Burn Rates & What Happened to the Growth Canada?

Posted by Ryan Irvine: Keystocks

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Market Buzz – What Happened to the Growth Canada?

Toronto’s main stock index closed sharply lower on Friday, but did bounce back from the new one-month low it hit earlier in the day, as weak economic data (within Canada) and the U.S. debt crisis pushed investors to the safety of the sidelines.

The index took a real kicking on the week dropping 4.1% and ended down 2.7% for July. With most Canadian markets closed on Monday for various provincial holidays, anxious investors moved to the sidelines in advance of Tuesday’s deadline for the United States to raise its debt ceiling – an exercise which has been ripe with political theatrics.

In the end, we believe some sort of compromise will be reached, but the long-term debt problems remain in place and without real spending cuts and some sort of tax increase (sales tax likely), the deficit will not begin to be addressed and tackling the debt is a pipedream. A hard pill of reality has to be swallowed, but we do not believe the appetite for the pill is in place.

North of the border, Statistics Canada reported that the economy shrank by 0.3% in May, the second consecutive monthly decline, with slumps in mining, and oil and gas production leading the downturn. The agency says the shrinkage comes on the heels of a stagnant April. The last rise in the real gross domestic product was the 0.3% increase recorded in March.

Mining, oil and gas extraction, manufacturing and construction all fell in May. There was growth in the wholesale and retail trade, the public sector, and utilities, as well as the finance and insurance sector. Wildfires in Northern Alberta and bad weather, as well as maintenance shutdowns, reduced oil and gas by 4.2%.

Looking ahead to what promises to be an interesting August, we will be reporting on 2011 second quarter results from K-Bro Linen Inc. (KBL:TSX) next week and the following week, we will take a close look at fiscal 2011 second quarter results from Boyd Group Income Fund (BYD.UN:TSX).

Looniversity – Don’t Get Burned by the Burn Rate

Burn rate refers to the amount of money a company spends from month to month (money burnt) in order to survive. Thus, a burn rate of $100,000 would mean the company spends $100,000 a month above any incoming cash flow to sustain its business.

Keeping a sharp eye on cash flow, which is a company’s life-line, can guard against holding a worthless share certificate. When a company’s cash payments exceed its cash receipts, the company’s cash flow is negative. During a bull market, unprofitable companies can finance cash burn by issuing new shares and investors are more than happy to cover cash burn – look no further than the junior mining boom we recently saw end. But when a bear hits, companies can get stuck living on their bank balances or scrounging for unfavourable finance terms and if the cash dries up, go bust. For investors, it’s important to follow a company’s available cash, evaluating how long it will last and what will happen when it runs out.

Particularly in times of turmoil, pay close attention to cash on hand (limited debt as well) and examine the company’s cash burn rate. If a company burns cash too fast, it runs the risk of going out of business.

Put it to Us?

Q. Can you give me the “411” on the “Dogs of the Dow” investment strategy?

– Daryl Andrews; Calgary, Alberta

A. The idea behind the “Dogs of the Dow” strategy is to buy those Doe Jones Industrial (DJI) companies with the lowest P/E ratios and highest dividend yields. By doing so, you’re selecting those Dow stocks that are cheapest relative to their peers.

In a nutshell, at the beginning of a given year, buy equal dollar amounts of the 10 DJI stocks with the highest dividend yields. Hold these companies exactly one year. At the end of the year, adjust the portfolio to have just the current “Dogs of the Dow.” In theory, what you’re doing is buying good companies when they’re temporarily out of favour and their stock prices are low. Hopefully, you’ll be selling them after they’ve rebounded. Then, you simply buy the next batch of Dow laggards.

Why does this work? The basic theory is that the 30 DJI stocks represent well-known, mature companies that have strong balance sheets with sufficient financial strength to ride out rough times. Some people use five companies, some use ten, some just one. You might call this a contrarian’s favourite strategy.

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