In a year when Wall Street has already lurched from bull market peaks to bear market territory and back again, it’s nice to see our pivot toward higher-yielding dividend stocks has smoothed our ride and kept cash flowing. We’ve booked a little under 6.5% a year in income on the current Buy List, beating Treasury yields by at least 1.5% and generating double the cash return of “safe” sectors like real estate and utilities.
And that’s what it’s all classically been about in the world of value investing: finding great companies that generate reliable cash flow and locking in the portion of that that goes back to investors at a level that compares favorably to other “safe” or low-risk investments. This is not where we go to make a fortune. There are other stocks for that.
This is where we go when we want some confidence that the cash will flow back into our investment accounts at a fairly predictable rate . . . no matter what happens to the stock price in the intervening time. That’s more than a huge comfort. It’s a strategic advantage.
By mitigating our current cash flow needs, the daily crush of news and speculation becomes less urgent. We no longer need to worry quite so hard about the stock price as a way to make sure we have a shot at making decent money on a position.
As long as the dividends stack well enough, the returns are still respectable even if we never sell a single share in our lifetime. Maybe we’ll exit some day when something better emerges. We’ll be pushing the “buy” button on a new opportunity today, which means rotating out of the weakest of our current names.
Otherwise, we’re no longer the prisoners of Wall Street and its sometimes frustrating ability to ignore great companies longer than we can remain patient or solvent. Waiting for Wall Street was the old Value Authority approach. While it often worked, the process was slow . . . while more dynamic styles ran rings around us and left us somewhere between disappointed and envious of other investors’ gains.
We can’t compete with growth stocks in this environment. “Slow and steady” is nice and calm, a low-risk experience, but unless you are willing to invest years or decades to a slow burn, a low-risk style naturally points to low short-term returns.
What we’re competing with is low-risk investments. Bonds. Money markets. CDs and other bank products. They don’t promise anyone a thrilling outcome. At best, investors who favor these instruments are OK with grinding 3-5% a year out of their accounts.
They do it because they want the opposite of a thrilling ride. They don’t want the rollercoaster. They want to beat inflation and protect their savings, maybe earn an extra percentage point or two a year.
How are we doing? The bond market has been a disaster this year, but even investors content to clip coupons and hold their Treasury debt to maturity haven’t been able to lock in an annualized 5% interest rate. On that basis, the current Value Authority portfolio is tracking more than 1.5% ahead.
And as a check on how Wall Street evaluates our stocks versus bonds right now, the Value Authority has a positive total return YTD. Not much, but a couple of points. Treasury bond funds are DOWN.
So far this year, we’re beating CDs, money markets and so on. This has been a good place to park cash if you’re nervous or just don’t want to deal with the headaches around trading in and out of stocks.
Of course we can always do better. While a few of our stocks have done extremely well YTD (looking at established WEC and HON as well as relatively obscure TCPC), others have been either a drag on our overall yield, weak in terms of a declining stock price or, in the case of PEP, both.
PEP has been with us for over a year and even though we’ve booked nearly $7 per share in dividends, that income hasn’t completely compensated for the stock simply failing to get its groove back on Wall Street in the intervening time.
In the old Value Authority, we’d be trapped with names like this: great companies, dead money stocks drifting sometimes for years for the market to come around. Now we can rotate to better income footprints while we wait.
I think it’s time to bring Prospect Capital (PSEC) to the Buy List. Like TCPC and ICMB, PSEC is a business development corporation that makes money by lending money to small businesses that want to grow.
It’s been around since 2004. Think about all the twists and turns management has needed to navigate in that timeline, and yet the fact that the company has survived and even thrived says a lot here.
That management team made the tough decision to cut the monthly dividend from $0.06 to $0.045 per share last year, but I respect the honesty and the discipline. We know the current distribution is payable.
PSEC has booked $0.19 per share or more in profit every quarter over the past year. Again, management will do what it takes to maintain the payout if it’s at all possible. I think we can get it here for at least the remainder of the year if not a long way beyond that.
The accountants say the investment portfolio is worth a net $7.25 per share. On average, BDCs trade at a slight discount to NAV (maybe 0.95X) so this is extreme. I wouldn’t be surprised to see PSEC recover to at least a 0.65X valuation in the next 6 months, which would suggest “fair value” of $4.70 or so if all goes well.
Here at $3.30 that’s an attractive outcome. And in the meantime, if we can grab $0.045 per month, that’s a 16% annualized return on our money . . . TRIPLE bonds or money markets.
Cutting PEP and adding PSEC raises our implied yield by 1.7 points. If nothing changes in the payout profiles, we’ll be making 10% a year overall, again without ever needing to check the stock price or worry about selling.
As with PEP, I’m thinking the capital appreciation factor is the most important part of what makes PSEC interesting. As a result, I’m putting it in the Value Trades category.
Sell PEP to make room for PSEC. Don’t pay more than $3.45 at this stage.