Thursday, March 19, 2009

More on Investing Process and Blackjack/Large Risks & Opportunities In the Savaged REIT Securities/ AA, GE

When thinking about the AIG retention bonuses for the Masters of Disaster this morning, and the entire process of paying people hundreds of millions of dollars to engineer colossal failures of epic proportions,  an ancient piece of information stored in one my few remaining brain cells popped into my memory for the first time in ages. Back in the 1950s, there was a major league baseball player, Ralph Kiner, who then played for the hapless Pittsburgh Pirates, a perennial last place doormat.   Ralph was one of the best hitters in baseball during the late 1940s and early 1950s. Ralph Kiner - BR Bullpen 

(I even have one of his baseball cards from back then) So based on his outstanding performance, he went to the owner, Branch Rickey and asked for a raise.  Rickey told him no way was Ralph going to receive a raise, saying "We finished eighth with you, and we can finish eighth without you". Maybe the Masters of Disaster need to be told that story- it is not like we are winning with them. In fact, it would do the Masters good to have worked for my Dad when he was in business. Value of Real Labor)

I wanted to add a few comments to an earlier post where I discussed practicing risk management by playing blackjack at a casino. BlackJack and Stock Investing: Lessons Learned & Applied

Before you sit down at a table and play your first hand,  you need to learn whatever your mind can absorb about the game.  The same process of learning before doing is applicable to a stock investor.

Tyler and I were at the bookstore, shortly after watching a movie called 21 about a group of MIT students who were taught to count cards.  Tyler came up to me with a book and asked whether he could learn to count cards by reading that book. I glanced at it and saw that the first few pages dealt with basic blackjack strategy ( a small crib sheet of a basic strategy chart may be necessary for some since there are a very large number of variations & rules)

I replied that you need to know basic strategy, and most of the book discussed card counting techniques. He said that is what he wanted to learn to do.  

By watching the movie Tyler understood that the cards turned up contained important information, when taken together, relevant and material to the decision making process.  

Similarly, before the  investor ventures into buying individual securities, there is also a learning process that has to be followed before jumping into it, a much longer and far more difficult than learning to play a card game. The process is the same however, learn whatever you can, remove emotion and ego from the decision making process, and develop risk management rules.

My posts indicate a very detailed process that I follow in making any investment.  As I stated in the following linked post, my comments about individual securities are not meant to be exhaustive or complete but simply to illustrate an investment process of gathering information and managing risks.  

Throwing 300 billion into buying 2 to 10 treasuries will prolong the bubble in treasury prices but will not prevent it from bursting.  The ten year treasury had a huge move yesterday and is now price to yield around 2.5%.  When I adjust that yield for inflation and taxes, I simply can not see how treasuries are worth the risk to me, when my after tax inflation adjusted return would be negative.  I am willing to take on more risk when I know for certain that the "safe" alternatives move me backward, and that is the genesis of my purchases of other, higher yielding securities. All of the consumer staple stocks recently purchased, for example, have a higher yield than 10 treasury and the dividends are taxed at a lower rate.  While I do not question that Uncle Sam will make good on that treasury bond in 10 years, an opinion subject to change, I do understand the risk of lost opportunity, that is, the risk that a better opportunity will present itself for the funds used to purchase a 10 year treasury now.  

If the 10 year rates spike in a year or two to say 4 or 5%, a purchase today of a ten year treasury will lose value.

Then, the entire amount of capital used to make an investment to buy a 10 treasury now would not be available to buy a similar term with a yield more acceptable to me.  

Sure, the ten year bond yielding 2.5% could be sold for a loss and then the remaining proceeds applied to the purchase of one yielding 5% or even higher.

I seriously doubt that I would take a 20% loss in a ten year treasury just to obtain a couple percentage points better yield.  Most likely, I would just hold that security until it matures and just get my money back, suffering through 10 years of a negative real rate of return adjusted for taxes and inflation.  

Anyone can find on the internet how a rise in interest rates will impact the value of an existing bond.

An example would be Andrew Bary's column a few weeks ago, that I previously discussed in a post, where he noted the 30 year treasury was then at 2.82%. If rates rose to 4.35% the value of the bond purchased with a 2.82% yield would have to fall 25% to bring its yield up to 4.35%, and it was not long ago that the 30 year bond was yielding that amount

Generally a rise in rates will have the biggest adverse impact on the longer dated maturities, a period of rising interest rates like that experienced in the 1970s and early 1980s is anathema to an investor with bond investments purchased before the rise.

The Federal Reserve has data on the ten year treasuries going back to 1953. The current rate is abnormally low. By not investing in the note now, I have the opportunity to use capital to buy the 10 year when the yield is more attractive or at least acceptable to me on an inflation and tax adjusted basis.  

Some investors might also find themselves in a position where they have to sell a ten year bond at loss.  

For now,  my only recent buys of any treasury security has been the TIP, with the last purchase at 93 and change.

When the Fed ends its manipulation of the treasury rates with its massive 300 billion in purchases, and the chickens come home to roost after the current debasement of the currency and money creation flood, then I am even more convinced that problematic inflation is in our future, and inflation will then cause the value of any long bond to fall. David Swenson's comments on Inflation/ TIP-WIP-Floaters 

David Swenson, the famed manager of Yale's endowment, said in an interview in January 2009 that the massive fiscal stimulus can not help but produce "massive inflationary pressures"

The monetary stimulus and money creation by the Fed, which is now on steroids, on top of the incredibly large fiscal stimulus, has to make the inflation problem down the road even more problematic and possibly acute.

Having said all of that, I do believe that the Fed is pulling out all of the stops to prevent the world from sliding into another Great Depression.  Another GD would be far worse than a inflation problem in a year or two.  If nothing had been done after the Lehman failure, no TARP monies for example, there would have been an implosion of the entire financial system.  The extreme leverage would have acted as a black hold sucking in virtually every major financial institution in the world in an whirlwind of annihilation.  So all of this happy talks brings me to one of my small investments in my quest for yield. 

Another REIT reduced its common stock dividend, Brandywine Realty (BDN), cutting the common dividend from 30 to 10 cents. The regular cash dividend was declared on its cumulative preferred stock which I do own. I am going to label Brandywine, an owner of office buildings, a serial slasher since this is the second cut in the last six months.  (44 cents to 30 cents to 10 cents)  Y

Yesterday, I came close to buying a lottery ticket in the common when it approached 3 bucks a share, but decided to contain that impulse for now. I did recently reinitiate a position in one of  its cumulative preferred issues, BDNPRC since I am becoming a glutton for anything with a yield. BUY 50 BDNPRC  My yield based on my acquisition cost is around 20%

For a U.S. investor, an equity preferred issue such as this REIT's cumulative preferred does constitute a qualified dividend subject to the maximum 15% tax rate. Buy of HNZ at 31.67/Tax Advantages of Equity Preferred Dividends As long as BDN continues paying that common dividend, it has to pay my preferred dividend in full, and the BDN Board declared the regular cash preferred dividends.

Another reason to avoid the common was the Boards willingness to consider mixing stock and cash when paying the common dividend. I am certainly fishing in a disfavored asset class even when I invest in the more senior equity preferred issues, more senior than the common, but still way down the totem pole of priority.  Buy 50 LXPPRD, Bought PG/ Lexington Realty 

My goal for the REIT cumulative preferred is to trade them, collect a bunch of dividends, spread my risk around to a number of different companies, and hopefully secure a modest 10 to 15% annualized total return on them as a class. I was able to successfully to reach that goal last year which was very good under the circumstances. This year, however, has resulted in some problems like BEEPRA which was the first one that went into a deferral of its cumulative dividend.

I have suffered some unrealized losses in it and my two positions in First Industrial preferred stocks, both of which are still paying the preferred dividends. But First Industrial has just eliminated its common dividend which places the preferred shareholder in an enhanced danger of a deferral.  

 I have only been able to realize one gain in the taxable account on a REIT preferred in 2009 , and that was at the start of the year in a quickie round trip on CUZPRA.

The Brandywine transaction was in a retirement account. Sold BDNPRC

I am collecting large dividends while I wait for an improvement, with my largest yield being GRTPRF, a very risky position, that yields 75% based on my $2.9 cost, and it is still paying having just declared its preferred dividends.  Buy of UL/GRT

Assuming payment of the one just declared, that would make two received and it does not take many to recoup my cost.  At a 75% yield, my money is recouped in 1.24 years.  So I will soon be almost half way to recoupment The Rule of 72 (with calculator) - Estimate Compound Interest  At least for now, the purchase made at $2.9 has an unrealized profit in addition to the dividends. But there are several that I own which have yields of 20 to 30% and all of them are still paying except for Strategic Hotels, BEEPRA.  

A deferral of a cumulative dividend would place an exclamation point on the company being in severe financial distress. It also has disadvantageous tax consequences to the owner of the preferred security in a taxable account, since income taxes have to be paid on the accrued and deferred interest which of course may never be paid.  

Bankruptcy would not be certain, though possible and even likely in the event of a continued deterioration in the economy and/or the drying up of sources to refinance maturing debt which is more probable in a major credit crunch as now.

That is why it is necessary to at least be cognizant of the debt maturity schedule and the amount and nature of debt.  By nature, I mean the following: is the secured debt recourse or non-recourse to the corporation; is  the debt senior or secured; and how many properties have no mortgages on them.

This is important for a REIT like First Industrial which appears to have a manageable maturity schedule for the next two years and a large number of unencumbered properties. On the flip side, there is the REIT General Growth Property that is already having  extreme difficulty securing a refinancing of matured debt.   

FedEx had a dismal earnings report.  
This does look like a very deep hole.  I have to look long an hard to see the daylight. 

J.P. Morgan upgraded Alcoa to overweight and raised it price target to 12 from 8. MarketWatch  Alcoa priced its common share and convertible note offering, raising more money than expected. Reuters The 150 million new shares was priced at $5.25.

Why not raise the money when the stock is at $30, tell investors that it is going to be put into a rainy day account and used when the next bad recession hits?  Others may howl but I would go along with that plan.  I understand that putting money set aside for the rainy day makes sense.  And, without a doubt, I would be better off long term as a shareholder if the company would raise that money during the bull market rather than the depths of a bear market after the stock had already been mauled, crushed and beaten to pulp.  

GE said that it expects its finance unit to be profitable in the first quarter.  Yahoo! Finance

The wizards at AIG's Financial Product unit in London, though small in number (377 total souls), were paid anywhere from 423 million to 610 million per year since 2001.   This could be as much as 46% of the REVENUE that their wizardry generated for AIG who assumed all of the risk.  

So what has happened now, compensating them for failure, is not anything new.

This kind of compensation scheme distorts the proper assessment of risk since compensation is actually increased without consequences by taking irresponsible risks.

No comments:

Post a Comment