend and the company is effectively executing its strategy. Our best advice is to be patient and follow the research. If there is an issue that we are aware of, we will let you know.

We have already repeated it, but we will say it again – be patient and control your emotions. Restlessness, fear, and greed are the surest roads to trouble in the investing world. The stock market will go up and down, opportunities will come and go, and some of your investments will lose you money. What’s important is that over time, your overall portfolio performance is strong. When I think about this advice, it reminds me of a famous quote made by Warren Buffet who is almost universally considered the most successful investor of all time. “At a normal level of intelligence, success in investing is not correlated with IQ. More important is character and the ability to control the urges (relentless, fear, and greed) that get most investors into trouble.”