Disclosure: I now own a tiny stake in Automodular. This article is NOT a recommendation that you buy this — or any — particular stock.
The week before last I bought Automodular (Symbol: AM.TO), a stock traded on the TSX. Automodular was the best purchase based on my process of fundamental analysis for value investing (a.k.a. dividend stock investing). Today I’m going to explain why I bought these shares at $1.80 each (by the way, my commission was only $4.95, thanks to Canada’s best discount brokerage, Questrade – sign up now for $50 in free trades!).
When I ran a stock screener search back in August, I noticed AM.TO based on these three criteria:
- The Dividend Yield (DY) was off-the-charts. They pay a quarterly dividend of 6 cents a share. My purchase price means the yield is over 13%.
- Its Price-to-Earnings (P/E) was low, which is awesome. But it’s so low — varying between 2 and 4 over the last year — that I was kind of worried (“too good to be true”, etc.).
- Automodular’s Price-to-Book (P/B) fluctuates around 1. Again, crazy low. Book value almost always involves some intangibles so, in the event of bankruptcy, shareholders won’t get all of the book value back. But given its high ratio of tangible assets, this is an extremely nice cushion.
It also passed my “smell test” for solvency and stability:
- The company keeps more than enough cash on hand to pay its current liabilities (current ratio).
- The Debt-to-Equity ratio is low and its Interest Coverage ratio is great.
- During the Great Recession, this company had some cashflow issues but, from what I can tell, not anymore. It seems management learned from its mistakes and keeps the company more liquid.
- The dividend appears very sustainable. For the quarter ended June 30th, 2012, the payout ratio was under 30%.
As I researched the company, I had two nagging concerns about Automodular:
1. Ford is the company’s bread-and-butter. The Big 3 manufacturer holds a near-monopsony (exclusive buyer relationship) over Automodular. If Ford croaks, reneges, or awards its sub-assembly contract to another company (this contract expires in 2014), then Automodular is toast. If Ford stays with Automodular for another few years, then the latter company will likely remain a milk-able cash cow for small-time investors. This is the gamble that I think is priced into the shares. If my friend Nelson can make a residual equity bet on Research in Motion (which appears to be Canada’s next Nortel), then surely I can bet on the desire of Canada’s auto industry to subcontract work to smaller, more efficient companies.
The company is trying to diversify into other markets, e.g. wind energy. But let’s be honest: AM lives and dies by Ford. I’m rolling the dice, hoping that Automodular will have some nice equipment and plant assets to liquidate if the company breaks up with Ford in two years.
2. The CAW negotiations were looking pretty grim for a short period of time. If the Canadian Auto Workers had gone on strike, Ford probably would have shut down a lot of production, hurting revenue in the short-term. Luckily this didn’t come to pass, but I still waited to hop in until labour peace was assured.
To buy this stock, I disregarded two of my general ‘rules’ of investing:
- Automodular is a penny stock. I avoid stocks trading well under $5. The nominal price shouldn’t truly matter, but I do think “penny stock” status can adversely impact a stock. Clearly I believe in the semi-strong efficient-market hypothesis (EMH); technical analysis is a valid consideration, but is always trumped by fundamental/value analysis.
- AM.TO is a nano-cap stock on a US scale. Even for Canada, a sub-$50 million market cap is small compared to the mean cap of over a billion dollars. You may recall that I prefer the relative liquidity and stability of large cap stocks over micro-cap stocks.
While I don’t think disregarding those two principles was a bad idea, I did make one key mistake in executing my trade.
No, it wasn’t the cost of commission. I used Questrade so I paid next-to-nothing.
I failed to buy AM near the bottom of a recent dip — despite the fact that it dropped well below my target entry price. I’ve been watching Automodular hang around close to two bucks since August. When the price started to fall with strong trading volumes, I chickened out (even though it was ex-dividend so a drop made sense). It hit $1.60 for a brief moment and I should have gladly jumped in (though I bet I would have gotten it for closer to $1.65). But I didn’t buy. The stock promptly regained its footing. I executed my purchase of AM.TO at $1.80 — instead of a 14.5% annual dividend, I stand to earn 13.5%.
Dividends matter, emotions shouldn’t. Live and learn.
I wish you luck. You certainly seem to have done your balance sheet homework, and (although completely the wrong reason to invest in something) I certainly wouldn’t ever fault you for desiring to make a bet on Canadian manufacturing. Also kudos for having the courage to detail your picks online – lots of people talk tough, but don’t always have the cojones to put their money on the table and tell the world about it.
I am no more than a novice investor, but in my limited experience, you are in for a move here, one way or another. 13-14% dividends are not sustainable. Either the stock will go higher, or the dividend will shortly be cut. I have no idea which one (I hope for you, the former)… but I’d be willing to bet any day that the stock won’t sit at the current price with a 13% dividend for years.
As for me… I am a recent stock-picking refugee. Been there, done that, won some, lost some (on average generally lost more than won). I’ve decided that I am neither smart enough nor have sufficient time to pick stocks properly – and even if I did, most research says even the professionals can’t reliably beat any index. So it’s passive investing for me all the way now – anything else, I may as well just head to the casino.
BTW have you noticed that Virtual Brokers recently smashed Questrade’s “lowest fees” argument to bits? Virtual Brokers chargers $0.01/share (same as Questrade) but with a minimum of just $0.99 (compared to Questrade’s $4.95).
Granted that may not have helped you if you are buying $1.50 stocks like this – but for most, on aggregate, this is way cheaper.
https://www.virtualbrokers.com/contents.aspx?page_id=100
I think Questrade should watch out. Besides being by far the cheapest, they’re not particularly good at anything. And now they’re not the cheapest.
(Full disclosure – I have been and am still a Questrade customer. One that is now strongly considering a switch)
Thanks for this heads-up. I hadn’t seen them.
I do think Questrade, like any business, should stay on the look-out for competitive threats. But I do think it’d a smidgeon unfair to say “Besides being by far the cheapest, they’re not particularly good at anything”. If a person wants to pay for Level 1 data, they can, just like any other discount brokerage. My personal customer service experiences have been better than when I dealt with TD. I think we can both agree, nevertheless, that cheapness is by far the most important characteristic of a discount brokerage (assuming the brokerage is compliant with securities law and such lol).
The commission structure is amazing, Virtual Brokers has got that. I am definitely going to consider them. There are, nevertheless, some fees at Virtual Brokers:
$50 annual fee will be charged for accounts under $15,000 in assets (higher threshold, no waiver with one trade, and fee can’t be used as commish for trades)
US RRSP – $50 per year (lame considering it’s free at Questrade and this amount is likely to be small for an average holder)
US TFSA US – $50 per year
RESP – $25 per year
So perhaps it would make sense to keep specialty investments at Questrade so long as the value exceeds $5k, and move a general trading account (so long as you’ve got MORE than $15k) to Virtual Brokers. There’s also the fee-free ETFs, although I’m concerned about the lack of Vanguard funds (only 1) and the presence of a lot of high MER / leveraged type ETFs.
My stock picks have done well, ever since I switched to my strict “dividend-only” policy. I don’t even look at prices anymore after I buy, so long as the dividends keep flowing. I dabbled a bit too much in garbage stocks during university (why would I buy Global just because I liked their Sunday night line-up!? That’s $300 I’ll never get back) but luckily I made as many smart picks and came out even. (I knew about dividends, why didn’t I just ONLY play the dividend game!? Stupidity of youth.)
I, too, am a reformed “stock-picker”, but not as reformed as you lol. Now I have a cohesive system. My portfolio spins off reliable cash; at this stage of my life, liquidity is #1.
On paper, it sure looks good. Except that it’s only got one customer, hard to get past that. I know a local company which is joined at the hip with General Electric to the tune of 80 percent of revenue. Insiders are selling heavily.Nothing against penny stocks, though, wish you the best on it.
There’s a couple of good Canadian dividend payers that I’m constrained to buy, as for some reason they’re not offering stock reinvestment on the pink sheets (where I have to buy them, being American). Rogers Sugar, Corby Distilleries, Liquor Stores… ah, if only!
There are definitely some nice dividend plays in Canada. The trouble is that the tax rates are probably awful for non-Canadians.
Then again, it’s hard to feel bad for you guys when you’ve got the NYSE lol
Andrew, you might want to check out the tax status of holding them in your 401(k):
http://seekingalpha.com/article/248039-withholding-tax-rates-by-country-for-foreign-stock-dividends
Thanks for this thoughtful heads-up to US readers, Jacq.
Hey, which discount brokerage should I use to buy shares? I’m not quite sure I know which one you recommend.
I was going to write a giant long comment about how penny stocks are awesome, but screw that. I’m not giving you free content. Look for it on my blog in a week or so.
There’s no single answer for all investors given the new entrant, Virtual Brokers, because your choice between Questrade and Virtual Brokers depends on your asset holdings and mix.
I’m angry about the worsening situation for Canadians lately. The October 1st introduction of an account admin fee by Questrade, the reduction of SmartCash cash-back… Canadians already get a raw deal compared to the US.
When Canadians smarten up and vote with their wallets (rather than living off lines of credit and imaginary home equities per our 163% gross debt ratio) it’ll get better.
Micro-cap stocks aren’t that bad. After all, it just takes a couple of well-placed blog posts to drive up the price and make a quick profit
Ok, I know you have better things to do than that. But if Automodular runs out of real things to sell they can always turn into one of those companies that buys banner ads for their stock.
lol! TBH, I doubt this site gets sufficient traffic to influence enough buyers that would in turn influence the price. Also, most I hope most readers are extremely discerning and are able to understand the “gamble” involved as I described and as other commentators recognized. IF the stock price goes a lot higher then, well, the price wouldn’t be justifiable given risk and dividend levels.
But let me be even clearer: I’m not telling people to buy this stock, and this isn’t my attempt at a pump and dump. If it more than double in price, I would sell half (or less than half e.g. what I did with CarFinco before I ever discussed it on my site) to get back my capital, pay capital gains on the gain realized, and cover my 3x trade commissions (1 to buy, 1 to sell half, and 1 to sell the residual value if the stock bit the dust so I could take the investment loss deduction on the remaining half of the stocks). But even in that highly unlikely scenario I’d STILL be in the stock without any realized profit. Why do I buy? Dividends. And it’s the same reason I’d stay in AM.TO!
The only thing that could make me much happier about AM.TO is even they cut their dividend and put all their cash into buying back stock for a year or two. The price would plummet but my shares would become increasingly valuable and I could probably load up on some more even cheaper.
Quick note on am.to If I read correctly their normal quarterly has been set at $0.05/share again, about 3 days after their last dividend declaration.
Really?? I depended on these sites to confirm the $0.06 dividend discussed on the Canadian Money Forum:
http://tmx.quotemedia.com/quote.php?qm_symbol=AM
http://www.automodular.com/investors.php
If it is down to a nickel a share, I’d be disappointed.
My apologies. You are absolutely right. The August date referencing their $0.05 dividend was last year, not 2012.
Thanks for clarifying! I was going to call up their Investor Relations and rage lol
Having owned this now for a couple of years I would like to point out the one great aspect of a small publicly held company doing exclusive business with another larger publicly held company that in this case posts monthly sales figures which give an early warning of the small companies quarterly results.
Ford releases data the first week of the month that gives sales numbers for the four models produced exclusivly at Oakville and with parts supplied exclusively by Automodular. By tabulating the sales one gets a pretty good idea of units supplied quarterly to Ford and therefor revenue and this all within days of the quarter end as opposed to the six weeks or so for quarterly reports.
Now that the foray into wind turbines with the the Vestas contract is over the data once again is fairly pure.
Furthermore the contract renewal should not be expected until June 2013 as the past two contracts were announced only a year before expiration. I believe there will be another dip creating a buying opportunity prior to this.
Smart, great information advantage (even though it’s all public information). A good reason to believe in the semi-strong efficient market hypothesis.
What are your thoughts on the stock now after they announced the Ford contract cancellation? Were you able to get out before the dip yesterday?
On a liquidation value basis, it looks like the stock might have been oversold, as the cash flow to be generated from now until Q4 2014 should cover closing costs (they estimated $6mm in their press release but I’m sure it will end up being more than that) and book value right now is around $2 even with conservative assumptions for how much they can sell pp&e and A/R for. The problem is they’re most likely not going to liquidate the company and they might burn too much cash by the time they find another business opportunity/contract or buyer of the whole company.