Stock Gumshoe

This teaser came in recently for the Motley Fool’s Income Investor newsletter which, you will be unsurprised to hear, is focused on dividend investing — though they often focus just as much on dividend growth as on current yields, so not all of their picks have super-high yields.

They would love you to take a flier on a subscription to their service, which is currently run by James Early and Andy Cross, and they’d love to charge you $149 a year for the newsletter … which may or may not be worth it. According to Hulbert, this one has underperformed the broader market for the last three years, but more than half of that time was with a different person at the helm. To be fair, it’s also quite likely that, like most income investing services, they have a lot of financial stocks in their portfolio, which would have significantly depressed returns. The last stock we saw from Income Investor was the very aggressively promoted CapitalSource mortgage REIT, which is still in the weeds but has staged a “small recovery over the last couple weeks.

But anyway, whether or not this is a fabulous Read the rest of this entry »

These things tend to run in cycles — here we are with yet another Motley Fool teaser, after chatting up rule makers yesterday.

Today, it’s the Motley Fool Income Investor newsletter that’s being teased, by editor James Early … and it’s still on sale, for $119, for what that’s worth (”normally” $199, though it was on sale for $119 back in June when I last saw an ad, too).

Aside from the pick that might have been his in the Rule Makers teaser, ADP, I think I’ve only looked at one of his teaser picks before — Alliance Resource Partners, an MLP stock. It has been down since his recommendation, the other MLP stocks we’ve sleuthed out (remember those “American Oil Pension” ones?) have performed better overall — but that’s not necessarily a fair comparison because those were picked in April, when MLPs were a little cheaper than they were when Early picked his in June. Nearly all the MLPs have performed somewhat poorly of late.

But that’s old news — what have we got today?

They pull out the old saws, the “Government Guarantee” and the “obscure act of Congress” to tease this one. I guess that makes these investments seem more secret or mysterious.

“Government-Enacted 16% Dividend Payouts YEAR IN and YEAR OUT…”

OK, so that sounds pretty nice … they go on to say that these high yields are locked in in perpetuity, and that the “U.S. government will penalize these companies if they don’t pay you at least 90 cents for every $1 they earn!”

Ah, guaranteed money, right?

Well … that assumes, of course, that they earn that dollar … but let’s see what they’re really talking about.

Early is talking about three stocks that offer “High Yield With Serious Growth Potential”

And these are a special kind of company involved in the private equity markets, but the Fool characterizes this as a “highly profitable yet SAFER layer to private investing.”

They’re talking about (and I’m not revealing anything just yet, they say as much in the ad) Business Development Companies, also called BDCs.

These are a special class of investment vehicle, indeed authorized by “Act of Congress”, that essentially works just like a REIT, though with a different focus. They invest in, finance, or lend money to other businesses, and pay out 90% of their income to shareholders. Unlike REITs, they don’t have to focus on real estate, but otherwise I think they’re conceptually the same kind of company. I’m sure they have all kinds of rules and such that they have to follow, but I won’t try to fool you into believing that I’m an expert on BDCs, it’s been a while since I’ve looked at most of these. (I do hold one in my portfolio, TINY, that doesn’t have any income and, as you might guess, therefore doesn’t pay a dividend … definitely not one of the ones the Fool is teasing us with).

They put on the tease pretty hard for these: “In the next year or so, these 3 stocks will likely shoot up in value. And our tight-knit group … is expecting safe 50% gains or more.”

So what are the “James’ top high-yield recommendations right now,” which the Fool says “could very well be our most profitable recommendations ever?”

We’ll check ‘em out one at a time:

Number 1.

This one has an unusually large “spread,” according to the Fool, twice that of “many conventional lenders”

The “spread,” for those not hip to the lingo, is the difference between what a finance company has to pay to borrow money (ie, the coupon rate on their bonds) and what it can charge to its borrowers.

Grew “commercial lending and investment assets” at 43% in 2006.

8.8% current dividend.

And the Fool sez: “You could pocket safe annual returns in the neighborhood of 16% with this stock!”

Not a lot to go on, huh? And therefore I can’t be certain about this. My guess, among the several BDCs that have a yield near 8.8%, would be Allied Capital (ALD). That’s the granddaddy of this business, has been around for closing in on 50 years, and has a current yield of 8.7% … another possibility, though I think it’s less likely, is Gladstone.

And … Stock #2

“If you’ve eaten a popular brand of tuna, or had your car serviced at a company you see all over the place, you’re familiar with this company’s investments…”

Finally, a decent clue!

“The company started in the founder’s apartment in 1986.”

Thankfully, this one is a little easier …

American Capital Strategies (ACAS)

The tuna company they invested in through a mezzanine loan was Bumble Bee — according to their current list of investments they’re out of Bumble Bee Seafood at the moment. Malon Wilkus is the head honcho that started ACAS in his apartment in 1986, not too far from me in the suburbs of DC.

These guys are credited with breathing some new life into the business, especially by creating debt instruments instead of issuing secondary offerings of stock to raise capital and grow their portfolio. Compared to Allied Capital they look a little racy, with a higher growth rate and dividend, but I don’t have any idea what their spread is, or whether the general problems with commercial debt at the moment are trickling through to these folks.

So … we move on, to stock #3.

“When it comes to private equity, a few names are now legendary. One such name has generated compound annual returns of 34% since its 1990 inception.”

This company has a “child” company that does private lending of some type, apparently.

So, according to the Fool, “this firm has a world-class parent company that funnels it deals — the vital raw ingredient of private finance.”

James values this stock at around $30 per share, which provides more than 30% of upside from today’s levels. Plus, it already sports a 8.6% yield!

There are several candidates for this one, too, and I’m having trouble being definitive because I don’t know when they wrote this teaser — the stock that I think it is has a higher yield now because the price has declined of late, but it could have fit these criteria a month or two ago.

And, according to what I’ve read, this company has outperformed that 34% compound annual growth rate … they claim 40%.

So what company is this that I think is a good match?

Apollo Investment Corporation (AINV)

This is a fairly new company, started in 2004 (and I actually held shares in it for a few months back then, though I don’t now). It is the child of the “legendary” Leon Black’s Apollo Advisors (number 5 on the Fortune “power” list), which itself was indeed launched in 1990. If memory serves, this is structured a little bit differently than ACAS and ALD in that the parent charges its child a fee not unlike what hedge funds charge to investors (paid by AINV to Apollo, I think, and I believe they get the familiar 2/20 deal, 2% annual fee and 20% of returns over a certain threshold).

So, with the clues we’ve got it’s hard to be absolutely certain about numbers 1 and three above — I know that ACAS is correct, but I’m less sure about Apollo and Allied Capital … though all three are certainly among the leading lights of the BDC world.

If you want to know more, the Fool did an explanatory article about BDCs at the beginning of this year that summarizes what they do fairly well (and talks about Allied Capital specifically).

And there aren’t that many BDCs, as I noted, and even fewer if you’re talking about the ones that are making a profit (and aren’t really venture capital firms). Quantumonline.com is a good resource for basic information and lists of these (as it is for almost all high-income investments — you do have to register, but it’s free).

The Fool also chatters on for a bit about how important dividend growth is to these companies — and, since we’ve been in a pretty sweet spot for private equity in general, you might imagine that these companies have shown some nice dividend growth in the past. Certainly true in many cases, and one assumes that if they continue to grow their businesses they’ll be compelled to raise their dividends, and if you’re compounding that return does indeed get to be signficant over time (that’s how these 8-9% yields turn into the 16% teaser rate).

But of course, these are businesses — there’s no guarantee that these companies will continue to outperform or be profitable, or that they will be able to raise their dividends.

And for individual investors, the usual metrics of PE ratios and such don’t always make lots of sense for these guys — Apollo and ACAS both have trailing PE ratios of under 5, but that doesn’t really tell the whole story about their business, nor does it mean those two are dramatically less risky than Allied Capital with it’s PE of 13. If you’re tempted to invest in these it would probably be worth your while to really dig in, do your research, and understand the business.

One might argue either that these firms will be hurt because it’s hard for them to get financing or to sell bonds or securitized loans on the secondary market, or that they will be in better position because the companies they might lend to don’t have as many other places to go anymore, so their rates might be higher. I don’t know which one of those is the more accurate assessment of the future, but probably both have some merit.

This email ad came in from the Motley Fool’s Income Investor newsletter, which I don’t think I’ve sleuthed before. They’re running a subscription sale right now for $119, perhaps because their lead analyst, Matthew Emmert — who did manage some pretty impressive returns — appears to no longer be running the show. The new guy is James Early, who I don’t think I’ve heard of before.

But hey, $119 is still a lot to pay if you just want an investment idea — and they’ve got an interesting one they’re teasing today.

This, while pitched as sort of a clean energy play, is actually a high sulfur coal play. The argument they provide is that new scrubber technology makes high sulfur coal usable without polluting the environment unduly, and that the increased efficiency of high sulfur coal will mean that the companies who mine it, who have long been valued lower than their low-sulfur coal compatriots, will soon see a rebound on higher use of their products. It helps that high sulfur coal in the eastern US is very close to the power plants who need it, while low sulfur coal in Indonesia is quite a ways away.

Not an unreasonable argument, in my view — we do see power plants burning “higher” sulfur coal these days with new scrubber technologies, or at least I’ve seen anecdotal evidence of this. I don’t know what the overall market looks like, but coal is still so abundant and so much cheaper than natural gas that it certainly makes sense to me that cleaner coal technologies will remain near the front burner for electricity generation.

But you didn’t come here to find out what I think — you came for the name of a company. So let’s check out their clues:

“The parent company of this New Energy Superstar is one of the largest coal producers in the eastern U.S.”

“Many of its coal operations are close to many power plants, originally designed to burn high-sulfur coal.”

They’ve got “590 million tons of high- and medium-sulfur, ’scrubber quality’ coal”

Has industry-leading profit margins.

5.6% annual dividend.

Massive insider/management ownership at 44%.

So … a few minutes on “liquefy” in the Thinkolator, and we get …

Alliance Resource Partners LP (ARLP)

This is a Master Limited Partnership, not unlike the “American Oil Pension” MLPs we sniffed out earlier, only this one is a coal miner instead of a natural gas or oil pipeline. There are not any standard (non-MLP) coal companies with yields approaching 5%, to my knowledge (though if you want to go to China or Canada there are a few decent yields in this space in both of those countries — Yanzhou and Fording come immediately to mind, though YZC doesn’t yield as much as it used to and FDG has the CanRoy tax problem) . Most of the big US coal companies yield less than 1%.

They do have heavy insider ownership at what looks like 42% right now, but this email cites May numbers elsewhere so the data’s probably a little bit off from today’s numbers. The dividend has dropped a little as the price has climbed, but it’s still at 5.4% today and the dividend has been hiked a couple times a year in the recent past.

The [pdf] presentation they gave at the AG Edwards High Yield Conference pretty much confirms all the teasers, including the specific size of their coal reserves, and is an interesting read if you’re going to invest in this space. As one might expect from a corporate presentation, it clearly describes how they are much better than every other major coal company. One might note that they are slightly biased — not unlike the Gumshoe telling you that stockgumshoe.com is clearly better than any other investing blog. Of course, it’s also entirely possible that both of those things are completely true.

ARLP’s operating margins blow away those of the big non-MLP coal producers like Arch or Peabody — ARLP gets about 18%, the others range around 10%.

Two other ones to look at in this space are Penn Virginia Natural Resources (PVR) and Natural Resource Partners (NRP), both also MLPs that do coal mining. PVR is also a midstream natural gas company, so the comparisons get a little more strained, but the numbers for ARLP do look a little better to me. It is certainly the smallest of the three, and it is the most efficient of the coal-only ones. NRP’s numbers look, on the face of it, significantly inferior to ARLP’s, but I certainly don’t know the whole story on either.

PVR is really the second-closest match on this, but PVR’s parent company is really an oil and gas firm, where Alliance Resources was really born of a coal company, and there was absolutely no mention in the teaser email about non-coal businesses, of which PVR has a lot. PVR’s operating margin is about 20% thanks to the midstream natural gas business, which puts it above ARLP, but they’re not really peers.

And of course, as with all MLPs the management structure is a little odd — a fair amount of the company is owned by Alliance Holdings (AHGP), which has something to do with the operating company as well and pays a smaller dividend. Check out their presentations if you want to understand this, but the higher dividend company is ARLP.

Lots of readers seem very interested in MLPs and high yielders in general, so hopefully this will provide more grist for the mill. Please share here or in the forum if you’ve got ideas on MLPs, coal companies, or dividend investing in general.