Attractive Yield Equals A Good Defense

Includes: ABR, IRT
by: Bret Jensen

(Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.)

"Defense wins Championships"

This time test NFL truism proved itself once again this Super Bowl Sunday as the best defensive team in the league trounced the league's best offensive team in one of the biggest blowouts in Super Bowl history.

It also proves there is a big difference in racking up statistics and easy wins against inferior competition in the regular season and playing the best teams in the more stressful "win or go home" playoffs. My own take is the huge rally of 2013 was like the NFL regular season. 2014 has not started out at all like most complacent investors expected and it is looking more and more like playoff conditions.

The widely held consensus to begin the New Year was that the market would treat investors to another up year, albeit not to the same extent as 2013. Interest rates would incrementally rise as the global and domestic economy slowly accelerated and equities would shrug off the Federal Reserve slowly withdrawing liquidity from the market.

It certainly has not worked out that way in the first month or so of 2014. Equities are in the midst of staging their worse decline since late 2011, interest rates are falling as the 10-year Treasury yield have fallen to 2.6%, emerging markets are cratering and recent domestic economic reports have not been encouraging.

Given conditions have changed; it is only prudent for investors to change their strategy for the new "season". Gone is chasing high growth stocks with stratospheric multiples like Amazon (NASDAQ:AMZN) or Tesla Motors (NASDAQ:TSLA) that worked so well in 2013.

What should take their place are defensive stocks selling at reasonable valuations with solid yields until market sentiment turns. Here are a couple of these types of plays that make sense at these levels. They are real estate investment trusts (REITs). This sector had underperformed the market significantly in 2013. However, the sector is showing strength as interest rates have pulled back sharply recently. Both are good for 'moving the chains' in these more challenging marketing conditions.

"Defense is superior to opulence." - Adam Smith

Arbor Realty (NYSE:ABR) is primarily a commercial REIT. The company invests in multi-family and commercial real estate-related bridge loans, mezzanine loans and other real estate-related assets. It also holds some investments in mortgage-related securities and real estate property.

The shares yield almost eight percent (7.6%) at current levels and the company has raised payouts substantially after coming out a near death experience during the financial crisis. The shares are reasonably priced at ~90% of book value and insiders hold over 10% of the company.

Only two analysts cover the shares. One has a price target of $9 a share and the other is at $9.25 a share. Both are substantially above the current price of Arbor which is at under $7 a share. ABR trades at a reasonable 10.5x forward FFO (funds from operations) given its over 7.5% yield.

I continue to like Independence Realty Trust (NYSEMKT:IRT) which is a real estate investment trust that seeks to own well-located apartment properties in geographic submarkets that it believes support strong occupancy and the potential for growth in rental rates. It was spun out for another REIT holding I have, RAIT Financial Trust (NYSE:RAS), in August of 2013. RAIT retains a 60% stake.

Being a new public company, Independence Realty Trust is very underfollowed by analysts and the market. If you go to Yahoo! Finance it does not even show a dividend yield for IRT. This is unfortunate as Independence pays a monthly payout that equates to 8.7% on an annual basis. As coverage increases, these discrepancies should get resolved resulting in a higher stock price.

Only three analysts cover the shares currently and they have price targets between $9.50 to $10.50 a share on IRT, nicely above the current ~$8.25 current price on the stock given its dividend yield. Insiders have been net purchasers of the stock since it came public and shares are priced at a very reasonable ~11x FY2013 FFO. Analysts expect revenue to grow over 80% in FY2014 on some recent acquisitions.

Neither of these REITs is going to yield a long touchdown in 2014. However, with their high yields and reasonable valuations they should outperform what I expect to be a very tepid market in the early parts of 2014. Both selections should produce first downs and keep the chains moving.

Disclosure: I am long ABR, IRT, RAS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.