Book review: When The Bubble Bursts

In Investment Theory on December 1, 2016 at 2:29 pm











Book review: When The Bubble Bursts: Surviving the Canadian Real Estate Crash
By Hilliard MacBeth

Investment advisor Hilliard MacBeth’s book about the coming Canadian housing crash is well researched and engaging. It is the scariest financial book I’ve read.

He starts with the observation that whatever his retail clients are fascinated by usually ends in epic disaster. In the early 80s it was oil and gas stocks; the mid 90s featured Bre-X. Tech stocks (including Nortel) took centre stage in the late 90s. Since the mid 2000s, his clients talk about one thing: real estate. What they say to him: “It keeps going up, it can’t go down, buy now before it’s too late.” Some of his clients own multiple properties which they rent out, often at a negative monthly cash flow in the hopes of future capital gains. Sound familiar?

MacBeth uses research and data to back up his arguments for a coming housing crash:

1. Over long periods of time, real estate tends to keep up with inflation. It doesn’t perform much better than that. Periods of price growth beyond basic inflation matching are unusual and often turn out to be bubbles. Canadian real estate, especially in major cities (Vancouver, Toronto, Montreal), have risen three-fold since 2000 which seems unsustainable; incomes and prices of other goods have not risen in proportion. Canadian house prices in relation to average household incomes have risen to some of the highest in the world, higher even than in the US at its housing bubble peak.

2. The bubble could burst for any number of reasons including higher interest rates or a recession. Interest rates are currently at historical lows. At higher rates, many people wouldn’t be able to afford their mortgage payments. In a recession, people who lose their jobs will be unable to meet their mortgage payments.

3. Structural shift. The large wave of baby boomers downsizing will create a large supply of homes. Boomers won’t want the upkeep, won’t be able to climb stairs, and will want to use those assets for retirement. This supply will be added to large supply that has been added in recent years due to the building boom. Taken together, this supply will overwhelm demand and prices will fall.

MacBeth tears apart commonly held opinions about real estate. These include the ideas that renting is wasting money (it’s cheaper than owning and the savings can be invested in stocks or bonds), that real estate always goes up (not true, look at USA/UK/Ireland/Spain/Japan/etc.), and that the Canadian market is somehow unique and immune from a downturn (sorry, it’s not).

MacBeth points to the government run CMHC mortgage guarantee program as one of the reasons mortgage lending and personal debt levels have gotten to this point. Without this program, banks would be more conservative in their mortgage lending because they would bear the risk of loss. In economics, this is called a moral hazard.

The people that will be most hurt by the crash are retiring baby boomers hoping to cash out and pay for their retirements, new buyers with high loan to value ratios, landlords trying to make money renting out condos, shareholders of Canadian financial institutions, those in the construction industry and last but not least the Canadian taxpayer (who will foot the bill for the CMHC losses and bank bailouts). But those won’t be the only groups affected. As housing is usually by far the largest asset for most households, the consumer, who drives our economy, will be negatively affected in a big way. Rather than continuing to enjoy the wealth effect from rising home values, they will feel poor. In response, they will start saving and spend less resulting in a dramatic effect across the Canadian economy.


Market leader in diabetes medication hits two-year low; Novo Nordisk (NYSE: NVO) shares reach $34

In Investment ideas, Uncategorized on November 7, 2016 at 7:38 pm


By any metric, Novo Nordisk (NYSE: NVO) , the world leader in diabetes medication, is an outstanding company. It commands a 28% global market share in diabetes drugs, one of the largest buckets within specialty pharma. Returns on shareholder’s equity last year was a whopping 45%.

The company is also growing fast. Over the last decade, annual growth rates for revenue and operating income were 15% and 23%, respectively.

Novo is very focused on just four disease areas: diabetes (79%), obesity (<1%), hemophilia (10%) and growth disorders (11%).


Diabetes is clearly its major focus. Diabetes is a medical condition that has affected mankind for millennia. It is currently experiencing rapid growth due to the lifestyle factors associated with modern urban life: western diet and lack of exercise. Type 2 diabetes, also known as adult onset diabetes, makes up 90% of the diabetes market. There is no cure for this condition except purchasing expensive insulin products from Novo, Sanofi and other drug companies.

As India and China urbanize and develop a middle class, there could be a large pool of new customers. Even the United States is a great growth opportunity; according to the American Diabetes Association and the CDC, if current trends continue, 1 in 3 American will have diabetes by 2050.

Novo is highly profitable. Last year, gross margins were 85%. Operating margins were 45%; that is an incredible number and beats almost anything I’ve seen (Coca-Cola’s is 20%, Starbucks’ is 19%, Walmart’s is 5%).

Due to pricing pressures in the US and European markets, management has reduced long-term revenue and operating income targets to 5% from 10%. This is a very sharp reduction and has led to a steep drop off in the share price. Shares reached a two year low today at close to $34.

At this price, the trailing 5-year P/E is 22x (a little pricey) and the forward 2016 P/E is 15x (quite reasonable). The shares sport a 2.79% dividend yield.

Based on my analysis, long term total returns on common shares (share price appreciation plus dividends) are expected to be 10-11% going forward. However, if shares are purchased below today’s prices or growth exceeds the new 5% target (quite possible), your results could be even better.

Despite setbacks, Deere will recover

In Investment ideas on September 23, 2016 at 1:11 pm


They say nothing runs like a Deere. Established in 1837, John Deere (NYSE: DE) is the market leader in agricultural equipment. Due to a challenging environment for farm incomes over the last few years, Deere’s sales and earnings are down. As a result, Deere shares are cheap. The Company has seen its sales trail downwards from a peak of $36.1B in 2012 to $28.8B in 2015. Due to low crop prices, farmers don’t have the money to buy new tractors and gear.

Deere generates 69% of its revenue from the sale of agricultural and turf equipment. More than half of that is in North American market. It has a dealer network that is unmatched in North America with around 1500 dealerships. This is a big competitive advantage because it means that customers who need equipment serviced can do so quickly and conveniently. I experienced this firsthand purchasing a ride-on lawnmower for a commercial property I managed in rural Nova Scotia, Canada. We chose Deere because of the local dealership’s proximity for service repair in addition to the brand’s reputation for quality. Another big competitive advantage for Deere is its large in-house financing department.

Deere enjoys high returns on equity with ROE averaging 20%+ over a 20 year period. Over the same period (1996-2015) the company never reported an operating loss in any year. The company is also remarkably shareholder friendly, returning more than 100% of owner income (CFO-capex) to shareholders in the form of dividends and share buybacks over the same 20 year period. Due to buybacks over that period, share count was reduced by 36%.

Management (CEO / CFO) have long tenure with the company as do other senor executives. And all senior managers (dozens of key people) are required to maintain large personal shareholdings in the Company, which is unusual.

Crop prices will rebound at some point in keeping with the agricultural cycle. In addition, tractors and other equipment wear out and will need to be replaced at regular intervals; thus most sales can be delayed but not entirely foregone. Also interesting, new technological advances (self-driving tractors) could mean a greater demand for next generation products.

Berkshire Hathaway bought some Deere stock ($1.7B) around $80 per share in 2015. At $84 per share, Deere has a market capitalization of $26B and around a 3% dividend yield. This price represents a 11x multiple on 5 year average EPS. Deere’s sales are expected to recover in 2020 to about $45B. At this time, EPS could be about $11/share. At 12x P/E ratio, this will result in a share price of $132. Total returns – share price appreciation plus dividends – could be 44-96% for an approximately 5-year holding period.