I follow income stocks pretty religiously, though I’ll admit it’s been a while since I’ve looked at tobacco stocks, which are some of the most consistent and well-known dividend payers out there. I sold my last tobacco stock – Marlboro-maker Altria – a few years 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…
Altria’s stock price has gone nearly straight up since then, and the yield has shrunk to just 3.4%. The stock trades for 27-times earnings… which is a significant premium to the broader market.
Now, I’m not the biggest fan of bubbly tech stocks like Facebook or Amazon. But I can promise you this: I’d much rather pay the current multiple of 38-times earnings for Facebook or even 171-times earnings for Amazon… even though I consider those valuations to be excessive… because I believe there’s at least a chance they could grow into those valuations.
It could happen. But tobacco stocks? Not so much. Big Tobacco operates in an industry in terminal decline. Volumes for cigarette sales fall with every passing year, and the regulatory noose just keeps getting tighter.
Now, there’s 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’s no scenario under the sun in which tobacco stocks should trade at a premium to the broader market.
None. Nada. Zip.
This goes to show how desperate investors are for yield these days. They’re willing to accept a sub-4% yield on a no-growth company in a dying industry because they can’t find a better yield elsewhere.
Well, the fact is, they’re not looking hard enough.
If I offered to pay you a crisp $1 bill for the 90 cents you have jingling in your pocket… well, you’d probably think I was either crazy or a scamster. Or maybe both.
But if, after inspecting the dollar bill, you determined the deal to be legit, you’d jump on it in a heartbeat.
In fact, you might even run to the bank and take out your entire life savings in dimes in the hopes that I’d give you a dollar for every 90 cents you could throw together.
Why wouldn’t you? It’s free money.
I’m not going to give you a dollar for 90 cents… so, sorry if I got your hopes up. But I will point to some pockets of the market today where these kinds of deals (or better) are on offer.
But first, we need a little background.
If you have a company that’s trading at 90 cents to the dollar, that means it’s trading at a discount to its book value. “Book value” or “net asset value (NAV)” is the value of a company’s assets once all debts are settled. Think of it as the liquidation value of the company.
Now, for most companies, book value is a pretty meaningless number. If you’re a service or information company like Microsoft or Google, the value of your business is in intellectual capital and in the collective brainpower of your workforce. That’s a little harder to put on a balance sheet.
Likewise, the accounting book values of old industrial companies with a lot of property, plants, and equipment – think General Motors or Ford – are also pretty useless, since the numbers on the books reflect historical costs rather than current market or replacement value. And this is further distorted by accounting depreciation.
But while NAV is more or less worthless for most mainstream companies, it’s extremely useful in a few pockets of the market, such as mortgage REITs.
In cases such as these, the book value of the companies is based on the real market value of the securities they own, minus any debt used to finance them. What you see really is what you get.
And this is where it gets fun. At current prices, many mortgage REITs are worth more dead than they are alive.
Mortgage REITs usually trade at healthy premiums to book value, which makes sense. The whole is worth more than the sum of the parts, and you’re paying for management expertise, instant diversification and the REIT’s access to cheap and abundant credit – three things you’re going to have a hard time getting on your own.
Well, today, it’s not uncommon to see these trading for just 80%-90% of book value, implying that you could hypothetically buy up the entire company, sell it off for spare parts, and walk away with 10%-20% in capital gains… all while collecting dividends.
I like mortgage REITs. But there’s another corner of the market I actually like a lot better. I call them “private income funds,” and they allow us to profit three ways:
- We make money on the current dividend – sometimes as high as 9%.
- We make money when the value of the portfolio it owns rises in value.
- And finally, we make money when larger-than usual discounts to net asset value shrink to more normal levels.
All in all, we’re often able to get better returns than what the stock market delivers but with low correlation to traditional stocks. If you’d like to know more, stay tuned, because I’ll soon reveal how to uncover the type of yields I’m talking about, and have automatic checks arrive at your doorstep every month. That way, you can leave the dimes at home.
Portfolio Manager, Boom & Bust