Diversifying from Property into shares

[chilliaa]

Hi just an update that i thought some of my fellow somersofters might be interested in. As i mentioned recently i was very impressed with another posters discussion on how he had diversified into shares using his property as leverage.
Basically from memory (although he explained it better than i can) INSTEAD of selling property directly, which involves transaction costs and realisation of capital gains taxes, you use the surplus equity in your properties to fund purchase of shares and then you top this up with a CONSERVATIVE amount of debt using leverage equity.

Last year i was not comfortable with this strategy because of the high level of the aust stock market. However i still put in the ground work by organising with my bank to increase the draw down facility against my properties since they had appreciated nicely last year. Bank had no problem because LVR was still under their requirements.

I am dont have a very large property portfolio like some of the somersofters out there, but here is a brief summary and the logic behind it.

Since the start of January when the market started to correct i have been selectively going into the share market.
Used the draw down facility to take out $70K, used additional savings of $30k. Gives me 'equity' of $100k. Established a margin lending facility with a theoretical debt value of about $250K, but to be conservative i have am only using $50 of margin lending debt. That way in simplistic terms the market would have to plummet by about 50% odd before i risk any margin call.

This is what i bought:
Stock 2008 Gross Yld (ie add back imputation credits)
AMP 7.3%
ANZ 8.14%
Aristocrat 7.7%
Goodman Fielder 9.64%
Insurance Aust 11.14%
Macquarie Bank 9.42%
Met Cash 7.7%
Perpetual Trustee 9.7%
Getting tired here doing all the calculations, but basically bought 15 stocks over the last two weeks. The gross dividends are mostly around 7% to 10%.
My borrowing costs from the bank is variable on about 7.8% and the interest cost on the leverage equity is now around 9.6%.

I am not sure how successful this will be longterm, but to me anyway it beets the hell out of purchasing ADDITIONAL property at the moment, with net ylds on houses around 2 - 3% on borrowing costs of 7.5%

 

[Chris.R_WA]

No resource stocks?

I'm surprised someone hasn't replied noting that ZFX is yielding approx 14% on current price...







Not a recommendation by the way

 

[WillG]

I am not sure how successful this will be longterm, but to me anyway it beets the hell out of purchasing ADDITIONAL property at the moment, with net ylds on houses around 2 - 3% on borrowing costs of 7.5%

Your success will depend on what you are trying to achieve. From what you have said, your are buying shares using $70k equity from existing IP's, $30k of your own cash & $50k margin lend - this equates to an LVR > 70% - are you comfortable with this ?

Are you chasing capital growth and income ? You portfolio seems to be heavily weighted towards banking, financial & insurance stocks; do you see good capital growth coupled with acceptable risk in this mix ?

 

[chilliaa]

Your success will depend on what you are trying to achieve. From what you have said, your are buying shares using $70k equity from existing IP's, $30k of your own cash & $50k margin lend - this equates to an LVR > 70% - are you comfortable with this ?

Are you chasing capital growth and income ? You portfolio seems to be heavily weighted towards banking, financial & insurance stocks; do you see good capital growth coupled with acceptable risk in this mix ?

Whilst the LVR against my own cash contribution is greater than 70%, it is only 33% for the purposes of margin lending (ie $50K/$150k). The margin lender is not the same institution as the lender for the properties. Thus i am VERY comfortable.
I believe the shares i have bought are 'good' shares with reasonable or minimum debt levels and good long term earnings. With gross ylds of 7 - 10%+ the dividends on the shares are covering the interest expense. This is BEFORE any tax effect accounting.

At this stage in the property market i am far more comfortable doing this (as shares have already corrected somewhat, and ylds are attractive) than say using the $70K from the bank to finance another property where net ylds will be much lower.

 

[chilliaa]

Are you chasing capital growth and income ? You portfolio seems to be heavily weighted towards banking, financial & insurance stocks; do you see good capital growth coupled with acceptable risk in this mix ?[/QUOTE]

From the way i see it, banking, financial and insurance stocks have already received a beating and thus represent the most value. I also have RIO as my sole resource share (i dont really understand resource company valuations so i tend to avoid them) and WOW. Tried to pick up Wesfarmers but it was only briefly below $34 and there were so many opportunities this week to search through. Now with Wesfarmers around $38 i am a bit more scared because of their, i believe, around $10billion debt.

Assuming i can acheive say about 5% long term growth i think this should be a reasonable return given i only used $30k of my money to finance $150k of stocks. My imputed return on capital employed ($30K) would then be 5x5 percent ie 25% return. If the share market grows at its long term average of around 12% odd then the return on capital employed will be much higher (or am i doing something wrong?????)
Also most of these stocks were bought during the recent sell off. So i feel safer than when everything was roaring like the early part of 2007.

 

[sue78]

I would be wary of the 70% LVR. You are relying too much on yield (to pay your loan) and with the market this year and for the next few years...it's very unstable. If company profit decreases and coupled with a decrease in share price then it won't be good for you.

Macquarie Bank is a risky one.

How cheap was ZFX? and the article yesteday helped today's share price too. They're talking about a bid or a share buy back with their $2.3 bil cash surplus...

I bought on Mon @ $9.60, went down to $8.50 and today back up to $10.60.

Just trading ZFX alone over the last 2 weeks you would have done ok.

 

[ethereal]

Chillia,

I congratulate you for having a plan and sticking to it. There is much fear about in the markets at present but historically that is the best time to buy. I think you're on the right track for what it is worth (and that's not much!), particularly as it appears you intend to buy and hold. As you said, far better to buy when the bloods running in the street than when things are boomy and rosy.

Only thing I would look at, as Will G mentioned, you do seem heavily weighted in financials and if things stay rough in that sector for a time, yeilds are very likely to decrease from their current levels.

Just my opinion, I am no expert. In fact, many would say I am heavily overweight in resource stocks. Just so long as you have thought it through, which it appears from your comments that you have.

Louise

 

[Sunfish]

I'm up $5k on ZFX in two days myself.

But just an hour ago I made a post on "pretending" to diversify. With your portfolio you have no more diversity, and more volatility, than if you'd simply bought another property.

You have a 70% LVR but the companies you bought are all geared up themselves. Most of them have little asset backing either. Their major asset is their brand name. If you are investing that much you must buy a charting service. I assume you don't have one by your selections. AMP is the only one which had a good '07, got hit recently and could be a good bet for a recovery. Looking at the charts nothing else appeals.

I won't discuss shares further with anyone with such a closed mind that they lock out resources after all I've said.

 

[chilliaa]

You have a 70% LVR but the companies you bought are all geared up themselves. Most of them have little asset backing either. Their major asset is their brand name. If you are investing that much you must buy a charting service. I assume you don't have one by your selections. AMP is the only one which had a good '07, got hit recently and could be a good bet for a recovery. Looking at the charts nothing else appeals.

I won't discuss shares further with anyone with such a closed mind that they lock out resources after all I've said.[/QUOTE]

I dont understand how i have a 70%LVR, especially from the point of view of margin lending. Against additional cash equity i agree, but thats like saying if i buy a property using increased equity from my property holdings then i have a LVR of more than 100% on the new property purchase. For example assume i use $70K from equity in the property to buy a $200k property and finance the other $130K from debt i have not used any cash. So the LVR on the new purchased property is more than 100% under your logic.
If i treat the $70k from equity in my cash caluclation then i have $70k equity from property refinance, an additional $30k equity from cash injection.
Then my actual gearing is $50k debt/$150k assets or just 33%

Thats essentially why i believe this is a low risk strategy. The actual gearing is just 33% of the asset pool. So long as i keep making repayments to the bank, they wont care how i used that $70k of finance from them. And from the margin lenders point of view so long as the assets dont fall from $150k to approximately $80k they wont care either. The $150k invested has to fall to below $80k in value before i risk anyform of margin call. Given these stocks were bought on a dip already i cant really see that happening.
ie ANZ would have to fall from $26 to around $13
PPT from $60 to $30
ALL from $9 to $4.5
IAG from $3.7 to $1.8
etc.
THese are big drops.

 

[chilliaa]

I agree that most of the portfolio is in finance/insurance, but not all of them.
I do hold RIO, WOW, GFF, ALL, MTS and TOLL.
So the % in finance/ insurance is roughly 60% of the total portfolio.
As i said i dont really understand resource companies and how to value them. So i am more weary of buying them.
I also am the first to admit i know NOTHING about trading/chartists etc.
SO i figure if i try anything based on trading rules i will get eaten alive by the professional traders.
Hehe nothing like an amature trader appearing to make the professionals drool with greed.

 

[chilliaa]

Hey by the way i do really appreciate the comments/critism its the only way to learn

 

[s_t]

Well done mate. I think now is a great time to buy - better than any other time over the last 6 months! I'm going to get myself a job (in addition to my lazy self empolyment...) for a while with the express purpose of generating additional funds for additional investments!

 

[chilliaa]

For those of you that are traders, no disrespect intented but i found an interesting video on youtube about cramer. Apart from the tv enternainment aspect about this guy, apparently he has a wide following in the USA, as being a 'trading' guru. According to the media he made millions several years ago on some big correct trades.
Anway this video makes entertaining watching and more importantly to me highlights the hazards of trading unless you are 100% on the ball.

http://www.youtube.com/watch?v=SGkrNJ19DSU

 

[chilliaa]

I just noticed the coffee lounge, and some posts where some members have asked for suggestions on high yielding shares. So i will explain my logic for some of the shares i purchased.

Again i emphasise i am NO TRADER, so anyone following this review please be have the attitude that you are buying for the LONG TERM, ie 5 years at least.
I have absolutely no idea where this stocks will be trading next week or next year. However over the next 5 years i am VERY confident in their ability to return above market average returns.

Also i would like to make another point about short term investing in the stock market. Did you know 65% of people LOOSE money (realised and unrealised) in the first year of purchasing a stock. ie there is a 65% chance that if you buy the market price will be lower within a year. However after that first year the probablity drops dramatically.


Anyway here it goes:
Aristocrat Leisure: 10 year EPS growth, ROE consistently above 20%, cashflow per share often above EPS, except for 03&04 10 years of growing DPS, 2008 div yld is reasonable.

Any of the big 4 domestic banks, because of their attractive ylds, and oligoboly situation in the australian banking market. Most have 10 yr growing EPS and DPS. However one point to note, their provisioning for bad and doubful debts as a % of loans writen is at 10yr lows and also their net margin on loans underwritten are also at 10 year lows.

Really sticking my neck out here, but Babcock & Brown and Macquarie banks. Very well run investment banks. Harder to fully analyse these companies because of the nature of their investments. But they have been really smacked down. Note also that babcock & brown upgrated its december year end EPS forecast from 40% to 45%. This upgrade was made sometime in december, so im pretty sure they are right about it.

Macquarie bank: Australias most successful investment bank, been around alot longer than the 'newcompanies' like alco finance. Macquaries interim profit was unscathed with the recent record interim result free of unusual provisions or write-downs; no problem trading exposures and no material problem credit exposures. Macquaries risk policies are closely aligned with those of Goldman Sachs which also avoided the carnage in global credit markets. 10 yr growing EPS & DPS, ROE consistently above 15%, great redeployment of retained capital.

Computer Share: 10 year EPS & DPS growth (except for yr 03), reasonable ROE. Cash flow per share above EPS, high barriers to entry. Reasonably low capital spending per share as a % of cash flow earned per share, and when capital has been held it has profitably been redeployed.

Perpetual Investments: One of the most prominant funds management company with great strong 'brand name' and investor loyalty. Its Australian share fund outperformed its benchmark for 12 of the last 13 years. If risk aversion returns to the australian stock market then Perpetuals better investment performance should lead to more consistent equities net inflows and hence profit, especially as Perpetuals funds have historically outperformed in times of low or negative total share market returns. 10 yr ROE is great, and 10 yr track history of growing EPS & DPS. Cashflow per share approximately EPS which will support the high payout of profits and thus perpetual should be able to keep up their high levels of dividends.

 

[Goyco]

Well Done Cilliia

But personally I wouldn't margin loan the shares just keep transferring the equity rom the properties into shares. Have you thought of using an index fund rather than direct shares? A lot less risky in my opinion. Your strategy otherwise is perfect except you are still open to a margin call however unlikely.

Just my thoughts

good luck

 

[chilliaa]

thanks buddy yes in the back of my mind that is the one issue that concerns me. However i figure with only $150k in the market worse case i get a margin call, the cash call wont be huge in dollar terms.

 

[chilliaa]

I'm up $5k on ZFX in two days myself.


I won't discuss shares further with anyone with such a closed mind that they lock out resources after all I've said.

Sorry Sunfish, but we are going to have major disagreements about this. To paraphrase warren buffet, its very hard to make above market returns when you are following what the majority of other investors are doing.

I just checked out aussie stock forums for the first time. Very interesting to note that the vast majority of forum posts concern resource stocks. Maybe by a margin of 5:1.
Excactly the reason why i have such a closed mind concerning resource stocks at the moment.

 

[redwing]

Buy Low - Sell High

Probably a good time to pick up some Bargains (I'll let you know in 12 Months),We Picked up some BHP and CBA on recent dip in the Market to add to the basket of goodies

 

[Sunfish]

Sorry Sunfish, but we are going to have major disagreements about this.

Fair enough. I went off half cocked and apologise.

I have been beating the resource drum for four or five years now and it has treated me well. I have spoken of a super-cycle and still believe in it, so I will stick to my philosophy. I am equally convinced that the financials will break your heart for a few years.

But these are my own thoughts. And be careful how you use contrarianism.

 

[Rino]

Chilliaa, you are doing exactly what I intend on doing in a few months time when I refinance my loans and unlock some equity in my property.

On the LVR side, I agree with you completely. As long as you can afford the interest payments, your strategy is low risk as a long term investment. A margin loan LVR of 50% or less is relatively low risk, especially after the recent drop in the market, and your margin loan is closer to 30%.

Regarding the charts, I agree with you, ignore them. They might be useful in short term trading strategies but you're a med-long term investor, so fundamentals are you friend.

Regarding your stock selection, as long as you're comfortable with the businesses you're buying and their balance sheets, then go for it. From the looks of your selection they all look like good businesses. You may well be heavily weighted in financials but guess what? Our market is heavily weighted in financials. 11 of the ASX 20 are financial stocks. There's no point diversifying into Australian IT stocks just for the sake of it. By all means diversify, and getting into an international/US MF when the dust settles could be a way of doing this. But the strength of the Australian market is financials and resources. Don't confuse weakness in US financials to mean weakness in our banks for example. In the long run our banks will benefit from all this. Our major banks have shown the type of behaviour and implemented policies that will see them avoid most of this, they are strong and for the most part the US credit crunch will help to flush out some of the non-banks and smaller institutions that had been growing in popularity in the last 10 years and return the power and profitability to the major banks.

As for investment banks, I don't trust them and don't like them on principal. I wouldn't be a long term investor in Babcock or Macquarie. But if you believe in them, go for it.

As for resources and materials, going for a long term investment in the big diversified like RIO and BHP is a good long term strategy. Companies like Zinifex may be good investments but they don't fit into my strategy in that they are not diversified enough for me given their capitalisation. For some oil exposure you could also consider Woodside which is a great company.

You're into WOW, which is great. If you want a little property exposure you can look at Westfields which also has a good yield at the moment and some long term growth potential in the US market.

I personally have a 40% Financials (Banks), 40% Resources (BHP, RIO) and 20% Other ratio. All of this is on margin loan with a 60-70% LVR (80% is the margin call limit) with around 20% of my total portfolio value in cash to cover any calls. I will be able to access some equity in my property in a few months and I will be aiming to add to my portfolio in a way that brings my margin loan LVR to around 30-35%. I plan on adding more banks, WOW and Woodside and an international managed fund that's heavy on US stocks.

If you can afford to go without the dividends, I'd consider reinvesting those bank share dividends until the day you stop working and need to live off them. The snowballing effect over the years is phenomenal.