There appears to be no fundamental basis for the shares of Cornerstone Progressive Return Fund (CFP) to be selling at almost a 40% premium to its current NAV (see list below). Based on a fundamental analysis, CFP’s stock, which is currently trading at $8.00 per share, should be trading around $6.00 per shares—closer to its NAV.
This would represent a 25% decline in the share price. Since the monthly return-of-capital (ROC) distribution is so large[i], shorting the stock becomes an expensive cost-of-carry item due to its substantial monthly distribution and is not recommended for retail investors.
Other Possibilities: This leaves two other possible explanations for its current excessive valuation:
- Retail investors are mistaking its current 30.2% (ROC) distribution yield as a legitimate distribution based on its return-on-investment; they don’t understand that they’re essentially paying a $1.40 to get back a $1.00.
- There may be a trading algorithm (dividend capture strategy, i.e., “dividend-roll”) that supports the stock price.
As it relates to the former, this is an irrational response to the facts, but it may perpetuate the inflated share price valuation. The second is empirical; it can be analyzed. That is the purpose of this article.
Under Every Rock Looking for Value: Before turning to the validity of a CFP dividend capture program, let me briefly list those fundamental reasons, that I’ve documented in detail elsewhere, why CFP’s current premium stock valuation makes little sense.
- The stock price is currently trading at a 38% premium to its NAV when the CEF market segment is trading at a 5.0% discount;
- Two-thirds of its portfolio holdings are other CEFs that investors could independently purchased at a discount;
- Since its inception 2007, CFP has lost 17% of its NAV value due to poor investment management—for which investors are paying a 1.2% management fee;
- CFP is essentially in the active process of liquidation as a result of distributing its capital to shareholders in the form of ROC distributions (its NAV has dropped 60.7% since its inception);
- Its major shareholder has been bailing out of the stock, having sold or distributed 4.5 million shares in the last 6 months, thereby reducing its holdings from 91.4% to 43.4%.
Dividend Capture Strategy: In a review of the percentage change in the 5 day moving average volume there appears a slight upward bias in volume prior to the ex-dividend date particularly since August of last year.
Is it a Profitable Strategy? The chart below is an illustration of trading gains or losses per share realized in a dividend recapture strategy for CFP. The assumptions were simple: an investor would purchase the stock based upon a three day average closing price prior to the ex-dividend date, capture the distribution, and sell the stock three days later based on that period’s average closing price.
With the exception of the most recent month (January), the chart below shows (“red bars”), this strategy (prior to transaction costs) has been positive since July of last year. This corresponded with the slight uptick in volume prior to the ex-date noted above.
Surprise! During the months of September through November of ’08, investors suffered significant losses in executing this program as a result of CFP’s declining share price. This price decline was a result of a combination of lower NAV and a decline in its premium from 34.5% in August ’08 to a discount of 10.8% in October ’08.
Will It Work in Reverse? Also examined was the reverse dividend-roll strategy (“blue bars”): buying the stock three days after the ex-dividend date and selling it prior to the next ex-dividend date based on the preceding three day average price. The hope here is that investors in a dividend-roll program would bid-up the price prior to the ex-date.
The Problem with the Strategy: The problem with both dividend-roll strategies is that several periods of small cumulative gains can be wiped out by one month’s big loss as the stock moves in the opposite direction needed during the set time frame. The reverse dividend-roll is a more vulnerable strategy as it is played-out over a month’s time period versus a dividend capture strategy which is centered on fewer days around the ex-date.
A Slippery Slope: A rising share price is important consideration for the success of each strategy. The chart below shows the monthly slide in its NAV and the components of its decline. The “red bar” is the cumulative return-of-capital distributions; the “ivory bar” represents investment losses generated by the management.
Feeling Luck? In addition to CFP’s labored growth in NAV, its current premium has declined from it 52 week high of 80% to approximately 40% currently. A further discount narrowing would depress share prices and likely chase dividend roll investors away. Thus, leaving only the uninformed retail investors to push the stock price up based upon an ephemeral 30% yield.
Caveats: The simple trading rules employed to generate profit or losses may not be representative of what a professional trader could generate buying and selling the stock at different times than the models. Lastly, I would not recommend retail investors short the stock due to the significant cost to carry during the holding period.
Request: I would be interested in anyone advancing a logical counter-argument with regards to why CFP is a good investment at this price. To date, I haven’t heard of one, but I’m eager to learn.
[i] Approximately 93.5% and an estimated 91.1% of its annual distribution in 2008 and 2009 was a return of capital, respectively.
Disclosure: Author doesn't hold a position in CFP