Canada’s Best Small Investors 2007: The fortune five

We’re the first to admit that profiles of successful investors can be misleading. So much depends upon timing. When dividend stocks are hot, anyone who happens to hold dividend stocks gets hailed as the next Warren Buffett. When real estate surges, anyone who owns bricks and mortar gets applauded as a genius.

No doubt some of these investors really are geniuses; others, though, just happened to be in the right place at the right time. How can you tell who’s smart and who’s just lucky? Simple. Follow them over the long term and see what happens to these geniuses when their chosen sector falls out of favor.

That’s what we’ve been doing with Canada’s Best Small Investors. We began profiling these private investors a couple of years ago. There was a former pipe insulator from British Columbia who had made more than $4 million by jumping in and out of energy and natural resource stocks. There was a retired school principal living north of Toronto who had amassed more than $2.5 million by diligently scouring the market for literally hundreds of solid, quality stocks. There was a former ESL teacher who retired at 34 with a small portfolio stuffed with high-dividend stocks. And there was a Winnipeg investor who turned $35,000 into more than $2 million by betting big on a handful of firms.

Some of our Best Small Investors have continued to do well. Others had a rough year. Whether you’re a whiteknuckle gambler or a play-it-safe risk avoider, we think you’ll find that their stories offer intriguing glimpses into what makes a great investor. The lesson that emerges is that successful investors follow many different strategies, but each of them diligently sticks to whatever works for his own personality and interests. We can all learn from their perseverance—and maybe even take away a couple of interesting stock picks to boot.

Bengt Kaus was a new addition last October to our investing hall of fame, and the 61-year-old Winnipegger has demonstrated over the past year that he richly deserves his place. Kaus’s portfolio gained 26% in 2006 and a further 6% so far in 2007 to stand at $2.2 million, after a $100,000 withdrawal. Not bad for someone who largely sticks to conservative investments and keeps a quarter of his portfolio in cash.

His buttoned-down approach makes Kaus indifferent to the market’s tremors. “The violent swings we’ve been seeing are more indicative of a market top than a temporary low,” he warns. But although he expects the market may tumble, he isn’t running for the hills. Instead he’s sticking to a small group of value stocks, loading up on cash, and taking profits where he can.

For instance, he sold off about 20% of his holdings in Brookfield Asset Management, his second-largest holding, early this summer when he felt the shares had hit a short term high. The shares have since dropped further and Kaus thinks the next few months could be rocky as the property and power generation company rides out the shocks from the sub-prime mortgage implosion in the U.S. “Still, it’s always a good time to buy Brookfield, if it’s for a long-term investment,” says Kaus.

Kaus’s largest investment is ING, the international Dutch banking and insurance giant. It, too, has dipped a little in recent months, but Kaus doesn’t seem concerned. “ING is my defensive position in case we have a bear market,” he says. “The P/E ratio shows that it’s still very cheap. Unfortunately, in the U.S. the ‘E’ part of the ratio—the earnings—hasn’t held up because of the mortgage crisis.” The stock still commands a full 20% of Kaus’s portfolio and he says he isn’t planning on selling it any time soon.

When we checked in with Kaus last October, he mentioned that he was doing some research into the shipping sector. His research paid off when he decided to load up on a Greek shipping company called Euroseas. “It was trading over-the-counter at $8 a share when I bought it, and I sold it for $15 this past summer.”

Kaus has recently been dabbling in the shares of Chinese manufacturers that are trading over-the-counter in the U.S. as they wait to be listed on North American exchanges. He bought a basket of six such companies, including China-Biotics, which produces live probiotic bacteria for use in yogurt and other food products. (Its flagship bacteria goes by the moniker “Shining Essence.”) “I like these things because I can buy them for less than 10 times earnings, and they’re primed for a high rate of growth,” he says. “Plus they’ll get an immediate boost once they’re trading on the North American exchanges.”

Dale Johnson endured the scare of his life last Halloween. When we last talked to the 51-year-old former pipe insulator, he had built his portfolio’s net worth to about $4.7 million by using truckloads of borrowed cash to invest in energy income trusts and junior mining companies. Then, late last October, he was at his home in Coldstream, B.C., when disaster struck. Ottawa announced it was going to tax trusts. The announcement obliterated billions of dollars of investors’ wealth—and more than a million dollars of that wealth belonged to Johnson.

“I only slept about three hours that night,” says Johnson. “I woke up at 3:15 in the morning, but the markets don’t open here in B.C. until 6:30 a.m. So I sat in front of the computer and drank coffee. I remember thinking to myself that if I get out of this with just a 30% loss today, I’ll be lucky. But I wasn’t that lucky.”

By early afternoon, Johnson had lost $1.2 million on the accounts that he manages for himself and his brother, and the losses didn’t stop there. He spent the day madly selling off his weaker trusts to avoid a margin call, but prices continued to drop well into the following month. “By mid-November, I had bottomed out at about $2.7 million,” he says. “I think if I had hit lower than that, I would have turtled and protected my nest egg.”

Many investors would have sworn off income trusts altogether. But Johnson, who lost a total of $1.6 million, jumped right back in. Over the following 10 months he has traded aggressively to rebuild his portfolio to $4.3 million. His portfolio has almost completely recovered from the damage of last October—and Johnson has already built his leverage back up to significantly more than $1 million.

What lessons did Johnson learn from the experience? He says he went back to fundamentals and now focuses on trusts that can pay their distributions out of net income; he avoids trusts that have to borrow money or sell more units to pay existing unitholders the yield they expect. He has also put more money into Canadian miners, especially firms looking for copper and molybdenum.

His top holding is Trinidad Energy Services Income Trust, just as it was at this time last year. Trinidad, which builds and operates oil and natural gas rigs, makes up a full 65% of Johnson’s holdings, and he still considers it a buy, despite that fact that it’s been falling since mid-May. “I’m still bullish on it for the long term,” he says. “It might be weak for the next little while, but I recommend it for anyone with a window of two months or more.”

Johnson’s second-biggest holding at press time was Roca Mines, one of the companies he mentioned when we checked in with him in our October 2006 issue. Back then, Roca was trading at about $1; at press time, it was around $2.50. Roca’s main product is molybdenum, a silvery metal that’s added to the steel used in pipelines and oil drills to make it stronger and more heat resistant. The price of molybdenum has recently gone on an epic tear, soaring from $5 (U.S.) a pound in 2003 to $35 (U.S.), and Johnson says Roca should do well as long as the price stays high.

Johnson’s not alone in liking the prospects for moly. Sprott Asset Management in Toronto recently started up a molybdenum fund, which is Johnson’s third-largest holding, and Johnson feels the metal’s price will continue to soar. “Sprott’s very smart and the fund they’ve set up doesn’t have a closing date,” he says. “That indicates to me they’re bullish on moly over the longer term.”

Despite his million-dollar loss last Halloween, Johnson hasn’t slowed down one bit. In June, he switched in and out of various holdings more than 120 times—and he says that he has no plans to ease back on the throttle, thank you very much. “I still have about $1.7 million in margin right now,” he says. “I know that what I’m doing is pretty dangerous, but I’m aggressive and I like playing the game the way I play it. It’s been a bouncy year, but I can’t complain about things. I’m not too far off from where I was the last time we talked.”

Jim Chuong has achieved a 9% average return over the past year, much better than the year before—but he’s far from excited about it. One of his holdings, the California sunglasses company Oakley, is in the process of being bought out by Luxottica, the eyewear behemoth, and he’s not taking the news well. “I can’t believe it,” says the 35 year-old resident of Mississauga, Ont. “That company was a cash machine. The worst part is they’re buying it out for cash. I would have much preferred shares in Luxottica.”

Still, Chuong is taking some solace in the fact that Oakley is being bought out at $29.30 (U.S.), more than double what he bought it for. Plus, he seems thrilled that one of his other holdings, K-Swiss, has dropped by about 8% over the past year, thus presenting him with a buying opportunity. “I think that’s really awesome,” says Chuong, whose day job is working as a pharmaceutical rep. “I haven’t had an opportunity to buy K-Swiss in years.”

Otherwise, Chuong’s portfolio has been pretty much unchanged, and his other holdings are doing very nicely. Fossil, which makes watches and accessories, is up by a whopping 75%, The Buckle, a casual apparel retailer, is up 60%, and Warren Buffett’s Berkshire Hathaway (class B) is up 24%.

Meanwhile Chuong is getting more and more interested in real estate. He has devised a methodology for evaluating income properties that involves coming up with independent estimates for property expenses and ignoring most of the numbers provided by sellers. Based on this method, he believes he’s finally found a winner, a 12-plex in Kingston, Ont., that he snapped up in late August to join the two rental condos he already owns in Toronto.

Thanks to his property holdings, Chuong estimates that his net worth is now $1.1 million, up slightly from last year. He’s taking his success in stride and seems almost indifferent that, at 35, he’s already achieved what many never accomplish in a lifetime.

Carl Anderson, a 76-year-old retired high school principal in Toronto with a portfolio valued at $2.7 million, had a year that many investors will find eerily familiar. His portfolio of more than 200 blue-chip stocks and income trusts took a dive in late October when the government announced that it would tax trusts. Then his stocks enjoyed gangbuster returns until July. Finally, over the late summer, “I just got hammered,” he says.

That hammering reduced his year-over-year return to about 5%—not bad, but well below Anderson’s long-term average annual return of almost 20%. Still, Anderson, who plans on eventually donating most of his portfolio to children’s charities, is unconcerned. That’s because he’s much more interested in the dividend income his portfolio spins off than capital gains, and his dividends are steadily marching higher. Anderson calculates that they’re up by about 8%, this August over last, meaning that the roughly $65,000 in income Anderson gets from his portfolio is still growing at more than double the rate of inflation.

Since his dividend income is unthreatened by market fluctuations, Anderson has changed very little in his portfolio. His biggest move was to sell off $14,000 worth of Shiningbank Energy Income Fund, a gas trust that’s been swooning since early 2006 and recently merged with PrimeWest Energy Trust. He used the proceeds to buy into the AltaGas Income Trust, the Enbridge Income Fund and The Consumers’ Waterheater Income Fund, which he sees as much stronger trusts for the future.

Derek Foster retired three years ago at 34 with a portfolio valued at just over $400,000. That didn’t seem like a lot of money to make ends meet on for the rest of his life, but so far he’s not only supporting himself, but a growing family as well.

Foster’s fourth child, a little girl, was born in July, prompting a move to a larger 3,000 sq. ft. detached house in Ottawa. “I’ve been busy with the newborn, and we went to Disney World again, and we’ve just been taking it easy,” he says. “I haven’t really spent much time looking at my portfolio.”

That’s because things seem to be working fine. Foster’s plan was to build a portfolio that spun off enough income for him to live on, and then ignore it. So during his late 20s and early 30s he loaded up on safe, high-dividend-paying blue chips and trusts such as Canadian Oil Sands Trust, EnCana, Royal Bank, Manulife, and Johnson & Johnson. Since he never plans to sell off any of these major holdings, he doesn’t care how much they’re worth. All he cares about is making sure that the $35,000 or so in income his portfolio produces each year though dividends, distributions and tax credits goes up faster than the rate of inflation, and so far it has.

During the past year, Foster made just one big buy, The Consumers’ Waterheater Income Fund. “I picked this one because regardless of the economy, people will rent water heaters,” he says. “And the trust should be able to raise prices at least at the rate of inflation. So for me it’s like an inflation-protected bond.”

Outside his portfolio, Foster’s big project has been a sequel to Stop Working: Here’s how you can!, a book he self-published in 2005 and sells through bookstores and his website, www.stopworking.ca. He has sold over 20,000 copies and he hopes that a new book, The Lazy Investor, will do even better. His only complaint is that the money from his book sales is raising his tax bracket. “My tax credits have been reduced because of the extra income from the book,” he sighs. “I never thought it would do so well.”