the motley fool pro canada insider playbook: 6 pro

THE MOTLEY FOOL PRO CANADA INSIDER PLAYBOOK: 6 “Pro” Strategies for This Crazy Market

2 The Motley Fool Special Report fool.ca/pro

Table of Contents

• Introduction 3

• What Is Pro Canada? 4

• The “Pro” Approach 4

• How “Pro” Beliefs Are Put Into Action 4

• Pro Strategy #1: Compounding Machines 5

• Pro Strategy #2: Classic Values 6

• Pro Strategy #3: Special Situations 7

• Pro Strategy #4: Options Positions 8

• Pro Strategy #5: ETFs 9

• Pro Strategy #6: Cash 10

fool.ca/pro Special Report The Motley Fool 3

Dear Fellow Fools,

Compared to global markets, the Canadian stock market has had a rather muted past 12 months, up just 4.2% versus the S&P 500’s performance (+15.4%). Still, though, our market is quite near its all-time high.

Considering everything that’s gone on in the world … Trump’s controversial trade talks … more oil price shocks … a legitimate cooling of the Canadian housing market … es-calated worries over a nuclear confrontation involving North Korea … many investors are starting to wonder if the good times are nearing an end.

It’s a very reasonable question … and is something Motley Fool members and readers have been asking us more and more of late.

In Pro Canada, we utilize a very methodical, measured in-vestment approach. This Special Report is an attempt to detail exactly how I approach stock selection, portfolio construc-tion, and finding the right risk-reward relationships—which is important when the market is on sale but downright critical at times like now, when it’s at all-time highs.

What this means is that activity levels in the portfolio are likely to be sporadic. We’re not going to act for the sake of acting; we plan on running things in the spirit of this great quote from Warren Buffett:

“An investor should act as though he had a life-time decision card with just 20 punches on it.”

To be clear, we’re going to make more than 20 decisions over the life of this portfolio. We’re looking at companies all the time, and more often than not this results in a decision to pass (yes, taking a pass is just as much a decision as making a purchase).

But your capital, and ours, is precious—and we’re going to treat it as such.

Wouldn’t you know it, Mr. Buffett had something to say along these lines as well …

“We don’t get paid for activity, just for being right. As to how long we’ll wait, we’ll wait indefinitely.”

We’re surrounded by information—too much information. And the folks providing this information make us want to believe it all matters. The media certainly serves a purpose, and my day wouldn’t be complete with the business section from The Globe and Mail, but with so much information,

Introductionby Jim Gillies

to garner eyeballs, it has to be packaged with a high degree of sensationalism. (Heck, we here at the Fool are sometimes guilty of this sin!)

As a result, one of the most valuable skills for an investor is the ability to ignore the distractions and get to the meat of whatever it is they’re consuming. Often, there is no meat, and it’s important to make that realization as well.

Which takes us back to activity levels. A talking head that appears on TV on Monday and says “buy this and that,” and then appears the following Monday saying “sell” the same “this and that” may sound brilliant and insightful to viewers.

But it’s noise. Nothing more than noise.

And guess who has been quoted on this very topic? You guessed it, Warren Buffett:

“The stock market is a no-called-strike game. You don’t have to swing at everything—you can wait for your pitch. The problem when you’re a money manager is that your fans keep yelling, ‘Swing, you bum!’”

With the TSX off a bit in 2017, but still near all-time highs (and rather richly valued), you can bet we’re heeding this advice—and would urge you to as well.

Enjoy this Special Report. And Fool on—

Jim Gillies

Lead Advisor, Pro Canada


What Is Pro Canada?Pro Canada is a real-money portfolio service

catered to Canadian investors. Pro Canada is my (Jim Gillies here, Fools) personal investing service, and is where I scour Canadian and U.S. markets for my highest-conviction stocks. I also aim to equip members like you with some simple strategies to earn paycheque-like income in any market.

My publisher and I only open the doors to Pro Canada a couple of times a year to keep the service small, ensuring that you’re best positioned to potentially profit alongside the Pro Canada team.

Inside the service, my team and I are investing $250,000 of The Motley Fool’s own money in full view of our members, and we always give you a chance to invest in our recommendations before we do.

The service takes a holistic view of the member experi-ence by providing ongoing guidance on portfolio-level strategy, position sizing, and cash management in the model portfolio. We give percentage-based allocation and portfolio management information. The portfolio has a quarter-million dollars of The Motley Fool’s own money in it, but for members it acts as a “model.” You can choose to match the portfolio step-by-step in your own account (or not).

I’m admittedly biased, of course, but I believe Pro Canada brings a new level of sophistication to the Canadian product suite by introducing position-level valuation as well as blending in special situations, options, exchange traded funds (ETFs), and other off-the-radar opportunities that do not fit the mold of our existing services.

At its core, though, Pro Canada remains 100% Foolishly authentic: we know our greatest edge is a long-term focus (at least 3-5 years), and we’ll be patient as we invest in the best opportunities traded on the Canadian and U.S. exchanges.

I lead the service from my home base in Ontario. I have been the co-advisor of Motley Fool Options since 2008, and have been a full-time Fool even longer. My friend and colleage and fellow Ontarian Iain Butler (the Chief Investment Adviser for Motley Fool Canada) is my co-adviser; we are here to help members just like you navigate the sometimes treacherous waters of the stock market.

The “Pro” ApproachWe at Pro Canada hold these truths to be self-evident:

• Our greatest edge is a long-term focus (3-5 years). This allows us to tune out the noise of day-to-day market fluctuations.

• We invest in businesses, not ticker symbols.• Buying stocks at a discount to their fair value

reduces our risk and boosts our returns.• ‘Tis better to own a great business at a fair price

than a fair business at a great price.• Growth and value are joined at the hip.• Options are best deployed to leverage our under-

standing of the underlying business and its valu-ation. Not as speculation vehicles, but rather as tools for building portfolios and enhancing returns.

• Your best interest is aligned with ours. The Mot-ley Fool will invest its own real money into the portfolio, and many of the positions may repre-sent personal holdings of the portfolio advisers.

• Transparency is healthy and Foolish. We will announce all portfolio moves to our Pro Canada members before The Motley Fool or the portfolio advisers execute them.

How “Pro” Beliefs Are Put Into ActionOur ideal investment opportunity is a business run

by a seasoned management team with a large stake in the business, aligned incentives, and a first-class record of capital allocation. It is capital-light with a cash-rich balance sheet and the ability to reinvest at high rates for many years. It is also misunderstood and selling at a discount to our estimate of fair value.

Time is the friend of such businesses—and they give us multiple ways to win. We don’t, however, expect the market to provide such opportunities often, which is why we branch out into other investment avenues. We do, however, stand ready for those ‘fat pitches’ when they come.

Our investment candidates will fit into one of the following categories; recognize that there is deliberate category overlap in the following list. We love to buy the proverbial compounding machines at classic value prices, and we’ll use put writing to add shares of such!


Pro Strategy #1: Compounding Machines

Compounding Machines (35%-75% of total capital):Our ideal is to invest in companies with wide moats—even better, widening moats—and the ability to reinvest at high rates of return for many years. We like to see a history of organic, profit-able growth and durable competitive advantages via the likes of scale, switching costs, intellectual property, and network effects. We also appreciate first-mover advantages and high barriers to entry.

"The ideal business is one that earns very high returns on capital and that keeps using lots of capital at those high returns. That becomes a compounding machine."

—Warren Buffett

This concept of a “moat” is borrowed from Buffett (there he is again!) and his longtime business partner, Charlie Munger.

When evaluating potential investments, one of the first things Buffett looks for isn’t an undervalued stock price, a history of revenue growth, or the quality of a management team.

It’s an economic moat – and in this metaphor, the prospective business is a castle, protected by wide, deep, probably shark-infested waters.

As Buffett told Fortune magazine:

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.

The key to compounding machines is that they have moats, and the key to moats is that they’re protected by sustainable competitive advantages.

Hedge-fund manager and former Morningstar chief equities strategist Mark Sellers has argued that there are four – and only four – sources of true moats. They are:

1. Economies of scale

2. Network effects

3. Intellectual property rights

4. High switching costs


Pro Strategy #2: Classic Values

Classic Values (15%-50%):Sometimes the great ones can hit a speed bump. When that happens, we’ll be here to buy before they get back on course, buying the proverbial dollar for $0.50. We want to buy solid companies priced with (temporary) low expectations, trusting that then using our time horizon edge will lead to outstanding long-term performance.

“Price is what you pay, value is what you get.”

—Warren Buffett

Foolish investing is all about buying businesses, as opposed to trading stocks. We love to see wonderful companies fall out of favour with Bay Street—therein lies our opportunity.

But we’re not scraping the bottom of the market’s barrel, looking through the 52-week-low list for cigar butts. We’re not looking to eke out a couple of dollars per share on a mediocre but undervalued business.

The core part of this strategy is buying quality on the cheap. And we follow these Foolish tenets, as expressed by our U.S.-based colleagues:

1. Make ‘em show you the money: Cash is simply much harder to fudge than quarterly earnings reports, which are often so riddled with “one-time” charges that it’s difficult to make accurate year-over-year comparisons. Focus instead on free cash flow.

2. Follow the bouncing ball: If a company’s cash flow pattern is erratic or on a downward path, consider yourself warned. True, there may be a benign explanation -- a product launch didn’t happen as scheduled, for instance -- that could clarify the firm’s moribund multiples. But if there’s no rational short-term explanation for the cash flow jitters, the stock might still have a long way to fall.

3. Favor stability: All else being equal, favor busi-nesses with lengthy track records of cranking out cash and delivering for shareholders.


Pro Strategy #3: Special Situations

Special Situations (0%-25%):

Spin-offs, busted IPOs, activist tar-gets, or ‘jockey stocks’ are traded on Canadian and U.S. exchanges, but often overlooked by retail investors. They are prime hunting grounds for variant perceptions and asymmetric payoffs.

“If you spend your energies looking for and analyzing situations not closely followed by other informed investors, your chance of finding bargains greatly increases. The trick is locating those opportunities. It’s like the old story about the plumber who comes to your house, bangs on the pipes once, and says, “That’ll be a hundred dollars.” “A hundred dollars!” you say. “All you did was bang on the pipes once!” “Oh no,” the plumber responds. “Banging on the pipes is only five dollars. Knowing where to bang—that’s ninety-five dollars.”

—Joel Greenblatt, You Can Be a Stock Market Genius

Joel Greenblatt is the intellectual standard-bearer for information on special situations investing, and I encourage anyone interested to read the book (hilariously) quoted above.

A “special situation” can take many forms, including but not limited to:

• Spin-offs

• IPOs

• Mergers

• Rights offerings

• Bankruptcies

• Corporate restructurings A variation of strategy #2, special situations investments often work because so many on Bay Street and Wall

Street are focused on the wrong things, or have the wrong time frame.


Pro Strategy #4: Options Positions

Options Positions (0%-25%):Primarily of an income bent used to enhance overall returns, and never used a speculative ‘moon shots.’ Any option strategies deployed will be in accordance with Foolish guidelines for options use. The vast (vast) majority of options strate-gies/use will be covered calls to enhance income and/or puts deliberately written on stocks we want to own but at a better price—if we don’t get that price, we’ll have to console ourselves with keeping the cash as income.

We constantly preach the need to use options “Foolishly,” which is to say we think you ought to use them to complement a diversified, long-term focused portfolio. Below, I’m going to post our 7 Rules for Using Options Foolishly, condensed here for space:

1. Valuation First, Options SecondWe’re not options “traders.” The costs of trading are high, price movements occur rapidly, and options are designed to lose value steadily for the owner unless the underlying stock moves in a way to counteract it. We use options as part of a strategy related to an underlying stock, rather than as traders gaming for mere price movements.

2. We Think Long-Term Even As We Use Short-Term StrategiesBecause we’re stock-based investors, our options strate-gies have the long term in mind.

3. We’re Option Writers More Often Than Option BuyersOption writers (also called sellers) have many advantages. And on the other hand, the odds are stacked against option buyers.

4. Diversification If Necessary, But Not Necessarily DiversificationWhen the market gives us a valuation gift, we react accordingly. When the stock is priced fairly, we react accordingly. When the stock is grossly overvalued, we — you guessed it — react accordingly.

5. Stay FocusedOption prices are volatile, and it’s easy to get excited or distraught by weekly or even daily price moves. But stay focused on the underlying business and base decisions on these fundamentals.

6. We Go Our Own WayFools are motley indeed. Sometimes we agree, sometimes we do not. There is no one ‘Foolish way’ and no one ‘Foolish opinion’ on any particular stock.

7. We Believe in the Power of CommunityWe learn from you as much as you learn from us!


Pro Strategy #5: ETFs

ETFs (0%-20%):Exchange-traded funds (ETFs) offer instant, low-cost diversification into targeted markets and sectors. While we are neither top-down investors nor a macro-centric service, ETFs can be a useful and low-cost way to manage risk and gain specific exposures in an economy that can be sensitive to commodities, exports, and currency swings.

We share much of the great Peter Lynch’s disdain for market prognosticators, and don’t presume to know the direction the winds will blow. However, in our bottom-up fundamental stock research, we do develop investment theses about secular trends and themes, and occasionally look to ETFs to help us put some “skin in the game.”

As a security, though they may have been made popular south of our border, ETFs are a Canadian invention—the first-ever ETF, TIPS, launched in Toronto back in 1990. There’s a lot to like about ETFs:

• They tend to be cheap. Expense ratios are already low, and have come down even further as com-petitors push down fees.

• They are easy to buy and sell. ETFs trade like stocks, which makes them easy to buy, so long as you’re set up with a discount brokerage.

• They offer instant, broad diversification.

• They tend to be tax-efficient. Especially when compared with mutual funds.

The flip side of these benefits, of course, is that it’s easy to over-trade ETFs!

“If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wast-ed 10 minutes.”

—Peter Lynch, One Up on Wall Street


Pro Strategy #6: Cash

When we’re talking about cash, we’re assuming you’ve internalized Step 9 our 13 Steps to Financial Freedom series, which you can find in a direct link on our Fool.ca homepage. That is, the cash in question here is cash earmarked for the stock market in the first place…

(As Foolish investors know, any money you don’t need within the next five years is a candidate for the stock market; for shorter time frames, consider other options.)

One of my favourite ways to think about cash came from Buffett biographer Alice Schroeder. She wrote of Buffett: “He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.”

That is, cash is a boon for the patient long-term investor, who can deploy it tactically at times of market declines. Rather than a drag on performance, it’s an accelerant if used opportunistically!

Cash (0%-20%):Cash is a hedge, ballast, and the ultimate form of optionality. We will err on the side of fully invested—we want our money working for us and we have the luxury of being able to call on periodic cash infusions. But we will adjust based on opportuni-ties, as well as temporary occasions when we may exit one or more positions before re-deploying into new opportunities.

“If you can keep your head when all about you…”

—Rudyard Kipling, If


All figures as of September 1, 2017.This report is: (a) for general information purposes only and not intended as investing advice; and (b) not to be used or construed as an offer to sell, a solicitation of an offer to buy, or an endorsement, recommendation, or sponsorship of any entity or security by The Motley Fool Canada, ULC, its employees and affiliates (collectively, “TMF”). This report represents the opinion of the individual author and does not attempt to give you professional financial advice or advice that relates to your personal circumstances. © copyright: 2017 The Motley Fool Canada, ULC. All rights reserved. The Motley Fool, Fool and the Jester logo are registered trademarks of The Motley Fool Holdings, Inc. Published by: THE MOTLEY FOOL CANADA, ULC 1959 UPPER WATER STREET P.O. BOX 997 HALIFAX , NOVA SCOTIA B3J 3N2 NOVEMBER 2014 This publication is for general information purposes only. The studies in this report are not complete analyses of every material fact regarding any company, industry, or investment and they are not “buy” or “sell” recommendations. This publication is provided with the understanding that the authors and publisher are not engaged in the rendering of personalized investment advice. It also should not be used or construed as an offer to sell, a solicitation of an offer to buy, or an endorsement, or sponsorship of any entity or security by The Motley Fool and its affiliates. The opinions expressed here are subject to change without notice, and the authors and The Motley Fool make no warranty or representations as to their accuracy, usefulness, or entertainment value. Data and statements of facts were obtained from or based upon publicly available sources that we believe are reliable, but the individual authors and publisher reserve the right to be wrong, stupid, or even foolish (with a small “f”). Remember, past results are not necessarily an indication of future performance. The authors and publisher specifically disclaim any responsibility for any liability, loss, or risk, personal or otherwise, incurred as a consequence, directly or indirectly, of the use and application of any contents of this publication. Without limiting the rights under copyright reserved above, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of The Motley Fool Holdings, Inc.

How YOU can invest like a Pro in 2017 and beyond…Unfortunately, Motley Fool Pro Canada is closed to new members at

this time. And because this is our only real-money-portfolio service here in Canada, we only open Pro on rare occasions -- and often limit the number of members we accept when we do.

However, please rest assured that we’ve added your name to our “VIP advanced interest list” and we’ll contact you right away if and when Pro re-opens. Plus, we’ll give you the chance to take advantage of a significant VIP-only discount should you decide to join us in Pro.

So please be sure to keep an eye on your inbox for important updates. And good luck with you investments in 2017 and beyond!

the motley fool pro canada insider playbook: 6 pro

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