Every Monday we feature “A Stock to Sell” as our daily post. With every stock or investment we recommend as a sell, we give you a full explanation of why we advise against investing in it at this time.
Big Bank Big Oil Split Corp. is a split-share company with two types of stock: capital shares (symbol BBO on Toronto) and preferred shares (symbol BBO.PR.A on Toronto).
The company holds shares of the biggest six Canadian banks, plus 10 large Canadian oil and gas and pipeline companies.
Split-share companies typically issue two classes of shares. Usually the capital shares get all or most of the capital gains and losses, as well as variable dividend income, and the preferred shares get a fixed amount of dividend income.
In the case of Big Bank Big Oil Split, the capital shares receive a monthly dividend of $0.05 a share ($0.60 annually), which gives them a 6.4% yield. The monthly dividend has been as high at $0.09, most recently in 2010.
The dividend income the company gets from its portfolio isn’t enough to pay capital and preferred share dividends and management expenses of 1.22%, in addition to providing a return for the capital shares. To make up the difference, the company has to make a profit by trading its portfolio. It also aims to raise its returns by writing call options on the portfolio’s securities.
Buying stocks: Call options can erode capital gains
Selling call options generates a stream of income for the investor (and a stream of commissions for the brokerage firms involved). However, selling calls also tends to diminish any capital gains a portfolio might generate.
When stocks the company owns go up, holders of the call options it has sold will exercise those options and buy the stock from it at the price fixed by the option’s terms. Meanwhile, the company will want to hold on to its losers—stocks it owns that are going down—to offset its obligations under the call options it has sold.
We see most of the stocks Big Bank Big Oil Split owns (including the big-five banks, Pembina Pipeline, Enbridge, TransCanada, Imperial Oil, Crescent Point Energy, Suncor, Cenovus and Encana) as buys.
However, you are better off purchasing them directly. While dabbling in options can generate income, in our opinion it is virtually certain to eventually lead to a lower rate of return, if not outright losses.
TSI Network recommendation: SELL both capital and preferred shares.
