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Finding Income Gems in a Bubbly Market

Finding Income Gems in a Bubbly Market

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Thursday, 24 March 2016 08:47 PM Current | Bio | Archive


I follow income stocks pretty religiously, though I’ll admit it’s been a while since I’ve looked at tobacco stocks. I sold my last tobacco stock – Marlboro maker Altria (MO) — about a year ago when I took a long, hard look at the dividend yield (then about 4%) and decided it no longer made sense to own as an income stock. At that price, there was a lot of potential downside and very little upside.

Or so I thought…

It seems I sold too soon. Altria’s stock price has enjoyed a nice 20% bump since then, and the yield has shrunk to just 3.6%. The stock trades for 23 times earnings… which is slight premium to the broader market.

Now, I’m not the biggest fan of bubbly tech stocks like Facebook (FB) or Amazon (AMZN). But I can promise you this: I’d much rather pay the current multiple of 84 times earnings for Facebook or even 460 times earnings for Amazon… even though I consider those valuations to be wildly excessive… because I believe that there is at least a chance that the companies could grow into those valuations. It could happen. But tobacco stocks operate in an industry in terminal decline. Cigarette sales volumes fall with every passing year, and the regulatory noose just keeps getting tighter.

Now, there is nothing wrong with buying a stock in a declining industry, particularly if you’re playing it as a short-term trade. And even as a long-term holding, it can make sense so long as you’re buying them as deep-value stocks and realizing a decent current return via an outsized dividend. But there is no scenario under the sun in which tobacco stocks should trade at a premium to the broader market. None. Nada. Zip.

This is how desperate investors are for yield these days. They’re willing to accept a sub-4% yield on a no-growth company in a slowly dying industry because they can’t find a better yield elsewhere.

Well, the fact is, they’re not looking hard enough. As I wrote recently, prices in several corners of the income market are actually downright cheap. Yields of over 10% are common in mortgage REITs and business development companies.

These sectors are not without their risks, of course. But at least you’re being properly compensated for taking those risks at current prices and yields.

But while I like select mortgage REITs and business development companies, I see the very best opportunities in closed-end funds.

As a group, closed-end funds are trading at some of the deepest discounts to net asset value since the 2008 meltdown and its aftermath. It’s not unusual these days to find funds trading for 80 cents on the dollar. And some of the yields can be downright spectacular.

In the last issue of Peak Income, Rodney recommended a solid municipal bond fund paying a fat 6.7% yield… tax free. If you’re in the highest tax bracket, that amounts to a tax-equivalent yield of over 11%.

Now, getting these kinds of yields involves taking a modest amount of risk. The fund employs a little leverage and owns a small amount of bonds issued by some shaky issuers like Illinois and Puerto Rico. But the vast majority of the fund is invested the bonds of at least semi-responsible state and local governments that can reliably be expected to service their debts. And believe me, I consider a fund like this a lot safer than an Altria trading at today’s prices.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. As of this writing, he was long AAPL and MSFT. To read more of his work, CLICK HERE NOW.

Disclaimers: If I mention a stock favorably, you should assume that I have a position in it, both personally and in client accounts.  This does not, however, automatically mean that you should own it. I am expressing my opinions in this newsletter, not offering individualized financial advice or soliciting you to buy securities.  See full disclaimer here.

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CharlesSizemore
I follow income stocks pretty religiously, though I'll admit it's been a while since I've looked at tobacco stocks.
invest, stocks, income, tobacco
677
2016-47-24
Thursday, 24 March 2016 08:47 PM
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