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Prospect Capital: Massive Insider Buying in this High-Yielding BDC

A high dividend yield, large-scale buying by company insiders, and recent buying by funds controlled by Joel Greenblatt and George Soros.

Sound interesting?  Then I suggest you take a look at shares of Prospect Capital Corporation (PSEC), a business development company (“BDC”) traded on the Nasdaq.

If you’re unfamiliar with BDCs, you can think of them as publically-traded private equity firms.  BDCs provide financing to small and middle-market companies that are too early in their development to get funding from more traditional sources, such as the bond and equity markets. It’s a high-risk but potentially very high-return financing niche.

Similar to REITs, BDCs pay no taxes at the company level on the condition that they distribute at least 90% of their income to their investors via dividends.  This makes BDCs some of the highest-yielding investments on the market, but—as is the case with REITs and MLPs—their inability to retain earnings for future growth also means that they regularly have to issue new shares, which dilutes current shareholders. That’s not necessarily a bad thing if new investments are accretive to earnings.  But it means that management has to be extremely disciplined.

Let’s dig into the details of Prospect Capital.  PSEC invests primarily in first-lien and second-lien senior loans and mezzanine debt and provides financing for leveraged buyouts, acquisitions, recapitalizations, and capital expenditures for growth. PSEC also invests in the higher-risk but potentially much higher-return equity tranches of collateralized loan obligations. Most of PSEC’s individual investments would have to be considered risky given the early stages of the companies involved, but the portfolio is diversified across a wide variety of industries.

PSEC pays an absolutely massive dividend, sporting a current dividend yield of 13.7%.  Now, normally, that would make me pause.  An exceptionally high yield is often a major red flag for an income investment, as it is often a prelude to a dividend cut.

In PSEC’s case, our risk is mitigated by three major factors.  First, the company managed to sail through the 2008 meltdown without slashing its dividend. The company survived Armageddon with its dividend intact; that says a lot about its staying power.  Secondly, the company has continued to modestly raise its dividend throughout 2014.  And finally, the company’s management team has been aggressively buying the stock on the open market.  If a dividend cut were likely, I have a hard time believing the people running the company would be putting millions of their own dollars into the stock.

Speaking of the insiders, let’s take a deeper look at what exactly they have been up to:

Insider
Position
Date
Shares
Trade Price ($)
Cost ($)
John F BarryCEO9/16/2014100,00010.171,017,000
Eliasek M GrierCOO9/16/20145,00010.1050,500
Eliasek M GrierCOO8/29/201420,00010.26205,200
Eugene StarkDirector8/28/20144,00010.3241,300
Brian OswaldCFO 8/27/201427,30010.40283,900
John F BarryCEO6/13/2014100,00010.371,037,000
Eliasek M GrierCOO6/12/201424,00010.28246,700
John F BarryCEO6/12/2014100,00010.331,033,000
Brian OswaldCFO 6/12/201430,00010.25307,500
Eugene StarkDirector6/12/20141,00010.2710,300
John F BarryCEO3/20/2014100,00010.861,086,000
Eugene StarkDirector2/6/20141,00011.1011,100

Four company insiders—including the CEO, CFO and COO—have collectively poured $5.3 million into PSEC stock in 2014, and all at prices higher than those we see today.  CEO John Barry made a mill-on-dollar purchase as recently as a month ago.

Oh, and as an added sweetener, funds controlled by hedge fund gurus Joel Greenblatt and George Soros have recently taken positions in the stock.

Are there any risks we should be concerned about here?

Sure.  PSEC’s dividend payout ratio is currently 125%, which means that PSEC is effectively issuing debt and new equity to fund its current dividend. That is sustainable in normal, healthy capital markets.  If we were to see the markets seize up again as they did in 2008, PSEC’s dividend would be at risk.  But I consider that risk small enough to safely ignore for the time being.

PSEC’s stock currently trades at a 10% discount to book value.  This means that you could hypothetically sell the company for spare parts and come away with a decent profit.  While PSEC is mostly an income play, the discounted stock price makes respectable capital gains over the next year likely as well.

Disclosures: Charles is currently long PSEC in his Dividend Growth portfolio.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

 

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Update on the DRIP and Forget Portfolio

One of my most popular portfolios in the Sizemore Investment Letter and Macro Trend Investor was the “DRIP and Forget” portfolio, also called the “Core Dividend Portfolio.”  I’ve created a landing page here to track the portfolio’s continued progress, and I will periodically post updates in Sizemore Insights.

I’ve also added a new column–“yield on cost”–which calculates what your effective dividend yield today would be based on the original price at which I recommended the stock.  I realize that most people reading this today will not have purchased the stock at my original recommendation date.  I’m ok with that.  This is for illustrative purposes only.  My goal here is merely to show you how a solid dividend portfolio can provide for your income needs in retirement.

The DRIP and Forget portoflio is a supplementary list of recommendations that I consider a substitute for fixed income. As with all investments in the stock market, it will have more short-term volatility than a fixed income portfolio, but taken as a group, I consider the investments in this list a viable substitute for retirement income. Unlike bond interest, their dividend payments can be expected to rise over time. The DRIP and Forget stocks are intended to be held long-term in a dividend reinvestment program (“DRIP”), hence the name “DRIP and Forget.”

Total returns are cumulative and include capital appreciation and dividends assuming the buy price and buy date shown.

*Last updated October 14, 2014

Company
Ticker
Buy Date
Buy Price
Current Price
Current Yield
Yield on Cost
Total Dividends Recieved
Total Return
Abbott LaboratoriesABT11/5/201230.8141.312.15%2.86%$1.4438.04%
Colgate-PalmoliveCL11/8/201036.4164.042.24%3.95%$4.7588.93%
DiageoDEO10/8/201070.8109.923.75%4.88%$11.7668.81%
IntelINTC7/21/201021.2631.892.86%4.23%$3.5466.65%
Johnson & JohnsonJNJ7/7/201059.0896.862.74%4.74%$9.6880.33%
Kimberly-ClarkKMB8/6/201065.29106.553.12%5.15%$12.8481.57%
Altria GroupMO7/7/201020.5446.134.52%10.13%$7.36157.89%
MicrosoftMSFT7/7/201023.8244.182.84%4.70%$3.61100.63%
National Retail PropertiesNNN7/8/201034.9736.634.66%4.80%$0.817.06%
NestleNSRGY12/8/201056.0670.933.39%4.32%$8.624.19%
Realty IncomeO7/8/201342.6543.345.15%5.15%$2.556.75%
Procter & GamblePG7/7/201059.3483.33.09%4.34%$9.4956.37%
Philip Morris InternationalPM4/8/201052.5284.284.76%7.62%$14.4286.02%
UnileverUL12/8/201029.4340.113.78%5.22%$5.0153.31%
Wal-MartWMT6/7/201376.3377.942.48%2.52%$2.385.23%

Note: These returns are presented for illustrative purposes only and do not correspond to a real-money portfolio. My objective here is to illustrate the power of rising dividends and the superiority of dividend-paying stocks over bonds as long-term income investments.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.

 

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Three Stocks for a Worry-Free Retirement

After a terrible start to the quarter, stocks are showing signs of life again.  Perhaps it was the unexpectedly strong showing of pro-market candidate Aecio Neves in the first round of Brazil’s presidential election, or last Friday’s stronger than expected jobs report, but investors seem to be getting over their third-quarter jitters and looking to a strong finish to the year.

But here’s the truth: If you in or near retirement, you have no business worrying over every squiggle the market takes.  First and foremost, you need a portfolio that allows you to sleep well at night, one that will provide stable, if not necessarily spectacular, returns.

A good retirement stock should have the following characteristics.  To start, its underlying business should be stable and predictable.  You don’t want to bet your retirement on a faddish new technology or on a hit-or-miss biotech gamble.  Secondly, the company should be financed responsibly.  As we saw in 2008, otherwise stable business ran into severe distress when their access to the lending markets was cut off during the crisis.  And finally, you want stocks with a long history of taking care of their shareholders, ideally through regular dividend hikes but also potentially via share buybacks.

So, with that said, let’s jump into three of my favorite stocks for a worry-free retirement.

Unilever PLC

I’ll start with what is possibly the most boring company in the Europe: consumer products giant Unilever PLC (UL).

If you’ve ever set foot in a supermarket anywhere in the world, then you are familiar with Unilever’s brands.  Among many others, they include: Axe, Ben & Jerry’s, Bertolli, Dove, Lipton, St Ives, VO5, and Vaseline.  If there was ever a set of products that was unlikely to fall to technological obsolescence or a black swan event, it would  be Unilever’s.

But while its products may be mundane consumer staples in the West, Unilever has excellent growth prospects abroad.  Unilever gets nearly 60% of its revenues from emerging markets, and while that has hurt the company over the past few years of emerging-market currency volatility, it ensures that it has a bright future as living standards continue to rise.

Unilever has one of the strangest share structures of any company on the planet.  It’s listed in both London and Amsterdam as two separate companies, Unilever PLC and Unilever NV, respectively, and both trade in the U.S. as ADRs under the tickers UL and UN.  Back in the 1930s, management found it easier and cheaper to do a “business merger” rather than a “legal merger” between the British and Dutch companies that today make up the Unilever Group.

Don’t be distracted by any of this.  For all intents and purposes, UL and UN are the same.  The only effective difference is that UN is subject to 15% withholding taxes on dividends in the Netherlands, whereas UL is not.  This matters, as the dividend is an important part of Unilever’s returns.  The company has raised its dividend every year for over 25 years and currently yields 3.9%. For this reason, I recommend UL over UN.

Realty Income

Next on the list is one of my very favorite long-term income holdings, triple-net retail REIT Realty Income (O).

I’ve commented in the past that I own shares of Realty Income that I intend to hold forever and pass on to my kids someday.  If they are smart, they’ll pass the shares on to their own children someday as well.

Why my enthusiasm for Realty Income?

Simplicity. Realty Income has what is perhaps the simplest business model of any stock trading today.  It buys high-quality properties in high-traffic areas and rents them to high-quality tenants; its “typical” property is a pharmacy run by Walgreens (WAG) or CVS Caremark (CVS).

Realty Income has been in business for 45 years and has paid 530 monthly dividends since going public in 1994.  Realty Income has also raised its dividend 77 times in that span.

I wrote last month that Realty Income is on sale again, and I would reiterate that point today. Realty Income, along with most income-focused stocks, took a pounding in the third quarter on fears that the Fed would be tightening sooner rather than later.  But bond yields have sense eased, and Realty Income now yields and attractive 5.3%.

Buy Realty Income, collect the dividend, and sleep well at night.

Apple

My last retirement stock recommendation is Apple (AAPL).  This is a stock I wouldn’t have recommended for a staid retirement portfolio a few years ago because, frankly, its core product markets were too new to warrant consideration for conservative investors.

Apple spent most of the 2000s and 2010s as an explosive growth stock, and investors who got in early made a fortune. But as the smartphone and tablet markets have matured, Apple as a company has matured as well. Today, Apple is a profitable company with an unrivaled hoard of cash, no net debt, and a strong recent history of dividend hikes and share repurchases.  While Apple, as a tech and consumer electronics company, is less predictable than Unilever or Realty Income, at this stage I am comfortable including it in our list of retirement stocks.

Will the iPhone 6 outsell its Android rivals?  Maybe, maybe not.  I’m not too concerned about the performance of any single product iteration because Apple has managed to do for mobile devices what Microsoft (MSFT) did with PCs in the 1980s and 1990s: They’ve built a platform.  And via their new partnership with IBM (IBM), Apple is elbowing its way into the longer-lasting, less-fickle world of corporate enterprise relationships.

Smartphones and tablets are no longer explosive growth businesses.  In fact, in the developed world, they are close to the saturation point.  But these are also products with relatively short life cycles; most users replace their phones every 1-2 years.

Apple has major competition from Samsung (SSNLF) and other makers of Google (GOOG) Android devices.  Over time, Apple may have trouble maintaining its fat profit margins in the face of such worthy competition.  But given that Apple trades at a significant discount to the broader S&P 500, a fair amount of margin compression appears to be baked into current prices.

Buy Apple and collect its 1.9% dividend, which I expect to double in the next five years.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Realty Income Is On Sale Again

Here we go again.  Hand-wringing over the Fed’s tightening schedule has caused a sell-off in bonds and all things income related.  After falling for most of July and August, the 10-year Treasury yield has jumped to over 2.6% on speculation that the Fed may start tightening monetary policy sooner than previously thought.

We’ll see. The Fed may indeed start to raise short-term rates as soon as the first quarter of next year.  But that by now means guarantees that longer-term rates will follow suit. Long-term yields have drifted lower for most of 2014, even as the Fed has continued to taper its quantitative easing program from $85 billion per month to just $15 billion per month.  Meanwhile yields in much of Europe are sitting at multi-century lows—yes, as in multiple hundreds of years—and the 10-year yield in Japan is less than 60 basis points.  Inflation remains below target across the developed world, and demand for fixed income is stronger than ever due to the aging of the baby boomers.

My prediction? The market consensus that the Fed will begin raising short-term rates by the end of the first quarter is probably “about right.”  But I do not expect longer-term yields to follow.  In my view, a range of about 2.2% to 3.2% on the 10-year Treasury over the next 4-5 years is the most realistic scenario.

So, what’s the trade?  Buy bonds?

No.  Even at a yield of 3.2%, at the upper end of my range, your real, inflation-adjusted yield will be about 1% at best, with no potential for income growth or capital appreciation.  A better option would be to buy the shares of “bond substitutes” like safe, triple-net REITs.

I’ve recommended Realty Income (O) before, and I would do so again today.  This is a stock I would feel comfortable recommending whenever bond yields drift towards the upper end of my range.  At current prices, Realty Income yields 5.2%, and the REIT has a long history of raising its dividend every year—and sometimes multiple times in a year (see chart).

chart

Realty Income is down about 9% from its 2014 highs to a current price of $41.76 as of Thursday’s close.  I would recommend accumulating shares whenever they fall below $43.00.

Are you going to double your money in Realty Income?  I would seriously doubt it.  But if you’re looking for retirement income, I would consider it a strong substitute for fixed income at current prices.

This piece first appeared on TraderPlanet.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Choosing the Right Dividend ETF

Well, it happened — again. The 10-year Treasury fell all the way to 2.3% last week on a string of bad geopolitical news and mixed economic data. The last time yields were this low was June of last year, in the early stages of the “Taper Tantrum.”

Could yields continue to go lower? Sure, they could. But it doesn’t matter. If you are an income investor with more than a five year horizon, you should be looking outside of the bond market for your income needs given the pitifully low yields on offer. And one area that still looks attractive at today’s prices is the world of dividend ETFs.

Company dividends — unlike bond interest — generally rise over time, giving dividend stocks far better long-term inflation protection than bonds.

Not all dividend stocks are the same; some are slow-growth dinosaurs that are little better than bonds with respect to their sensitivity to rising interest rates. Others are high-growth dynamos that share their bounty with their investors by continually raising their dividend. And in the same way, not all dividend ETFs are the same. Some are concentrated in slower-growth companies and sectors, while others are a who’s who list of quality growth stocks.

I don’t like choosing between growth and income; I want both. And today, I’m going to share some of my favorite dividend ETFs that I expect to deliver the two.

High Dividend Yield

Any discussion of dividend ETFs should start with the granddaddy of them all, the iShares Select Dividend ETF (DVY). 

 DVY’s underlying index takes the universe of dividend-paying stocks with a positive dividend-per-share growth rate, a payout ratio of 60 percent or less, and at least a five year track record of dividend payment and then selects the 100 highest-yielding stocks.  The result is an ETF loaded with high-yielding, reliable dividend payers.

Not surprisingly, DVY is heavily weighted in utilities and defensive consumer staples, currently 34 percent and 16 percent of the portfolio, respectively.  The current dividend yield is 3.1%—significantly higher than what the 10-year Treasury pays.

As it is currently constructed, DVY is not likely to outperform the S&P 500 in a normal, rising market.  It should, however, hold up far better during a market rout—though this was not the case during the last bear market. DVY took a beating in 2008 because it had a high allocation to the financial sector at the time.

Dividend Growth

DVY is fine for current income.  But if it is growth you seek, try shares of the Vanguard Dividend Appreciation ETF (VIG)—a long-time favorite of mine.  At 2.0 percent, VIG’s yield is not significantly higher than the S&P 500.  But you don’t buy VIG for its dividend today; you buy it for its dividend tomorrow

VIG is based on the Dividend Achievers Select Index, which requires its constituents to have at least 10 consecutive years of rising dividends.  The rationale is easy enough to understand.  There is no signal more powerful than that of a rising dividend.  Company boards hate parting with their cash; it’s a natural human instinct to stockpile it—just in case.  A willingness to part with the cash is a signal that management sees a lot more of it coming.

Paying a dividend requires discipline, as it means less cash to waste on value-destroying empire building.  And a rising dividend also shows that management knows its place.  They work for you, the shareholder, and increasing your dividend every year is a way of showing that they have their priorities straight.

By definition, any stock currently in the portfolio continued to raise its dividend even during the crisis years of 2008 and 2009.  These are companies that can survive Armageddon because, frankly, they already have.

There are drawbacks to VIG’s 10-year screening criteria.  A more recent dividend-raising powerhouse like Apple (AAPL) lacks the history to be included in the Vanguard ETF. Also, as with any investment strategy that depends on historical data, there is no guarantee that a ten-year streak of raising dividends in the past will mean another good ten years of increased payouts going forward.

Still, if you’re looking for a portfolio high-quality stocks with a long history of rewarding shareholders, then VIG’s dividend growth methodology is a fine plan place to start.

VIG is not the only ETF to focus on dividend growth, of course.  PowerShares runs two competing products. The PowerShares Dividend Achievers ETF (PFM) is based on the same underlying index as VIG, though its fees are higher—0.55% vs. 0.10%.  It’s hard to justify losing almost half a percent a year in additional fees for what is substantially the same investment product.

The PowerShares High Yield Equity Dividend Achievers ETF (PEY) offers a smaller, higher-yielding slice of the dividend achievers universe, taking only the 50 highest-yielding stocks from the dividend achievers screen.  Though also more expensive than VIG with an expense ratio of 0.55%, it pays a higher yield at 3.4%.

And finally, Standard & Poor’s has its own competing dividend growth strategy called the Dividend Aristocrats, which goes even further than the Dividend Achievers. The S&P 500 Dividend Aristocrats Index measures the performance of the companies within the S&P 500 that have increased their dividends every year for the last twenty five or more consecutive years.

The SPDR S&P Dividend ETF (SDY) is an ETF that builds a portfolio out of the 50 highest-yielding Aristocrats.

So, if I love the 10-year Achiever screen, I should really love the 25-year Aristocrat screen, right?

Well, in principal, yes.  Though in practice, I find it to be a little too restricting.  Limiting your pool of stocks to companies that have raised their dividend for 25 consecutive years leaves you with a portfolio of older, slower-growing stocks.

Don’t get me wrong; there are some real gems in SDY’s portfolio, including long-time favorites of mine National Retail Properties (NNN), Target Corp (TGT) and Procter & Gamble (PG).  But overall, in SDY, you are left with a defensive portfolio that I would expect to lag during a normal bull market.

Combing Dividend Investing With Guru Following Strategies

One brand new dividend ETF is the AdvisorShares Athena High Dividend ETF (DIVI), which I wrote about earlier this month when it launched.

DIVI is managed by Thomas Howard, a former academic turned money manager superstar and the author of Behavioral Portfolio Management. It is also very different from all other dividend ETFs I follow.  Virtually uniquely among dividend ETFs, DIVI includes equity REITs, mortgage REITs, master limited partnerships (MLPs), closed-end funds and business development companies (BDCs) in its investment universe, giving it a vastly different portfolio composition than its competitors.

Also uniquely among dividend ETF, DIVI employs a guru-following strategy that makes it similar in principle to Global X Top Guru Holdings Index ETF (GURU) and the AlphaClone Alternative Alpha ETF (ALFA), but with a more active management style. DIVI uses Howard’s behavioral research to identify the “high conviction” picks of active mutual fund managers, then selects high-dividend payers from the screen. DIVI then diversifies across sector, strategy and country to reduce risk.

DIVI is a little on the expensive side for a dividend ETF with a net expense ratio of 0.99%.  But given that DIVI is essentially an actively-managed mutual fund in an ETF wrapper, the expenses are not disproportionate.

Of course, no discussion of a dividend ETF is complete without a mention of the dividend yield.  DIVI has been trading for less than a month and thus has no historical dividend yield.  Based on the average yield of its top holdings, minus manager fees and expenses, I believe that it will generate in excess of 5% per year in dividends and perhaps more.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities.