Five Smart Money Dividend Stocks

Now and then it is nice to take a peek over the shoulder of a successful investor to see what their high-conviction buys are.  When you read a headline that “Warren Buffett is buying Company X,” you’re naturally inclined to do a little digging into Company X’s financials.  After all, if it’s good enough for Buffett, it might be good enough for you.

You have to be careful with this line of thinking, of course.   The SEC filings that disclose the holdings of large investors are generally pretty dated by the time we have access to them.  For all we know, the conditions that made a guru buy a given stock may no longer be valid by the time we read about it, and there are no guarantees that they haven’t already sold it.  For these reasons, I tend to focus on larger holdings, the conviction buys that they are likely to hold onto for a while.

Today, I’m going to look at one high-conviction dividend stocks each from five well-known superinvestors.  My criteria is simple enough: the stock must be a significant holding in the guru’s portfolio and it must pay a respectable dividend.

Guru

Stock

Ticker

Yield

Warren Buffett Wal-Mart

WMT

2.10%

David Einhorn Apple

AAPL

1.80%

Joel Greenblatt Northrop Grumman

NOC

3.30%

Bill Ackman General Growth Properties

GGP

 2.20%
Mohnish Pabrai Goldman Sachs

GS

1.8%

 

We’ll start with Mr. Buffett.  Warren Buffett’s Berkshire Hathaway ($BRK-A) has been accumulating shares of retail behemoth Wal-Mart ($WMT), and it’s not hard to understand why.  Wal-Mart is exactly the kind of company that Buffett is famous for buying.     It has a dominant position as the leading discount retailer in the world.  It has competitive “moats” in its size and logistical efficiency that competitors have a hard time scaling.  And naturally, it’s attractively priced. Wal-Mart trades for 14 times 2013 expected earnings and at 0.55 times sales.  Its 2.10% dividend, while not exceptionally high, is growing at a nice clip.  Wal-Mart raised its dividend 9% last year and 20% the year before.

Our next guru is David Einhorn.  Einhorn is better known for some of his high-profile short positions—he even wrote a book about his short of business development company Allied Capital, Fooling Some of the People All of the Time—but he is certainly not afraid to make large, concentrated long bets as well.

As of his most recent filings, former high-flyer Apple ($AAPL) was his largest holding by a wide margin at fully 15% of Greenlight Capital’s publicly-traded long portfolio.

It is debatable whether Apple should be considered a “dividend stock” given that the company only recently started paying a dividend and yields less than the broader S&P 500.  Still, given Apple’s gargantuan $100 billion cash hoard and continued shareholder agitation, it is safe to assume the dividend will be rising in the years ahead.

Joel Greenblatt of Gotham Capital is one of my favorite gurus. His “Magic Formula” is one of the best stock screeners I have ever come across, and he gives away access to it for free.  I’ve stumbled across more great investment ideas than I can count from browsing his site, and I recommend that you give it a look.

Greenblatt is heavily invested in defense firms these days, and one that caught my eye was Northrop Grumman Corporation ($NOC).

Northrop Grumman is not a “high conviction” pick of Greenblatt, per se, as its weighting is not materially higher than any of his other holdings.  It is, however, a highly-profitable company selling at a very attractive price.  Northrop Grumman trades for just 9 times expected 2013 earnings and yields an impressive 3.3% in dividends.

Next on the list is Bill Ackman, Greenblatt’s former partner at Gotham Capital and the principal of Pershing Square Capital Management.  Ackman is an activist investor with a history of taking large positions in companies and then agitating for radical change.

One such company in need of radical change is the iconic American retailer JC Penney Company ($JCP).  Penney is Ackman’s largest position, comprising fully 17% of his portfolio.

The company recently cut its dividend and is in the midst of an existential crisis, so we’ll move down the list to his first dividend stock of any size, diversified REIT General Growth Properties ($GGP).

A retail REIT may raise eyebrows when consumer spending appears to be slowing, but investors don’t appear to be worried. General Growth is up 20% year to date, roughly double the return of the S&P 500.

With a yield of 2.20%, General Growth is certainly not a big income generator, particularly by REIT standards. Still, a reliable 2.2% is attractive in a low-yield world.

As a side note, Ackman has a large position in Sizemore Investment Letter recommendation Beam Inc ($BEAM), the maker of Jim Beam bourbon whiskey.  Though not much of a dividend stock, it is attractive as a recent spin-off and as a money-minting sin stock.

Finally, we come to Mohnish Pabrai, author of the Dhandho Investor and one of my favorite investors. Pabrai is known for running a highly-concentrated portfolio and for good reason.  As of his most recent filings, two thirds of his portfolio was invested in the financial sector.

Pabrai’s largest holding that pays a dividend of any size is Wall Street superbank Goldman Sachs (GS), which yields a modest 1.8%.

Pabrai is betting big on the financial sector, and Goldman alone accounts for over 19% of his portfolio.  To say that this was a “high-conviction” investment for Mr. Pabrai would be an understatement.

Of all the guru stocks profiled in this article, the one I find most compelling is Mr. Buffett’s Wal-Mart, which I own both personally and in client accounts.  Though considering the track records of each of the gurus, a case could be made for considering any of these dividend-paying stocks.

Disclosures: Sizemore Capital is long BEAM and WMT.

 

How to Spot a Value Trap: Research in Motion

Question: When looking at cheaply-priced stocks, how do you know which ones are solid value stocks and which ones are dreaded value traps?

Answer: The value stocks eventually recover, whereas the value traps do not.

I realize that my answer is no more useful than Will Rogers’ advice to “Buy stocks that go up; if they don’t go up, don’t buy them,” and that is precisely my point. There is no systematic way to recognize a value trap.

Some sectors are more prone to value traps than others, and this is something I’ll elaborate on later in the article. But first I’ll give an example of a value trap that ensnared yours truly—BlackBerry maker Research in Motion ($RIMM).

When I first started considering RIMM last July, it was one of the cheapest companies in the world. At one point in time it traded for just 3 times earnings and barely half its book value.

My thinking when I bought RIMM was straightforward enough. While the company was losing the smart phone war to Apple ($AAPL) and Google ($GOOG), it had a strong and growing services business with sticky revenues, a strong and growing presence in emerging markets, and a rock-solid balance sheet. Yes, the company was losing market share, but its sales were still growing and a decent clip. At the price at which it traded, RIMM didn’t have to win the smart phone war in order to be a good investment; it merely had to survive.

In most industries, this would have been sound thinking and the makings of a great contrarian investment. But in technology, where platforms are everything, it doesn’t hold. Much like the Game of Thrones, with technology platforms you win or you die

Shrinking market share for your platform begets further shrinking market share. Retailers don’t want to take up shelf space better used for more popular products. Carriers don’t want to offer incentives. Programmers don’t want to write applications for a shrinking platform. Rather than a gentle decline, you get a sudden collapse.

Case in point RIMM. With the BlackBerry, RIMM invented the smartphone as we think of it today and quickly rose to dominance. After conquering the corporate and government markets, the success of the BlackBerry spilled over into the consumer market. BlackBerries became known as “CrackBerries” for their addictiveness. As recently as 2010, RIMM held nearly half of the smartphone market, only to see that market share shrink to single digits today.

Believe it or not, I do believe that RIMM has a future. But its future lies as a software and services company, providing enterprise e-mail, messaging and security, and not as a hardware maker. A slimmed down services-only RIMM would be worth owning at the right price. But before that happens, management will likely destroy quite a bit more value attempting to salvage their hardware and operating system.

Not all cheap tech companies are value traps, of course. Microsoft ($MSFT) and Intel ($INTC) have both been cheap for years, though both have strong underlying businesses nearly impervious to competition and both have been rewarding shareholders with a high and growing dividend.

As much as we would like for it to be, this is not an exact science, and you’re not going to get it right every time. In the end, the best defense against a value trap is emotional discipline. Look at your investments critically and don’t make excuses when they fail to perform. Use stop losses when appropriate. And be honest with yourself when you ask the question, “If I didn’t already own this stock, is this something I would want to buy today, knowing what I know?”

Oh, and follow Will Rogers advice about avoiding stocks that don’t go up.

Disclosures: Sizemore Capital is long INTC and MSFT. Alas, we were formerly long RIMM.

The Next Boom: Profiting from a Housing Recovery

Last week, I announced to the world what a momentously bad investment I had just made (see “I just made a horrible investment”).

Yes, dear reader, I was dragged kicking and screaming against my will into homeownership by my wife and two-year-old son.  My days of enjoying my Saturday mornings as an urban yuppy, drinking freshly-ground French press coffee and reading the weekend edition of the Financial Times on the patio of my Dallas Uptown highrise, are over.   Instead, they are spent at the local Home Depot (NYSE: $HD) buying rope and tools to hang a tree swing.

Men who pound away on financial calculators for a living have no business being within 100 yards of a Home Depot.  We don’t have the foggiest clue what we’re doing, and we end up spending small fortunes on tools we don’t need and have no idea how to use. And after buying it all, we generally abandon the project halfway through and end up paying a professional to redo it all.

I bring all of this up for an important reason.  The housing market has a disproportionately large impact on the health of the economy.  In addition to the obvious construction and mortgage finance industries that directly benefit from the construction and sale of homes, virtually every other industry benefits as well from an overall higher level of consumption.  When you own your dwelling, you tend to spend a lot more money on the things that go in it.  This would include furniture, appliances, electronics, decorations and artwork, and—yes—even tree swings.  Many of these purchases (though probably not the tree swings) are purchased on credit.  Thus housing and credit booms go hand in hand.

Of course, this also works in reverse. The U.S. economy has been in the dumps since the bursting of the housing bubble, with consumer spending and retail sales growth tepid at best.

All of this is about to change, and the catalyst will not be another stimulus bill or quantitative easing.  It will be demographics.

As a “thirty something” member of Generation X, I’m actually a little late to the homeownership party.  Knowing full and well what a terrible “investment” a personal residence is, I put it off as long as I could until family considerations made further delay all but impossible.  My generation is small relative to the one that came before it—the Baby Boomers—and the one that came after it—the Echo Boomers.  And our impact (or lack thereof) on the housing market has already been made.

It is the Echo Boomers that should have property developers salivating.  These children of the Baby Boomers, born in the 1980s and 1990s, form a generation even larger than that of their parents.  And they are quickly entering their peak marriage and family formation years.

The settling down of the largest generation to date will create unprecedented demand for starter homes and rentals.  Meanwhile, new supply has all but disappeared in the wake of the bust.  New home construction hit its lowest levels on record last year…breaking the record lows of the year before and the year before.

It may seem absurd to talk about given the foreclosure backlog that still plagues the market, but in a few short years we may actually have a housing shortage, at least in the cities attracting these new families.

It’s too early for me to recommend that readers buy homebuilders based on these fundamentals, and in any event homebuilder stocks have already had a phenomenal run.  The SPDR S&P Homebuilder ETF (NYSE: $XHB) has nearly doubled in less than six months, and homebuilders tend to be wildly volatile.

Figure 1: SPDR S&P Homebuilders

The best course of action would be to build a portfolio of entry-level rental properties.  While your principle residence is a terrible investment (it’s a major drain on cash flow), rental properties are an entirely different story.  If bought correctly and at reasonable prices, they generate a positive cash flow every month that is tax advantaged.  Depreciation and other charges ensure that much (if not all) of your cash income is tax free.  And real estate is a more reliable hedge against inflation than precious metals like gold or silver.

No less an authority than Warren Buffett would appear to agree.  The Economist recently quoted the Sage of Omaha as saying that he would buy “a couple hundred thousand” homes if it were practical for him to do so (see “Holding Back the Spring”).

Investors without the patience or the bankroll to buy a portfolio of rental properties can settle for apartment REITS or for the stocks of companies that cater to a recovering housing markets such as Home Depot or rival Lowe’s (NYSE: $LOW).

Oh, and about that tree swing.  It took me four hours of cursing and swearing, but I finally got it hung properly.  My two year old son loves it.

This article first appeared on MarketWatch.

Warren Buffett Buying the Sizemore Investment Letter’s Picks

Lest I be accused of hero worship, I’ll spare readers another Warren Buffett lovefest article.  Yes, Buffett is a living legend, and yes, he is arguably the best investor of all time.  But these facts are nothing new, and there have already been more articles than I can count written about the man and his methods over the years.  Buffett has been elevated to something akin to a demigod in the minds of many value investors, and the art of investing like Buffett is a subject that has been thoroughly beaten to death by the financial press.

With all of this as a caveat, I’ll let readers in on a little secret:  I do like to keep tabs on what Buffett is buying or selling.

It is never a good idea to blindly ape the trades of another investor—even one with a track record like Buffett’s.  Due to the time lag in reporting with the SEC, an investor you follow may very well have sold the position you are copying by the time you buy it.  And what makes sense in that investor’s portfolio might make no sense at all in yours.

Still, given Buffett’s penchant for long investment time horizons, he’s a little easier to follow than most.  And, again, his track record over the years make him a man worth watching.

Imagine my pleasure this afternoon when I saw Berkshire Hathaway’s updated portfolio holdings for the third quarter of 2011 (see Warren Buffett’s portfolio).  Three out of Buffett’s five new additions were Sizemore Investment Letter recommendations.

Buffett initiated positions in SIL recommendations DirecTV ($DTV), Intel ($INTC), and Visa ($V).  His other two additions were pharmacy chain CVS ($CVS) and defense contractor General Dynamics ($GD).

While I was not invited to Buffett and partner Charlie Munger’s strategy sessions before these purchases were made (I’m sure my invitation was lost in the mail), I have a pretty good idea of what Buffett sees in DirecTV, Intel, and Visa.  Each is a leader in its respective industry, and all three benefit from durable, long-term macro trends.

Let’s start with DirecTV, the world’s largest provider of paid satellite television.  Given that TV-over-internet options like Netflix ($NFLX) and Hulu are increasingly crowding the turf of traditional paid TV—and given that the paid TV market in the United States is already saturated—Buffett’s choice here might raise a few eyebrows.

I can assume that Mr. Buffett’s rationale was the same as my own:  DirecTV is a direct play on rising living standards in the fast-growing markets of Latin America, where it already has 11.1 million subscribers (vs. 19.8 million in the United States).  Latin American revenues were up 46 percent in the 3rd quarter, due primarily to subscriber growth.  But even in the United States—where everyone already has paid TV service in one form or another—revenues were up 8 percent.  Not bad, given the precarious financial situation of the average American.  DirecTV is also very reasonably priced at just 10 times expected earnings.

Moving on to Intel, my only question to Buffett is “What took you so long?”

Intel absolutely dominates the market for computer processor chips.  But this very strength is what has caused investors to shun Intel.  You see, the PC is dead.  Smart phones and the iPad killed it.  And given that Intel is still quite weak in the mobile market, the company is resigned to be a slow-growth behemoth.  Who wants to own a dinosaur like Intel?

That story would seem to make sense at first.  The problem is that it’s simply not true.

The PC is far from dead.  Smart phones and tablet computers are growing at a much faster rate, of course.  And the PC market does depend more heavily on the corporate and enterprise market, which is not in the best of shape in this economy.  But tablets and smart phones do not replace a computer for most users.  And in most emerging markets, PCs are still very much a growth industry.

Intel’s revenues and earnings are growing at 28 percent and 17 percent year over year, respectively.  And that is in near recessionary conditions.  Meanwhile, the stock trades at just 9 times expected earnings and yields 3.4 percent.  At current prices, I consider Intel a safer investment than most AAA-rated bonds.

Finally, we come to Visa.  Visa and rival MasterCard ($MA)—also a Berkshire holding—have become somewhat trendy of late, but it wasn’t like that for most of the year.  Regulatory uncertainty cast a pall over credit card stocks, as did fears of a consumer slowdown.  Yet investors who were, in Buffett’s words, greedy when others were fearful did quite well in Visa and MasterCard.  Both are among the best-performing stocks of 2011.

Visa and MasterCard benefit from two powerful macro trends—the transition to a global cashless society and the rise of the emerging-market middle class.  As electronic payments become a larger share of commerce, credit and debit cards—as well as newer payment methods such as PayPal—will increasingly replace cash and checks.  And while this process is well on its way in the United States and other developed markets, it is only just beginning in most emerging markets.  This is a trend that will be with us for a while.

Visa trades for 14 times expected earnings, which is a bargain for a company with Visa’s brand, financial strength and growth prospects.

DirecTV, Intel, and Visa are all long-term holdings of the Sizemore Investment Letter.  And while Buffett’s reasons for purchasing may have been very different from our own, we’re glad to see the Sage of Omaha sharing our enthusiasm.

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What’s Working in 2011?

2011 has been a rough year for investors.  Stocks, as measured by the S&P 500, are down nearly 8% for the year and down 14% from the April highs.  And while 14% may not sound like all that much in the grand scheme of things, investors felt every point in a surge of volatility that brought back discomforting memories of the 2008 meltdown in which the major stock indices lost half their value.

Still, some market sectors fared better than others.  Let’s take a look at Figure 1.

Figure 1

Three sectors are in the black year to date—utilities ($XLU), consumer staples ($XLP), and health care ($XLV).  (Note: these figures do not include dividends.)  Consumer discretionaries ($XLY), technology ($XLK), and telecom ($IYZ) are down for the year, though less than the broader market.  After that, it gets ugly.  Energy ($XLE) industrials ($XLI) are down 10% and 14%, respectively, but the real losers for the year have been materials ($XLM) and financials ($XLF)—down 18% and 23%, respectively.

Investors who underweighted the highly-cyclical sectors and focused instead on the less-sexy, dividend-paying value plays haven’t had a bad year.

So WHAT if I bet the farm on banks and gold?

But what is remarkable about this year’s correction is that so few investors seemed to see it coming, and this included high-profile professionals.  John Paulson, the hero of 2008 who used the subprime meltdown to make the most successful trade in history, has had an abysmal year.  Due primarily to his overweighting to financials and materials—the two worst-performing sectors by a wide margin—Paulson’s flagship fund was down by as much as 40% this year. (See John Paulson’s portfolio holdings here.)  And over the past two weeks, his largest single holding—gold—has taken a tumble and may have much further to fall. (see “Is It Time to Call a Top in Gold?”)

No investor should be judged by a single nine-month period, and perhaps Paulson will ultimately prove to be “right” about financials.  Many banks appear cheap on paper, and sentiment is almost universally bearish towards them.  It’s entirely possible that he will eventually recoup the losses he took this year.

Still, Paulson’s heavy losses on his leveraged, concentrated portfolio should stand as a warning to investors.  Paulson ignored low-hanging fruit that was ripe for the picking—such as telecom and pharmaceutical shares trading at multi-decade lows based on earnings and dividends—and instead swung for the fences with a massive leveraged bet on an inflationary expansion.  Paulson risked his career and the wealth and livelihood of his clients without ever asking that all-important question: “What if I’m Wrong?”

Sir John Templeton

There is nothing wrong with betting big on a concentrated position.  Great value investors like Warren Buffett have made careers of doing so, and over-diversification is a recipe for mediocrity.   As the great Sir John Templeton said, “By definition, you can’t outperform the market if you buy the market.”

But the second half of Sir John’s quote is also quite illuminating: And chances are if you buy what everyone is buying you will do so only after it is already overpriced.”

If you’re going to take a large, concentrated position, two conditions should be met:

  1. You stand to make a bundle if you’re right.
  2. You won’t lose your shirt if you’re wrong.
Mohnish Pabrai

Value investor and financial guru Mohnish Pabrai  compares the investment decision to a coin toss in which “Heads I win; tails I don’t lose too much.”  I tip my hat to Mr. Pabrai, and I only wish I had thought of that quote first.

Unfortunately for his investors, Mr. Paulson did not apply the same logic.  He loaded up on gold after it had already been in a bull market for the better part of a decade and had become trendy.  And he bet big on financials even after watching what happened to them in 2008.  He swung for the fences…and struck out.

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