Dividends are one way companies share their profits with the investors who hold their common stock. But companies usually need to plow some of their profits back into the business, as well, if they hope to modernize their production operations, fund the kind of research and development effort that will guarantee a steady line of improved products, and make other improvements so necessary to the longer-term success of the business.
PASS THROUGH SECURITIES
Most of the securities we follow in The 25% Cash Machine are paying dividends with yields upward of 10%. These companies are structured as "pass through" securities, meaning they simply funnel most of the profits to the shareholders in the form of regular distributions. Therefore, the kinds of securities we are investing in -- purely by design -- will have abnormally high payout ratios.
A company's payout ratio is a measure of how much profit it is returning to shareholders in the form of dividends. Some companies strive mightily to increase their dividends on a regular basis, even when their earnings may actually decrease. That will cause their payout ratio to jump, if only temporarily.
PAYOUT RATIOS
Context is all-important here. As far as common stocks go, utility companies tend to have the fattest payout ratios (roughly 40%), providing investors with a dividend yield of somewhere between 3% and 4%. An investor is well advised to compare the payout ratio of a company with other companies in the same industry, in order to better understand if the ratio is out of line.
Different industries sport very different payout ratios.
Much depends on the type of security we're talking about. Canadian Trusts have payout ratios that average about 75%, which is normal for that kind of security. On the other hand, if General Motors had a 75% payout ratio, you'd be darn certain it couldn't maintain that level of dividend payment -- not unlike the recent 50% cut GM shareholders were just nailed with earlier this month.
Here's how some of our high-yield 25% Cash Machine sectors compare with traditional income sectors, in aggregate terms of payout ratios:
Type of Security
Average Yield
Average Pay-Out Ratio
Utility
3% to 4%
60%
Fortune 500 Company
2% to 3%
45%
Canadian Trusts
10% to 12%
75%
Business Develop Corps.
9% to 11%
65%
REITs
7% to 10%
100%
Oil/Shipping Tankers
10% to 20%
80%
Master Limited Partnerships
8% to 12%
100%
Grantor Trusts
10% to 11%
100%
In the context of the dozen or so classes of securities in which we are investing, the payout ratios will run between 50% and 95%, because they are not your average blue chip stocks that retain most of the earned income for organic growth purposes. Our chosen Cash Machine stocks are designed to kick out the majority of what they earn and pay the higher pay-out ratios.
As you can see, these pay-out ratios vary quite a bit. Most of the security types listed above want to maintain consistent payouts, so as their earnings fluctuate, their payout ratios fluctuate accordingly. The numbers above are an average for each group, but there are also extreme cases in each.
If I were invested in a fixed asset like an iron ore grantor trust or a gas pipeline master partnership -- entities that are not growing the assets -- then I want a 100% payout ratio.
If I'm in a growing entity like a Business Development Company or shipping/tanker company, then I want these entities to show they can pay out a double-digit dividend and (most importantly) still have money left to reinvest in the business for future growth.
Look at it this way -- if we're going to get two to three times the dividend yield of common stocks then we would naturally expect the payout ratios to be much higher.
Ideally, we want to see our high-yield growth stocks pay out a double-digit yield and stay under an 80% payout ratio. When I research a high-yield investment, aside from those securities that are strictly designed to pay out 100% of net income, I want to see a payout ratio of no more than 80% on our other pass-through securities, because then I know there is at least 20% of net capital going back into the business to grow it.
So you can see how companies like the ones we follow (having payout ratios averaging 70% to 95%) can pay out double-digit dividend yields on businesses that are showing fundamental improvement (i.e., re-investing in themselves for the future).
As income investors, we are simply getting the lion's share of the earnings while accepting the fact that less of the profits will be available for expanding the existing business -- and this is a payout process that works for these companies.
One overlooked corner of high income paying investments is in the once rarified air of master limited partnerships (MLPs).
These are limited partnerships that are publicly traded on the security exchanges. They combine the tax benefits of a limited partnership with the liquidity of publicly traded securities.
And these babies are only taxed once at the corporate level leaving plenty of cash to pay back in the form of dividends to its shareholders.
Master Limited Partnerships (MLPs)
Never heard of an MLP? That’s not unusual. They don’t show up on the radar screen of most individual investors.
From the outside, they look complicated. They don’t get played up by the talking heads on TV. And, they suffered a big reputation hit in the 80’s and 90’s when many MLPs were involved in a number of investment scams. Secret deals. Serious debt problems. A few big partners got left holding the bag.
MLPs were once only the investment playground for the rich and big institutions. All of that’s changed now.
Today, MLPs have been cleaned up and have gone main stream. Most of them are traded on the New York Stock Exchange.
You can purchase shares directly from your broker. Ownership is in the form of units as opposed to shares which in effect makes you a limited partner.
MLPs are limited partnerships whose interests (limited partner units) are traded on public exchange just like corporate stock (shares). MLPs consist of a general partner (GP) and limited partners (LPs).
Why Do I Like Master Limited Partnerships?
First, they pay a nice high yield. Usually 7% to 9% and most pay dividends on a quarterly basis. MLPs earnings are taxed only once, at the unit-holder level. By contrast, the earnings of most publicly traded corporations are taxed twice, once at the corporate level and once again at the shareholder level.
As a result, the MLP can pay out significantly more of its cash flow to you, the unit-holder.
Second, a number of MLPs are increasing their dividends. That’s because many MLPs are in mature, asset-rich businesses that generate large amounts of cash flow.
Third, they are relatively safe investments. Most MLPS are energy exploration and production companies, natural gas liquids businesses and pipelines. These businesses are not affected by the rise or fall of oil prices, and their rates are set by regulatory agencies, keeping them predictable and stable.
And fourth, unit-holders, in turn, enjoy real tax deferment. You get enhanced distributions of cash because of the tax shelter provided by the pass-through of the non-cash expenses, at a time when tax shelters are particularly hard to find. This means you will not pay taxes until it’s time to sell the MLP . . . perhaps in retirement when you are in a lower tax bracket.
This tax deferment can be a big plus for investors. While the explanation behind the deferment is too complicated to go into in this article, it’s worth noting that you will receive a separate IRS form from the partnership outlining the tax deferments making it easy for you or your tax adviser include it on your returns.
That’s why MLPs are good long-term investments. You’re not going to want to trade in and out of these companies.
What Do I Look For in an MLP?
First, I look for a MLP that’s paying a big distribution.
Most of the MLPs that I follow all pay out between 6% and 10% annually. Take Dorechester Minerals LP (DMLP) for one, which paid 8.70% this past year and is looking at a 9% plus forward looking dividend.
I look at the financial strength of the partnership. In particular, I keep an eye out for debt. Any partnership carrying a debt-to-capital ratio below 60% is a safe play by me. Another company I follow, Energy Transfer Partners LP (ETP) carries less than a 50% debt-to-capital ratio while paying a growing dividend of 7.5%.
I also look for companies with good management.
Terra Nitrogen Co. LP (TNH) fits that profile. A company engaged in the business of manufacturing fertilizer, has a solid management team and a good long term growth record. TNH has doubled its stock price over the last year while paying out a nice 7.6% dividend.
And finally, I like to go with companies that are in the safe and mature businesses, less exposed to the wild swings in commodities. Pipeline companies are a good example of a relatively safe bet because their prices are regulated. A good name is Valero LP (VLI), a company involved in the energy production and pipeline business with a great track record, and it pays a decent 6% dividend.
MLPs—High Dividend Payments and Steady Price Appreciation
Like any equity, there are risks to MLPs including lack of capitalization, changing regulatory environment and any kind of major economic downturn.
Their prices could turn down if interest rates rise too rapidly. But unlike bonds, MLP prices are regulated, giving them a softer landing and slow rate of change.
So if you’re looking for an investment with reasonable price appreciation while getting paid a nice dividend and with less volatility than the average large cap stock, then consider Master Limited Partnerships.
Combine that with the ability to defer tax payments, MLPs look like one investment that should be in everyone’s portfolio.
Federal Reserve Chairman Ben Bernanke signaled this week confidence that inflation is headed lower reducing fears of higher interest rates. I wouldn’t be surprised if we see the potential for lower rates as we head into the summer months.
Even after a dozen rate hikes by the Fed over the last three years followed by no increases, bond yields still remain at relatively low levels, with the long bond.
New Classes of Double Digit Income Securities
It's not surprising to see new classes of securities emerge that are custom-tailored to pay much-higher yields than traditional investment to satisfy the appetite of income-oriented investors.
Many folks need a lot better than 4% to 5% to meet their retirement goals, and therefore will take some risk to achieve higher yields.
I want to introduce a class of security that fits right into our search for listed securities that pay out a dividend yield of at least 9%, with the goal of obtaining another 15% upside appreciation in a one-year period. I'm talking about managed option income funds.
These funds buy stocks and sell, or "write," options on them, pocketing the payments, or "premium." With that income, some funds are already yielding 9%-11%, which is awfully attractive in today's low-yield market. Just this year alone, Wall Street has more than $9 billion for some 15 closed-end "buy-write" or "covered call" funds that use this strategy and that are all listed on the NYSE.
The number of available option income funds will grow to more than 25 by over the next year, providing us many choices. Most of the current funds went IPO 2 years ago and underperformed due to the influx of new funds in a sloppy market. But starting in 2006 they began to stabilize with the broader market and are, in my view, starting to look attractive.
This is not the first time option income funds have made their way to Wall Street. They were once popular in the '80s, but fund managers back then only bought stocks that carried the highest premiums, which meant they were in the riskiest stocks. The crash of 1987 brought an end to that wild west strategy, and today's managers shoot for solid underlying stock performance and not just ballistic income.
Various funds take different approaches to how they execute their covered call strategies. Some will buy dividend-paying stocks and sell only index options against the portfolio. This way they never run the risk of being called away.
Pretty smart, huh?
Other funds combine dividend-paying stocks with convertible bonds to lower the volatility. One such name in the group that has caught my eye is the S&P 500 Covered Call Fund (BEP). It invests in all the common stocks that make up the S&P 500, and then sells the SPDR calls against the basket of stocks. Because of the volatility in the market this year, the option premiums have expanded, providing for excellent yields.
Currently, this fund, which carries a $300 million market cap, has an average annual yield of 10.1% -- not bad for a managed option account that pays monthly. And if the market just keeps grinding gradually higher, as I believe it will, then this strategy is appropriate for our model portfolio.
Another well-managed option income fund is the BlackRock Global Opportunities Equity Trust (BOE), which sports a yield of 8.1%. The fund buys foreign stocks and sells covered calls on them all over the globe, so you can have some foreign exposure that pays well at the same time.
When we are selling covered calls on common stocks, we want those underlying stocks to appreciate, but not so quickly as to have the stock called away. The idea is to try to capture the call premium each month without losing the stock. This way you maintain long-term capital appreciation on the underlying common stock while using mini-rallies to sell covered calls and take in premium. It's very much a timing game with this strategy.
Risk vs. Reward
Keep in mind that option income funds carry higher degrees of risk than most other types of income vehicles. The underlying holdings are stocks, which are more volatile than bonds and have a higher risk of losing your principle. But when rates are low, such as we're seeing in the current environment, then the only way you are going to generate more income is to take more risk. There is no free lunch, but good research and good timing can make the difference.
In essence, by investing in option income funds, investors are willing to forgo big gains when the market rallies in lieu of higher current income. In periods where the market rallies strongly, you can bet most of the stocks will be called away, meaning the fund manager has to put on new positions at higher, less-attractive levels.
When purchasing option income funds, I recommend that you resist getting in on any IPOs. As brand-new funds, they haven't yet set their dividend payout, much less invested the monies they have raised. Also, the underwriting fees, as much as 8%, are buried into the initial offering price. Older closed-end funds have already sold off to reflect those fees, so buy the seasoned funds that have been public for at least six months.
This is just another way you can diversify your income-oriented assets and get the kind of returns we need to accomplish our retirement goals. Don't settle for 5% when there are astute methods by which we can double that yield and still grow our assets.
Here is my latest video where I explain why BDCs are the emerging sector combining the best of high yield payments with strong capital appreciation . . . and how one company we own in our advisory portfolio was up 36% in 2006.
I’m talking about a steady growth stock paying 9% dividends in one of the hot money sectors going—Business Development Companies (BDCs). Check this out:
Invest Like The Rich Do
In recent years, BDCs are a new type of investment vehicle – one that mimics the way the rich have long invested – has become available to everyone else.
In fact, the variety and quality of these investments have really taken off in the last couple of years.
And frankly, I believe every investor – from the most conservative to the most aggressive – should hold at least a portion of their portfolio in these stocks.
Just because a company pays a high dividend, doesn’t mean it’s a great investment. You have to look beyond the high yield to the financial health of the company. It’s not unusual in the 80’s and 90’s for companies to hide questionable financing or results behind a big fat dividend.
High-Yield Use to Mean High-Risk
Back in early “80s, the term “high yield” was reserved for the junk bond market, which was about the only place one could find yields topping 10%. Most of us have been around long enough to remember Drexel Burnham Lambert and its famous CEO Michael Miliken, who earned a whopping $550 million for himself in 1987.
At that time the perceived engine of the takeover movement was the junk bond. Some argue that this debt instrument itself was the cornerstone of a decades marked for its excesses on a massive scale bordering lunacy. Research departments of boutique junk bond firms would prostitute their research for the purpose of deceiving innocent buyers, leading most investors in the late 1980s convinced the high yield market was tainted by manipulation and deceitful practices.
Those companies issuing debt with 10%-15% coupons had highly leveraged balance sheets and carried a lot of risk versus the potential reward. Companies issuing high-yield debt at any time are considered to be financially questionable, which is why they have big coupons, to compensate for the big risk associated with this kind of debt.
It’s Not Your Father’s High Yield Market Anymore
Today, smart investors are finding new companies within industries that pay out yields in excess of 9% as a result of passing through higher profits from strong operations. The stocks you can purchase in today’s market are by design pass-through securities, meaning they pass through 80%-90% of all net income to shareholders in the form of dividends and distributions.
Check out this video where I talk about the “whopping yields” some of these new high income securities are paying out today.
We are investing in royalty trusts, grantor trusts, master limited partnerships and REITS that are raising their payouts because business conditions are strengthening, not because they are leveraged to the eyeballs like the companies financed by junk bonds. The companies we own aren’t servicing double-digit debt like the companies of the 1980s.
In today’s market, mergers and acquisitions get financed if companies aren’t issuing low-grade debt securities? Companies tend to use their own stock as currency to merge with other companies in the form of stock swaps.
Rarely do we see a company issue high yield debt to buy another company. Those days are over.
Another attribute to the investments available today are that as these companies raise their monthly and quarterly payouts, their dividend yields rise resulting in rising stock prices as investors chase the rising yield on these classes of securities. You don’t get that with fixed income investments like corporate bonds.
Let's take a look at just one of the players in the “pass through” securities market—American Capital Strategies (ACAS). Here's a company that has $5 billion invested in a portfolio of 150 companies with a dividend yield of 8.5%. The shares are up from $35 to $47, or 34% over the last 12 months.
And that is just one name in the sector that is raising payouts to shareholders, reflecting strong business conditions.
My point here is that these high-income stocks hold up way better than 90% of all other common stocks. They just don't get hit that badly on bad news days because of the attractiveness of the yields.
This is what I'm talking about ... being in companies that are STRUCTURED TO PAY OUT a generous portion of their profits to their shareholders because they are generating higher cash flows from their underlying businesses.
ACAS and the other specialty finance income stocks that are benefiting from the current interest rate environment make for a great swap out of those losing, low-yielding bank stocks that are fighting the Fed.
You see, well-run businesses don't raise their dividends unless they believe they can maintain them. At a time when most investors are dragging around their stock portfolios like a bag of rocks, our strategic high-income model portfolio was up 17% in 2005, while all three major averages were less than 10% for the year.
So when you think high yield, it’s a different ball-game today.
Yesterday’s high yield was based on weak balance sheets and poor conditions. During the past 20 years a dozen classes of securities have come to market that are structured to deliver payouts commensurate with business conditions. This way, companies don’t pay out more that their current cash flow can accommodate.
Today’s high yield market, aside from the sub-prime corporate bond market, is based on strengthening business conditions, not weak fundamentals.
And now we have choices that simply didn't exist 20 or even 10 years ago, and if you are concerned that you are going to burn through your savings to maintain your lifestyle in your retirement years, then I suggest you start to consider getting involved in strategic high-yield investing.
You just have to be willing to listen, learn and put into action the right strategies at the right time. Isn’t it time to start looking again at high yield investments like “pass through” securities for your income needs?
Bryan
P.S. Thanks to your help, my The 25% Cash Machine book reached #2 on the Amazon.com investment books best-seller list and #10 at Barnesandnoble.com. I want to thank many of you who already bought the book. It’s great to see so many people interested in building a truth 25% cash machine.
If you haven’t had the chance to buy the book, there is still plenty of time. Just click on either of the following online bookstores: Amazon.com or BarnesandNoble.com
I know a number of you had trouble viewing my special One Stock Every Income Investor Show Own Now video post. We did manage to get it fixed for a number of viewers, but not everyone, so I apologize.
Here is the write-up that I used in the Video. I apologize for any problems this may have caused. I still like the investment. Nothing has changed there.
Thank you for your patience.
Bryan
Diana Shipping (DSX)
Every time I read a story about the future economic growth rate of China and India, I feel like we are way too underexposed to the potential rewards offered by such a "big-picture" macro trend. Both China and India possess enormous opportunities for investors, but few of those opportunities pay anything close to a double-digit dividend yield. That makes it a bit of a challenge for me to find suitable high-yield Chindia (a new word created by combining China and India) investments that fit our25% Cash Machine profile -- but not impossible.
Enter the dry bulk shipping stocks.
This relatively new asset class is a direct beneficiary of increased global trade. It specifically benefits from raw materials shipped to Chindia.
In fact, one of the first recommendations in my 25% Cash Machine Online Seminar last year, was Eagle Bulk Shipping (EGLE) that has provided us with a 23.51% total return in 2006. The business conditions are steadily improving as Chindia's build-out continues, and my view is that it will continue for the next 10 years, easy!
Here's the basis for my decision to go with Diana Shipping.
Diana Shipping is incorporated in the Marshall Islands, with principal executive offices in Athens, Greece. It completed an initial public offering (IPO) on March 23, 2005, and its shares are traded on the New York Stock Exchange under the symbol DSX.
COMPANY PROFILE
Diana Shipping is a global provider of shipping transportation services. They specialize in transporting dry bulk cargoes, including iron ore, coal, grain and other similar commodities along worldwide shipping routes. Their combined fleet consists of 13 modern panamax dry bulk carriers and two cape size dry bulk carriers, with a combined carrying capacity of approximately 1.3 million deadweight tonnage (DWT) measured as a long ton and equal to 2,240 pounds. The weighted average age of the vessels is 3.6 years (as of Dec. 1, 2006) without taking into account the two vessels to be delivered in 2010. So DSX has one of the youngest fleets in the dry bulk cargo business.
Among the distinguishing strengths that provide DSX with a competitive advantage in the dry bulk shipping industry are the following:
* They own a modern, high-quality fleet of dry bulk carriers.
* Their fleet includes four groups of sister ships, providing operational and scheduling flexibility, and cost efficiencies.
* They have an experienced management team.
* They have a strong balance sheet and a relatively low level of indebtedness.
The main objective of Diana Shipping's business model is to manage and expand their fleet in a manner that will enable them to pay attractive dividends and enhance shareholder value.
To accomplish this objective, DSX intends to pursue highly focused business strategies, including:
* Operating a high quality fleet.
* Strategically expanding the size of their fleet.
* Pursuing an appropriate balance of short-term and long-term time charters.
* Maintaining a strong balance sheet with low leverage.
* And maintaining low-cost, highly efficient operations.
In addition, they intend to capitalize on their strong reputation for high standards of performance, reliability and safety. Strong leadership is a hugely important component for success in this industry and Simeon Palios has served as DSX director since Mar. 9, 1999, and CEO and chairman since Feb. 21, 2005.
Since 1972, when he formed Diana Shipping Agencies S.A., Palios has had the overall responsibility for the company's activities. He has 39 years experience in the shipping industry and expertise in technical and operational issues. Palios served as an ensign in the Greek Navy (as a passenger boat inspector), and is qualified as a naval architect and engineer. What credentials! He da' man!
YIELD POWER
Diana is throwing off some serious cash flow. As stated in their IPO-offering prospectus, the company intends to pay out all its cash flow to shareholders after meeting the company's operating expenses. Last quarter alone, the company generated 40 cents per share in free cash flow. Take the 40 cents and multiply it by four quarterly dividend payments, and we come up with an annual dividend payout of $1.60 per share. And that translates into a current dividend yield of 10.50%.
I want to see improving fundamentals that justify the notion of future dividend hikes, and capital appreciation that has the potential to deliver a total yearly return of 25%. Diana's recent performance suggests to me that the company can attain that goal for us in 2007. Just look at the most recent numbers and the company's observations from their third quarter results posted back in November 2006.
Voyage and time charter revenues were $30.6 million for the third-quarter of 2006, compared to $25.8 million for the same period of 2005, representing a top line growth rate of 18.6%. This gain was due to an increase in the number of vessels in the company's fleet, which was partially offset by decreased hire rates.
Earnings per share (EPS) have continued its positive trend during the first three quarters of 2006. EPS rose to 32 cents (U.S.) in the third quarter, up from 28 cents in the second quarter and 26 cents in the first quarter. The rising tide of profits has resulted in DSX being able to increase the dividend for the third-quarter 2006 to 40 cents from 35.5 cents per share paid out from second-quarter 2006 operations.
One important note: The 32 cent EPS is calculated after deducting tax write offs of 8 cents per share. DSX generated 40 cents per share in free cash flow. Deduct the 8 cents for depreciation and amortization and you get 32 cents in earnings. So, in case you were wondering, they are neither borrowing money nor paying out more than they earn.
Looking forward, a consensus of eight Wall Street analysts see DSX revenues climbing from $110 million in 2006 to $141 million in 2007 -- a 28% growth. Diana is enjoying profit margins of approximately 52% of revenues, making this a cash cow for 2007 as long as day rates hold relatively stable. If expenses remain constant, or become a smaller percentage of revenues, then I expect the company to raise the dividend payout further during the course of the year.
SECTOR STRENGTH
In a recent 35-page report released in late November -- and based on a roundtable of six Wall Street analysts that follow the dry bulk shipping sector -- they found some particular business elements to be very favorable. They all tend to agree that the real driver is the intense demand for shipping, especially from China. The consensus forecast dry bulk order book -- a continuous measure of supply versus demand -- shows demand exceeding supply during the next five years.
One analyst from Lazard Capital Markets said it well. "It's not that tough of a business to analyze from the perspective that it takes a long time for ships to get delivered. It takes a lot of money for them to get ordered, asset prices are at all-time highs and staying up there, and charter rates are still quite good going forward."
Diana Shipping has 60% of their charter rates locked up for 2007, leaving another 40% open to what is called "spot market pricing," or day-to-day pricing. This simply means that the company has fixed its pricing for 60% of its fleet for one year or longer. But if day rates for hauling cargo overseas rise, as I believe they will, then the company stands to benefit from the 40% of its fleet capacity that is not committed to long-term contracts.
This is where the big pop in sales and profits for 2007 should come from -- by scaling into what should be higher day rates and raising overall average daily charter revenue for DSX.
Buy Diana Shipping (DSX). Buy it here and buy it now
We had a lot of questions on the Blog about the Canadian Royalty Trusts (Caroys) sector and I promised I would answer them in one complete update.
Since so many of the questions were the same, I’ve consolidated them and here is my position at this time:
Question: What is happening with the Canadian Royalty Trusts? If I own them, should I sell, and if I don’t own any, should I buy?
Answer: In a nutshell, many of the non-energy related Canadian Income Trusts are marching to a different drummer. Some trusts like Arctic Glacier (AGUNF) told me they intend to raise their dividend enough, down the road, to offset the forthcoming tax so shareholders can still maintain their after-tax yield at current levels. This probably explains why the stock has rebounded so well.
Others, like VersaCold Income Fund (VCLDF), are also back in the black since the announcement while the Priszm Income Fund (PSZMF) raised its dividend and is showing some recovery.
KCP Income Fund (KCPIF) has not rebounded with the other business trusts and is still down on the mat. I put a call in to the CEO after the company posted a story that they are exploring alternatives to enhance shareholder value, so I would sit tight until we learn the whole story.
So it’s a mixed bag for many of the Canadian income trusts. Some are moving back up, many are flat or still down, but remember, most of these are excellent businesses that still pay large dividends.
Needless to say, the rough spot in the Canroys are the Canadian Energy Income Trusts. They are beset by lower oil and natural gas prices of late, and these stocks are back down to their early-November "reaction lows" and seem to be once again groping for a bottom. My advice here is that if you own them, hold them. It looks like winter is finally going to show up for us next week in the Northeast, and I'm beginning to see some firming in the sector today.
At this point, investors have to look at these oil and gas trusts as energy stocks with benefits. Nothing in the U.S. energy patch pays the kind of dividend yields these stocks pay. They grow their reserves every year and will pay out whopping yields for the next four years -- at which time they will pay out an after-tax yield of about 8%. Folks, that is still way above anything else out there in energy-related securities. Be patient here, and we'll expect some cold weather to breathe some life back into the group.
If you don't own these stocks and you want to buy this pullback, I would consider the two higher-quality stocks Penn West Energy (PWE) and Provident Energy (PVX). They have very low payout ratios, which means they should have no trouble maintaining, or perhaps increasing, their dividends. They have little or no leverage and are the institutional favorites when that kind of money comes back into the sector. At current prices, their yields are up more than 11%, and both are showing excellent profit growth.
Canetic Resources (CNE), Harvest Energy (HTE) and Precision Drilling (PDS) carry higher risk, due to higher payout ratios and debt on their balance sheets, so they'll definitely want to see crude prices hold at $54 per barrel and gas prices hold above $5.50 per million cubic feet. I would hold off buying new or adding to your position with either of these two stocks at this time.
The bottom line here is that we still aren't out of the woods with the Canadian royalty trusts. I believe the overall perception of the sector is improving, but we do need some firmer energy prices to help us get further out of the woods with these positions.
So, if you own or have positions in Canadian Trusts, you need to exhibit patience here as I believe that selling out at this point would be tantamount to bailing out at the bottom. I don't want to hold anything that weighs down your portfolio, but I think you will get a much better chance to lighten up on some of your Canadian exposure at better prices than we are seeing now, and some solid Q4 earnings in the coming weeks should definitely help that happen.
Stay tuned to this Blog on Tuesday, January 16, 2007. That’s when my book, The 25% Cash Machine, is available in book stores and online.
I will e-mail you with special announcement about the book on Tuesday.
I know a number of you had problems viewing my Mini-Seminar on the Blog. I just posted a new version which should be viewable with all versions of Windows Media Player.
See the Mini-Seminar posted below.
I apologize for the problems this may have caused you.
I just put the finishing touches on the taping of a new mini-seminar, "The One Stock Every Investor Should Own", and it's ready for you view right now. Just push play:
I hope you enjoyed the seminar.
This security pays a nice 10% dividend, is in the hot "growth sector" of China/Asia growing economy, and I expect this stock to move up 15% to 20% in the next 6 months.
Good luck in 2007,
Bryan
P.S. Check back on this Blog for a special announcement about my new book, The 25% Cash Machine, which is due out in bookstores and online on Tuesday, January 16, 2007.
I received a number of great questions from many of you. I’ve aggregated a lot of the common questions and wanted to post them here today for you to read.
The most common question was in regard to Canadian Royalty Trusts (Canroys). Given the recent decision by the Canadian government last October to threaten the trust status of Canroys, I’ve been asked by many income investors, “What do we do with Canadian Trusts? Buy more, sell or hold?”
I will post a special “Canroy” position in the next several days, because so many income investors own Canadian trusts or want to get into them. Canroy's high yields and unique tax status mean that this question deserves more attention then a quick answer. Look for that special “Canroy” post by the end of the week.
Meanwhile, here are my answers to your most common questions:
Question: The question I have regards sector performance in 2007. Do you believe the capital markets, i.e., Apollo, Alliance, etc., and BDCs (Business Development Companies) will continue to perform well and take leadership positions?
Answer: Yes. There's more committed capital in private equities than there was a year ago. I expect deal flow for mid-size companies will be robust in 2007 and I anticipate the BDCs we own will have another exceptional year. I like both Apollo Investment Corporation (AINV) and Ares Capital Corporation (ARCC) in this sector.
Question: How do you factor in premium (or discount) to net asset value (NAV) when you screen for yields?
Answer: Ideally, we want to buy closed end funds at their NAV or at a slight discount. Premium and discount do factor in because a closed end fund trading at a high premium has little potential, whereas a closed end fund trading at a slight discount historically outperforms.
Question: If one were just starting to invest using The 25% Cash Machine and had $100,000 to invest, should the person go ahead and invest $3,000 in each of the 33 stocks even though some of them have grown tremendously since you first started? It seems that if you did this it would severely cut down on your percentage return. If not, how would you ever build a portfolio?
Answer: I provide a continuous Fresh Money buy list with The 25% Cash Machine advisory service, so people can enter at the appropriate price over time. Our Fresh Money buy list affords our subscribers the chance to be disciplined about building their portfolio. The bottom line is that folks can and should buy their favorite stocks on pullbacks. Click here to find out about our “no-risk” trial to The 25% Cash Machine service.
Question: I have one question for you. I do not (yet!) have a large amount of capital to invest, so I'm particularly concerned about transaction fees eroding my investment returns. For how long should we expect, on average, to keep hold of a stock like the ones you recommend with The 25% Cash Machine before selling -- one year, three years, or more?
Answer: We buy every position with the intent that our holding period will be at least one year. That's all the visibility we can reasonably expect from any business. I want to limit turnover to no more than 15% per year. Ideally, we want to own our positions long term, anywhere from 2 to 5 years.
Question: What is your opinion on the use of stops? Should they be put in as a trailing percentage? This has been my practice in the past.
Answer: I don't recommend using stops for the purposes of investing in high yield securities. If a sector begins to weaken, I will typically punch out at market. Some of the securities we invest in that pay 9%, 10%, or more in dividends, may not have the trading volume of an S&P 500 stock where you can safely use stops. I don't use tight stops in a volatile market because, more often than not, the market makers can (and will) take a stock down, clean out the stops and then rally the stock right back up.
Question: It seems harder to get good solid, up-to-date information on some of the "hybrid" high-yield securities from normal Web sources. Closed End Funds, as well as some of the mutual funds, just don't have that much investor information or detail -- like we would find on a normal stock. How can I dig deeper to feel confident in understanding the structure of some of these high-yield securities? Where should we go to get more information? I am having trouble seeing the top- and bottom-line growth rates on some of these securities in order not to just look at yield. Also, it seems that sometimes when I have looked at yield alone, I did get burned -- just like you said. But where should I go to see more of the fundamental data?
Answer: That's actually an easy answer to provide. Do what I do, which is to pick up the phone and call the company and talk to management -- but that’s a lot of work. Or, you can take the easy way out, subscribe to my advisory service, The 25% Cash Machine, and let me make the calls for you. Some funds and securities are obscure which is what makes them special, and where my service and I come in handy. I do all of that work for you. Click here to find out about our “no-risk” trial to The 25% Cash Machine service.
Question: When storing cash for a longer period of time, am I better off placing it in say, MO for an upside potential 4% yield, than say a 5% savings account?
Answer: That's not quite what I would recommend, but you are on the right track. I would take the cash dividends and reinvest them to build a new position in The 25% Cash Machine recommendation. Buying Altria Group is only going to lower your overall yield and my goal for income investors is to achieve a 10% yield -- overall. You could start with the one of the securities I mentioned above, Apollo Investment Corporation (AINV) or Ares Capital Corporation (ARCC).
Thanks again for your great questions. My book, The 25% Cash Machine, hits the bookstores and online sellers Tuesday, January 16, 2007.
Stay tuned to this Blog for a special announcement about the book and a great opportunity for you to get started building your own “25% Cash Machine!”
