Safe havens for widows and orphans

Classic examples of these stocks would be phone or electrical utilities. ROB CARRICK employed a Globe filter and came up with a basket of stable shares that have more upside than you might think

By ROB CARRICK

00:00 EST Saturday, March 05, 2005 Page B9

Your best investing friends this year could be some widows and orphans.

Widow and orphan stocks, that is. Once derided as a dull refuge for the safety-obsessed, these stocks are hot stuff in 2005.

Some are hot in performance terms, but there’s a broader theme here, too. While the stock market in Canada has been strong lately, there’s reason to question whether the market can repeat the excellent gains of the past two years. If not, widows and orphans could be a real help.

The origin of the term widows and orphans stock is obscure, but the definition is a stock that offers a generous dividend and a reduced risk of losing money for shareholders. Classic examples would be telephone or electrical utilities, which are stable businesses where fortunes don’t rise and fall along with economic growth.

Today, phone companies aren’t an automatic choice because of competition in the telecommunications sector, and even electrical utilities have their challenges. What investors need, then, is an updated way to think about widow and orphan stocks.

With the help of Globeinvestor.com analyst Pierre Javad, we’ve developed one that uses eight different criteria focused on safety and stability. This isn’t just an academic exercise, though. We put theory into practice by screening the universe of Canadian stocks and creating a list of 13 widow and orphan stocks that trade on the Toronto Stock Exchange.

What we ended up with is a well-diversified mix of companies with some unexpected names. For example, women’s clothing retailer Reitmans (Canada) Ltd. made the list, as did St. Lawrence Cement Inc.. steel maker Dofasco Inc. and auto parts maker Magna International Inc. Among the more traditional names are Fortis Inc. and Emera Inc.. both of which operate electrical utilities, as well as big financials such as Bank of Nova Scotia. Great-West Lifeco Inc. and IGM Financial Inc.

The past does not predict the future, so there’s no certainty that these stocks will be bulletproof in the months and years ahead. But if you’re looking for conservative blue-chip stocks, this list is a good place to begin your research.

The creation of our list began with a decision to focus on dividends, financial stability and share price appreciation. We’ll start with dividends because the income they provide is one of the attractions of investing in big, stable companies.

To make the cut, a stock required a current and five-year average dividend yield of at least 2 per cent, which is the posted rate for two-year guaranteed investment certificates at the big banks right now. A minor exception was made for Reitmans, which had a current yield of 1.99 per cent. Dividend stability is a key attribute of a widow and orphan stock, so we dropped any stocks that cut their quarterly payouts over the past five years.

As a way of ensuring a degree of financial stability, we also dropped any stocks that have not been profitable in each of the past five fiscal years. Then, we discarded stocks that had a revenue decline of more than 20 per cent over the same period. Twenty per cent might sound like a big drop, but our data shows that even stable financial companies can have sizable revenue swings without seriously affecting their appeal as investments.

A final measure of financial stability that we looked at was the debt-to-equity ratio, which helps show whether a company has borrowed too much money. Stocks were discarded if their debt-to-equity ratios were above 0.6, which would indicate that total outstanding debt is equal to 60 per cent of shareholder equity or, in other words, the company’s net worth. For gas and electrical utilities, a cutoff of 1.8 was used.

Finally, we looked at share price performance. The whole idea of widow and orphan stock suggests an emphasis on preserving rather than growing your money, but no one wants to own shares that are stagnant or fall in value over a long period. To weed out companies like this, we required that stocks have at least some price appreciation over the past 10 years. As it happens, the worst performer on the list, Emera, still managed to deliver a compound annual share price growth rate of 5.4 per cent.

Share price gains are great, but only if a widow and orphan stock is docile enough that it doesn’t inflict big price swings on shareholders. That’s why we included only stocks with a beta of less than 1, which suggests less volatility than the SP/TSX composite index as a whole (the index has a beta of 1).

If you think widow and orphan stocks are too tame to bother with, take a look at the list of 13 companies we came up with. While some are plodders, six delivered 10-year average annual share price gains of more than 15 per cent.

Insurer Great-West Lifeco was the top performer with an average annual gain of 25.5 per cent that was achieved with one-third of the volatility of the SP/TSX composite index. Reitmans, the second-best performer, made 21.5 per cent over the past 10 years with even less volatility.

Factor in dividend payments and even the lesser performers on the list look good. Add Emera’s average dividend yield of 4.9 per cent to its average annual price gain of 5.4 per cent and you have a total return in double digits.

If you’re using the list of widow and orphan stocks as a starting point for your own research, a matter you’ll want to pay close attention to is whether a stock is in favour or if it’s in a down phase and thus potentially attractive as a buy right now.

Reitmans is the top stock on the list over the past year thanks to a gain of about 114 per cent. Another indication of this stock’s rapid climb is that fact that its current dividend yield is well below its five-year average of 3.03 per cent. As a stock rises in price, its dividend yield falls.

Many of the other 12 widow and orphan stocks were strong over the past year, though not to the same extent as Reitmans. St. Lawrence Cement made 28 per cent, while Fortis and National Bank made a bit over 20 per cent; Scotiabank and Royal Bank of Canada were a bit below 20 per cent; Great-West Lifeco, Dofasco and IGM were around 10 to 11 per cent; Canadian Utilities was up 3 per cent; Emera and Thomson were pretty much flat; and Magna was down about 16.3 per cent.

Stocks that look attractive now based on how their dividend yield compares with the five-year average yield include Great-West Lifeco, RBC, Scotiabank and IGM.

After you’ve looked at share price and dividends, consider the industry that a stock is in. While Dofasco, Magna and St. Lawrence Cement qualified as widow and orphan stocks, they do best when the economy is thriving in Canada and internationally. If you see slower economic growth ahead, then stocks like these could decline in the months ahead. Then again, the data suggests these stocks will rebound at some point and reward investors who hold for the long term. That, of course, is what widow and orphan stocks are all about.

Hot stocks for the safety-obsessed

We have screened the universe of Canadian equities and created a list of 13 widow and orphan stocks that trade on the Toronto Stock Exchange. There’s no certainty that these stocks will be bulletproof in the months and years ahead. But if you’re looking for conservative blue-chip stocks, this list is a good place to begin your research.