Be Careful Reaching For Yield - You Could Get Burned

Over the past few years, "thanks" to record low interest rates, some investors have been starving for yield. Many have bought "investment" instruments with high dividend yields ( 5%-6%+) in search of income, with little regard to quality or price paid. Over the past few years the prices of many utility, telco's and pipeline companies have been bid up to very lofty levels ( I usually get a nose bleed around 20X earnings). Here's a quick look at 2 pipelines and 1 telco. Granted, some of these companies have had excellent financial performance and deserve a good multiple. The 3 companies listed below are good companies, just really pricey. However, as a whole, these utility type investments are well above traditional prices for low-growth, high capital expenditure, regulated businesses.

                                        P/E        P/B      P/CF   Div Yield*
TransCanada Pipelines      20X      2X       10X     3.8%   
Enbridge                           22X      3.5X     11X    2.7%
BCE ( Ma Bell )                15X      3X        6X     5.0%

* These yield may look low, but that's due to the rapid rise in the underlying stock price lately.

To be clear, owning a utility with consistently rising dividends is a good thing. As long as the price you pay is not excessive. If you overpay for the yield and the company-in-turn has a problem or encounters poor industry conditions, then the price can get hammered. Then, you're dreams of stable income forever are interrupted by a dividend cut and possibly a big capital loss.

Case in point: This past week investors were surprised when a Canadian power and infrastructure company, Atlantic Power Corp ( ATP.TO) reported results for 2012 along with a dividend cut. As little as 4 months ago, ATP was cruzing along with a market cap of 1.67Billion ( around $14/share ) and paying out a nice $1.15/share/year in dividends, for a yield of 8.2%. Paid monthly - starving income investors love that.
What people didn't realize is that ATP has been paying out virtually all of it's earnings as a dividend, leaving little to re-invest in a capital intensive industry like power generation. ATP has regularly raised both debt and equity to fund the business ( never good when you keep doing that long-term ). Management, all the while, inferring that the dividend was stable.

When the dividend was cut on February 28th to $0.40/share/year, a whopping 65%, the stock tanked some 50%. As I write, ATP is trading at $5.50. Had you been an owner at the $14 level you'd be sitting on a 60% capital loss and 2/3's less dividend income then you had expected. Not fun.

The message: it's OK to look for yield in the market, in fact it's the best place right now to get yield. But, you have to look under the hood before you invest - or risk getting burned. I too, have reached for yield, and was burned - anyone remember Amisco Industries??? Fortunately, it was many years ago and a very small amount of $$$ - but it still hurt.




If you're wondering if it's a good buy now? For me, I might get interested under $3. I'm not a fan of management's capital allocation practices and the shaky balance sheet.

More Proof Stock Prices Are Lofty

Maybe it's time I sign over my account to her...

16-Year-Old Actress Turns Into Stock Day Trader

Rachel Fox isn’t an ordinary 16-year-old. She's already graduated from High School and has been a working Hollywood actress for years, appearing in shows like Desperate Housewives as evil Kayla Scavo and in the film Dream House with Daniel Craig and Naomi Watts. When she’s not on set she can often be found on stage, singing and playing guitar in an indie rock band.

That would be a packed schedule for most of us, but Rachel has another activity that’s a real passion. For the last year-and-a-half she’s been actively day-trading stocks with her own money. She says she's been racking up stellar returns, claiming a 30.4% gain in 2012, versus the benchmark S&P 500 which gained 13% for last year.
While she’s doing it all, she’s also helping teach people about investing via her website FoxOnStocks.com. On the site she updates her thoughts on the markets and posts videos for those new to the game; teaching them how to do the basics like finding quotes and understanding what a stock option is. For now, the blog is just for fun, she has no plans to monetize; just teach others how to invest, the way her Mom taught her.

click here if you really want to read the rest of this article

American International Group (AIG)

This past November I wrote here about a "fallen angel" that I've started to buy ( ~$32). A fallen angel, is a company that was once very well regarded/high grade company that has, for whatever the reason(s), become very unpopular and hated by the market. The by-product of that unpopularity and hatred is a very low stock price . AIG, certainly fits that bill. While it's true, some parts of AIG were wildly mismanaged and over levered, that brought " down the house ", the major business lines ( insurance and wealth management ) were performing reasonably well - not withstanding the economic downturn of 2008/9. AIG, was rescued by the U.S. government in 2008. The government was recently fully repaid by AIG to the tune of $200+ billion. Yes, that's billion.

AIG, enlisted the help of retired Metlife CEO, Robert Benmosche in 2009 to fix AIG. Benmosche, who was tending to his vineyards in Croatia ( true story ) agreed, and started on a difficult path to restore AIG to operating health. He and his team have since sold non-core businesses, streamlined operations and restored a culture of pride and leadership at AIG. The market has been slow to recognize the great work that Benmosche and his team have done. The market which usually looks forward into the future, is having trouble getting over the past faults of AIG. The cloud hanging over AIG won't last forever.

Here is a snap-shot of some performance metrics of AIG during the "boom" years of 2002-2007.

Average P/E: 17X
Average ROE: ~13X
Price to Book: 1.7X - 3.0X

AIG's stock price was well rewarded for good corporate performance - as it should be. Fast forward to late 2012/early 2013, and AIG looks like this:

P/E: 8X
ROE: ~6%
Price to Book: 0.56X ( current stock price ~$38, AIG's book value ~ $65 )

Management has set a goal of returning to 10% ROE. As industry conditions improve ( premium pricing is already moving up ) and AIG continues to perform, value will continue to build on AIG's balance sheet. It will be extremely beneficial for current shareholders, if Benmosche continues to buy back stock at prices well below book value. AIG, may not return to the "boom" type metrics, as they are far less levered, but that's not required for us to achieve a well above average rate of return.

It's not hard, with grade 5 math and some conservative inputs, to see AIG's balance sheet grow to $75+/share in book value over the next 2-3 years. Even if the market only rewards AIG, with a 1.3X book multiple ( the 15yr industry average ), then you are looking at a $95+ stock price. A triple, with little downside ( AIG's tangible book value is currently $50 ).This is not an overnight investment, patience is required - like most deep value investments.



Not risky anymore...

Agrium (AGU) - Not So Fertile Ground Any More

This past week, I sold the my remaining position in Agrium @ $110/share. Agrium, reminds me of one of my favorite John Templeton ( the Godfather of global value investing ) quotes, it goes like this:

                       "stocks are rarely popular and cheap at the same time"

While AGU could move a little higher, there's no way to know exactly where the "top" is - to the penny. It's currently trading at a market capitalization of $17B and 13.5X earnings and 2.5X book value. Agrium is popular.

On another note,

My recent portfolio sales and the cash from the Nexen arbitrage deal, have raised my current cash level to 14%. I wrote recently that the market has come far quite quickly ( S&P 500 up 5% already in 2013) - caution is warranted. I'll be ready to deploy cash when the market turns fearful.

5 Year Highs, Now What?

The S&P 500 touched an intra-day 5 year high today. It's time to proceed with caution. That doesn't mean I've turned bearish, but it means it's time to pay extra attention to prices paid - when buying new stocks. It's also prudent to review your holdings and lighten up on companies that are close to or at their intrinsic value (IV). There will be better days (market pull backs) ahead to pick away at companies you like - it's good to have some cash around. In fact, I think 2013 will probably surprise most people, on the upside, but the volatility will be noteworthy. Volatility is opportunity. You want to be invested, but in the cheap areas of the market. That being said:

I have very recently sold my remaining position in tax preparer H&R Block (HRB) @ 20.30, which I bought in 2010 at $12.30. I have also sold 50% of my position in Agrium (AGU) @ $106.60, which I bought in 2009 at $47.

The plan for 2013 like any other year, is to buy cheap stocks and sell the expensive ones - sounds complicated eh? There's value in U.S. financials (banks and insurance), large cap technology companies, auto parts/car makers, healthcare and natural gas.

All the best in 2013.

Andre

A BIG Round Trip

The last few ideas I've written about have worked out reasonably well. Not wanting to risk looking like a hero, I thought it would be a good idea to write about an idea that hasn't worked too well. So I'll write about a " round trip", when you buy a stock and ride it all the way up, then all the way back down again. I wrote here about the discount retailer Big Lots (BIG) in June of 2011. After taking a position in 2011 @ $32, the stock promptly ran right up to $46, the bottom of my fair value range for BIG. Due to lack of brilliance on my part, I didn't sell, hoping for an even better price or maybe a buy-out. Then Q2 of 2012 rolled around and company reported poor earnings and the market ran for the exits.  It appears the inventory mix combined with really weak consumer confidence, in the first half of the year was way off and sales really suffered. Then to top it off, allegations ( and FBI investigations ) have surfaced that the CEO sold $10 million in stock just prior to the lousy Q2 earning report, while in possession of material inside information. That's a big no-no, as that sale was not part of his normal pre-programmed stock sales. The CEO has also announced his plan to retire.....hmmmm... That action, has hurt his otherwise good credibility and makes you wonder if he is looking out for shareholders or just himself.

So with BIG sitting in the $28-$30 range, I'll sit still for a few more quarters and monitor the situation. BIG still has good potential, particularily as the economy improves, and would be a nice fit for a private equity firm to take private. I'd tender for $55/share.

A Little More To Do

After a quiet summer and early fall, there's been a little flurry of activity. I recently sold the last of my position in Magic Software ( MGIC ) @ $4.55, after owning it since late in 2008. This investment turned out fine, well exceeding my own expected hurdle rate.

This latest period of market volatility has provided a compelling merger arbitrage opportunity. These kind of special situations don't come around too often and can provide an above average rate of return over a short period of time. I've taken a position in the Canadian oil and gas company, Nexen ( NXY.TO ) @ $23.77. As you probably know, CNOOC ( Chinese state-owned oil company ), has offered $27.50/per share in cash (USD), to buy NXY. The big question making the headlines lately, is whether the government will approve the deal. All indications are that the deal will be approved. The Canadian government has only blocked 3 deals out of 27 in the last 30 years. The decision will be made this December.

Also, I've recently started a small position in a very large American company, that one could call the "ultimate fallen angel". This company is currently waaay out of favour, but has a bright future, now that many of it's problems ( not all ) are put behind them. There's little downside in this company over the long term, but the investing public has been slow to warm-up to the story. That won't always be the case. I'll welcome lower prices over the next little while as I build-out this position. I will provide more detail on this good business - soon.