One of the biggest problems facing investors yet again this year will be the search for income producing investments.
The last few years of a zero interest rate policy has forced traditional fixed income investors out of their comfort zone and into stocks and other alternative investments. Given the recent Fed announcements on interest rates this is unlikely to change for the foreseeable future.
Investors could well see a zero interest rate policy continue as long as 2017 to spur economic growth and lend support to battered real estate markets.
For investors approaching the market for the first time in 2014 the challenge is even more difficult than it has been in the past few years.
A tidal wave of yield seeking money has flowed into the markets and many high yield stocks have been pushed to very high valuations.
Blue chip stocks that were once the haven of dividend investors now trade at levels of price to book value or price to earnings that simply are not supported by the value of the underlying business. Utility companies are constrained by a weak economy and increasingly complex and expensive regulatory policies. There has also seen the same type of indiscriminate yield chasing buying that has driven blue chips higher and most are no longer even close to being bargain issues worth considering.
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- ARI 15-Year Financial Data
- The intrinsic value of ARI
- Peter Lynch Chart of ARI
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Income producing REITs have seen buying pressure for several years now and most of the larger ones now trade at levels that are not supported by the value of the property held in the portfolio. Investors chasing income in these groups are exposing themselves to the very real possibility of permanent capital impairment when prices inevitable revert to reflect the real asset value and earning power of the underlying companies.
Income seeking investors who are approaching the market today might want to consider taking a barbell approach.
In the bond market a barbell is half of the portfolio in long term bonds with higher yields and more exposure to interest rate risk and half in lower yielding short term bonds.
Investors can adapt that approach for the broader equities and alternative income markets by putting half the portfolio into higher yielding investments that are often perceived as higher risk. The other half of the portfolio should be placed into more staid lower yielding stocks and investments that have the potential for above average growth of dividend and interest income over the next decade.
On the higher yielding side of the portfolio there plenty of opportunities right now to get some money to work. Colony Capital (CLNY) is well positioned in the commercial and residential real estate markets and current yields almost seven percent while trading at 90 percent of asset value. Apollo Commercial Real Estate (NYSE:ARI) also trades at 90 percent of tangible book value while yielding over nine percent. Business development companies such as Gladstone Capital (NASDAQ:GLAD) and Fifth Street Finance (NASDAQ:FSC) are also trading at discount asset value and yields over eight percent.
The mortgage REITs over yields approaching 15 percent or more and have been falling like a rock throughout 2013.
Although they are riskier than some other high yield securities, there are signs that they are starting to stabilize and could be a top performer in the New Year. The group is seeing substantial insider buying so either the people that have been running these REITs are complete idiots who do not understand their business or a bottom is in sight for these ultra-high yielding investments.
See also: 2014 Planning: Buy Signals To Watch For
The dividend growth side of the equation is a little harder to fully invest right now. The strong market rally has eliminated the number of stocks trading at a discount to book value. There are some regional banks like Susquehanna and Regions Financial that trade below book and have outstanding dividend growth prospects. Aircraft leasing firms like Aircastle Limited and FLY Leasing are cheap when compared to asset value and should be able to grow their dividend payout by double digit rates over the next several years.
Insurance companies like CAN Financial and Hartford Insurance also have above average long term dividend growth potential and are trading below book value right now.
Using the bar bell approach to income investing should provide you with a portfolio that has a yield well above traditional income investments and an income stream that grows year over year as well. By paying attention to valuation first investors can reduce the likelihood of suffering a permanent impairment of capital in a somewhat over heated market for income.
Tim Melvin is a value investor, money manager and writer. He has spent the last 27 years in the financial services and investment industry as a broker, adviser and portfolio manager. He has also written and lectured extensively on the markets with his work appearing on RealMoney.com, DailySpeculation.Com as well as several print publication including Active Trader and the Wall Street Digest. Learn which 3 low risk, high yield stocks Tim owns for the trade of the decade.