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Brett Owens
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Brett earned his first contrarian investing profits in 2004 when he purchased an obscure investment (at the time): sugar futures. His friends on Wall Street stopped laughing soon enough when sugar rocketed to multi decade highs, illustrating that it indeed pays to be contrary. Brett quickly... More
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  • Why Preferred Shares Will Be Fine If Rates Rise

    Many investors are concerned that high yielding preferred shares will not perform well in a rising rate environment. I've heard from several readers who share these sentiments. Since April 1, ETFs like the PowerShares Preferred Portfolio (NYSEARCA:PGX) and the iShares S&P U.S. Preferred Stock Index Fund (NYSEARCA:PFF) are down 2% and 3.7% respectively.

    These fears are overblown for a couple of reasons:

    1. It's unlikely that interest rates are going to rise high enough to make these yields unattractive in relative terms anytime soon.

    1. These days, more preferred shares have floating rates anyway.

    Not familiar with preferred shares? You're not alone - most investors only consider "common" shares of stock when they look for income. These are the shares in a company you receive when you place an order with your broker online or over the phone. You probably know the problem with this approach - common shares in S&P 500 companies pay just 2.1% today, on average.

    If you're only considering common shares, then you're settling for second-place in the shareholder return line. Many companies also issue preferred shares, which do indeed receive preferential treatment. Companies are actually obligated to pay their preferred shareholders first, even in the event of a bankruptcy. And many preferred shares pay a higher yield to boot.

    They're technically debt vehicles, like bonds. Preferreds usually pay a higher dividend rate than bonds - most pay between 5% and 7% today. As with other debt, companies issue preferreds when they need to raise additional capital.

    Earlier this month, Wells Fargo (NYSE:WFC) announced plans to offer $1 billion in preferreds with a 6% perpetual coupon. That's more than double the stock's current yield. If you're looking for income, and you believe that Wells Fargo is in good financial shape, then the preferreds are an attractive income alternative to the common shares.

    Many "first-level thinkers" want nothing to do with deals like these. They believe that preferred shares, like bonds, will get crushed in price when rates rise. So they've sold funds like PGX and PFF, which yield 6% as well.

    They're partly right - but they're more wrong than right.

    Their playbook is outdated by a decade. Today, more than 60% of preferred issues are fixed-to-float or floating-rate securities, versus less than 10% just ten years ago. These issues will not fall in price as much as fixed-for-life securities like the Wells perpetuals would during a rising rate environment, because their yields will reset higher as rates go up.

    This doesn't guarantee a smooth ride. But it means that a good portfolio manager can navigate a rising-rate tide by building a collection of coupons that always provide a "yield cushion" that's higher than prevailing interest rates at any point in time.

    Now I'm not recommending ETFs like PGX and PFF. I believe they're leaving some alpha on the table and exposing investors to unnecessary credit risk. The only way you lose with this vehicle is by giving your money to a driver who crashes your car. But the S&P 500 and NASDAQ are large enough that there's usually a company going bankrupt at any moment in time.

    That's why I recommend moving past a broad-based ETF in favor of a closed-end fund. You'll have an active manager working for you, and if you buy when everyone hates the sector (like right now), you can purchase your shares at a 5-8% discount to the underlying Net Asset Value (NYSE:NAV).

    The "secret" system behind my Contrarian Income Report service has already led us to one closed-end preferred fund that pays 7.7%, and we're adding another one to the portfolio this Friday that yields 8.7%. Both funds issue monthly dividends to boot. If you're interested in reading my latest research and recommendations on preferred share funds, you can sign up to receive Friday's issue right here.

    Oct 01 5:30 PM | Link | Comment!
  • Big Oil Remains A Big Dividend Trap

    This time last year, crude oil was selling for more than $90 per barrel. Today it's half that, and yield hunters are excitedly sorting through the spill in oil stocks. Stalwarts like Chevron (NYSE:CVX), Exxon Mobil (NYSE:XOM), and BP plc (NYSE:BP)are paying 5.6%, 4%, and 7.8% respectively. At first glance, these look like great deals from reliable dividend payers. Unfortunately, these "yield bargains" are likely to cost you a few times more than you'll earn in payouts.

    No matter how well these companies run themselves, the actual price of oil is outside of their control. And when the goo is in freefall, their stock prices get drilled. Exxon fared the least worst of the three over the past year, shedding "just" 27%. BP dropped 33% and Chevron, which some incorrectly believe is insulated from falling oil prices thanks to the diversity of its operations, fell 40% over the same time period.

    A mid-to-high single digit yield isn't a very good consolation prize for double-digit losses. And these stocks are still at risk, because the price of oil isn't done dropping. The two factors that sent it spiraling in the first place are still present:

    1. Record supply inventories, coupled with…
    2. A large number of long contracts in the hands of money managers.

    In April 2014, I warned that then-$103 crude was due for a drop. U.S. crude oil inventories were at 5-year highs, yet money managers were net long 319,000 contracts on crude oil futures. They were essentially betting that the goo would continue higher in the face of record supply and stagnant demand. These wagers didn't work out, and the oil futures gaming table tipped over onto itself.

    When the price of crude oil initially fell, the waterfall of money managers selling their long contracts soon sent the price cascading down. A lower and lower oil price became a self-fulfilling destiny, as the speculators sold 200,000 futures contracts over the next 18 months, creating a wave of selling pressure.

    And there's still more to come.

    Today, money managers remain net long oil by 110,000 contracts. That's a sizeable amount of fuel to drive crude's continued crash. And at 455 million barrels, U.S. crude oil inventories haven't been this high at this time of year in more than 80 years (according to the U.S. Energy Information Administration). As oil continues to drop over the next year or two, you're not going to want to hold the oil majors in your portfolio - no matter what they're promising in dividends.

    Besides, these companies have significant restructuring ahead of them to fund these payout levels. BP, for example, will earn just enough money this year ($2.41 per share in 2015) to be able to pay its dividend ($2.40 per share). Over the past two quarters, Chevron paid out more per share than it earned ($2.14 in dividends versus $1.67 in earnings). And Exxon's payout ratio rose to 73% last quarter, which is very high for a company that usually keeps this below 35%. (I usually like to see a payout ratio below 50% myself - the lower the better).

    On the surface these dividends may look like easy money. But the companies paying them are struggling to have viable business models at $45 prices. It's going to get worse for them as the goo slides down towards $30 per barrel. Stay away from this mess until someone else cleans it up.

    Sep 10 5:17 PM | Link | Comment!
  • Why Kimberly-Clark Is A Washed Up Dividend Aristocrat

    Consistently growing sales of diapers, paper towels, and tissues have padded the pockets of Kimberly-Clark (NYSE:KMB) shareholders since the company went public in 1928. KMB has paid a dividend for 81 years in a row, and raised it for 43 straight years and counting. But this streak is in danger if the company can't peddle more paper products soon.

    In 2014, KMB paid out 70% of its free cash flow (NYSE:FCF) - 86% of its earnings - in dividends. And while its FCF lingers near 2010 levels, the company has increased its dividend by 18% since then. As management "keeps the streak alive" it's taking on debt to fund shareholder rewards - ever increasing dividends and share buybacks. Since 2010 it's spent 63% of its FCF on dividends:

    KMB took on an additional $1.13 billion in long-term debt last year to fund these rewards. And this year alone, it will dump at least $750 million into buying back its own shares, which are trading for more than 18-times its current forecast of $5.65 to $5.80 earnings per share (NYSEARCA:EPS). Between dividends and buybacks, KMB shoveled about 110% of its 2014 FCF to shareholders.

    Management believes it must buy back shares at any price to juice its bottom line, with top-line sales growing by only 3-5%. It's hoping to boost its EPS faster than sales by reducing its share count. If shares were 50% cheaper, this might create shareholder value - but at 18-times earnings, it's a poor use of capital.

    Other than buybacks, mature companies often look to margin improvement to boost the bottom line when revenue growth is slow. KMB in fact did boast that it increased margins in the second-quarter - but a broader perspective shows that its profit and operating margins are both flat since 2010 as well.

    When exactly did it become difficult to make money peddling brand name diapers, anyway? When the internet trashed the barriers to entry. For example, Jessica Alba's startup Honest Co. sells premium nontoxic baby-products that many mothers - including my wife - insist on buying exclusively. KMB's Huggies brand has not been allowed in my house - and likely never will. Conscientious "mom-sumers" have powered big sales growth for Alba. Her startup's sales jumped from $60 million in 2013 to $170 million in 2014 (and gave the company a $1.7 billion valuation).

    There are some bright spots for KMB. Its own organic diaper sales are up 30% year-over-year in China, and its organic feminine care, baby wipe, and adult care products are up double-digits annually in developed and emerging markets. However these fast-growing segments are such a small portion of KMB's sales that it's struggling to make up for lackluster growth in the larger North American market. It also faces increasing competition from startup companies like Honest in the fast-growing organic segments (Alba's products are already available in 2,500 brick-and-mortar locations like Target).

    Trading at 18-times earnings, and tapped out from a shareholder return perspective, KMB is priced like an aristocrat in its prime. In reality, its best years are behind it.

    PS -I found 11 more stocks that are yield traps posing as dividend aristocrats. You should make sure that none of these issues are in your portfolio, as I believe you're at risk for a 20% loss or more for each one that announces a dividend cut. You can click here to get my report right now: The Dirty Dozen: 12 Dividend Stocks to Sell Now.

    Aug 27 3:37 PM | Link | Comment!
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