This series is designed to explore various strategies for generating yield in the equity market, which seems to be a topic of increasing interest to investors because of the decreasing interest paid on fixed income investments. Part 1 dealt with BDCs, Part 2 with agency mortgage REITS, Part 3 with non-agency mortgage REITs, Part 4 with telecom stocks, Part 5 with equity REITs, Part 6 with utilities, Part 7 with tobacco stocks, and Part 8 with MLPs. This article focuses on a strategy which cuts across a number of sectors.
First of all, I want to distinguish this strategy from another strategy often employed by some investors. The "dividend capture" strategy involves the purchase of a stock shortly before the ex-dividend date and the sale shortly thereafter in order to "capture" the dividend without tying up a lot of cash in the stock for a long time. That is not what I am talking about here. The Dividend Anticipation Strategy is more long term. It involves buying a stock on the expectation that at some point in the foreseeable future the stock will initiate or dramatically increase dividends and this will lead the price of the stock to appreciate substantially in value. It is generally employed on stocks which are in sectors which are attractive to investors because of dividends (like many of the sectors discussed in earlier Parts to this series). Because the target stock does not pay a dividend, it may be priced at a price substantially below fair value.
First let's take a look at the five stocks I highlighted when the original article came out on July 5, 2011. The table below provides the price and quarterly dividends as of July 5, 2011 and as of Friday's close for Cedar Fair (FUN), American Capital (ACAS), Saratoga Investment (SAR), Gramercy Capital (GKK), and Rait Financial (RAS). Price data is from Yahoo Financial. Dividend information is from each company's website and press releases.
|Price 7/5/11||Div. 7/5/11||Price 3/15/13||Div. 3/15/13|
A few points. FUN paid a special dividend of 70 cents at the end of 2011. SAR has paid year end dividends of $3.00 and $4.25 at the end of 2011 and 2012 respectively; however, these dividend were paid in stock unless the shareholder elected cash, and I am not certain whether the volume of cash elections permitted all those making elections to get 100% cash. RAS has paid 63 cents in dividends since the first article.
In general the group did well. FUN was the big star as its subsequent performance established that its dip did not really reflect a decline in underlying value. FUN's amusement parks provide it with a wide moat. It is a seasonal business - at least for the parks in the Midwest and Northeast although global warming may extend the season by a week or two in the Spring and in the Fall as we move forward.
ACAS still trades below an ever increasing net asset value. It is very unusual because it is a non-dividend paying BDC, and I think that is why it is undervalued. My understanding is that loss carry forwards allow it to avoid taxes without RIC status, and so it has opted out of RIC status, but may go back in once the carry forwards are exhausted.
SAR is a small BDC which I believe would be an interesting takeover candidate for a larger BDC. It has recovered from some problems generated by an earlier management team and seems to be on the mend.
GKK and RAS are both non-agency mortgage REITs that had near death experiences during the crash. They have each paddled back from the edge of the waterfall and are returning to normalcy (in the immortal words of President Warren Harding). In each case, there is interesting underlying value if the real estate sector continues to recover.
At this point, I would like to suggest some other ideas motivated by this strategy. In each case, I think the stock or sector may be poised to move up if dividends are initiated or increased.
1. Big Banks Historically, banks have been dividend payers. That came to an end with the financial crisis, government capital injections, stress tests and a general desire to build capital. We may be reaching the point at which strong enough balance sheets will permit the resumption or increase of dividends. Citigroup (C) and Bank of America (BAC) are trading below book value; a resumption of dividends would signal a return to normal. Some investors may read a lot into the incipient "consensus" forming among liberal Democrats and conservative Republicans to break up the "too big to fail" banks. It has been my experience that when liberal Democrats and conservative Republicans agree on something, they are usually wrong. Bear in mind that politicians do not adopt these kinds of public positions whimsically. They invest a great deal of time and money on research before taking a position. They research public opinion through expensive polling and interviewing studies and, only then, after discovering what the public wants to hear them say, do they take a public position. The practical problems of breaking up these banks are formidable. For openers, we have no way of breaking up the large European, British and Japanese banks and slicing and dicing our own would leave us at a significant competitive disadvantage.
2. Apple Apple (AAPL) already has a healthy dividend. It could easily double its dividend (giving it a yield of over 4%) or adopt the Einhorn plan of issuing preferred stock. It is increasingly becoming clear that it is going to do something and, when it does, shareholders will benefit from the something as well as from a nice pop in the stock.
3. iStar Financial (SFI) This non-agency mortgage REIT which has now evolved into more of an equity REIT was written up in an earlier article. It has extensive equity holdings and is unusual in that it does not pay a dividend. Although it may take time and the gradual pay down of debt, I think that dividends will be initiated and the stock will move up closer to fair value.
5. Municipal Mortage and Equity (MMAB.PK) had a near death experience during the Crash but appears to be bouncing back and is now trading over $1. There has been recent insider buying and recent deals with lenders suggest the potential for a healthy revival. Assuming things normalize, dividends would likely be resumed. Be careful of this one, because it can bounce around and the tax situation is tricky because it is taxed as a partnership (like the MLPs).
I think that this strategy is increasingly attractive because investors are heading into equities in search of yields, and that means that dividend stocks will command a premium. If an investor can get a little bit ahead of the wave, he can do very well.