Thursday, May 19, 2011

Bought Shares in BDCs in IRAs: 50 AINV at 10.8 and 50 PSEC at 11.2/Sold 50 HBAPRF at 22.44/Added 40 HPQ at 36.11/MACYS BOND UPGRADE

Some readers have inquired about what has happened to the Old Geezer. The OG has been sent to the Old Folks home for rehabilitation after suffering several senior moments as Head Trader.  Headknocker has shown his concern by reading some literature and making a number of recommendations about what needs to be done for the OG.  HK thought that the OG needed to be soaked in a vat of Phosphatidylserine for about a week, occasionally dunking the OG upside down into the vat, immersing him from head to toe for about three minutes, while playing rap and heavy metal music which might unclog some of those brain pores.

LB commended our Great Leader on his ingenuity and research, and thought the rap music was a nice touch.  The caregivers for the OG's mother have started to call him "Big Daddy" and "Big Papa" after some rap musician or some lyrics in a rap song, and one asked whether the OG had heard the song. Trying to be helpful, LB suggested playing that this Rappers collected works for the OG to improve his communication abilities. 

Some other staff members expressed concern that HK's proposed rehabilitation treatment might appear to some as eerily similar to waterboarding. Whereupon, the HK replied "how can this technique be confused with waterboarding if no water is used", which of course stumped most staff members including the RB.  

LB wanted to know why no one has expressed sympathy to it for having to put up with the OG.  It is really hard being a Master of the Universe when carrying all of this deadweight, plus having the constant noise problem from the incessant babble from that Nitwit RB.  

Louise Yamada says that the U.S. market is still in an uptrend and investors should not short a market in an uptrend. Important support for S & P is at 1300 for her. 

1. Added 40 shares of Hewlett-Packard (HPQ) at $36.11 Yesterday (own:Large Cap Valuation Strategy) (see Disclaimer): HPQ beat expectations for its second quarter, reporting a non-GAAP E.P.S. of $1.24 on a meager 3% increase in revenues to $31.6 billion. This report is discussed at MarketWatch. The company also cut estimates for the current fiscal year to at least $5 per share on an adjusted basis.

It would be fair to say that HPQ is now a hated stock by institutional investors. I viewed the price action on Tuesday to be a gross over reaction to the guidance given by the company. Those sellers at $36 to $37 have to be making assumptions about the future that are dire for HP. At the reduced estimate, the shares would be selling for a mere 7.2 times earnings. To justify their recent selling, the sellers would have to believe, with close to a virtual certainty, that HP will have to lower the estimate again for the current fiscal year and then matters would become much worse for the company in F/Y 2012, with earnings sliding further in F/Y2013. Based on currently available information and a rational forecast, those assumptions are not tenable.  

In the last quarter, there was revenue growth in all business segments except for the Personal Systems Group, which was hurt again by weak consumer demand for PCs, down 23% while corporate demand was up 13%.  Revenues in the BRIC countries rose 19% year-over-year. HP Enterprise Business reported a respectable  6.7% increase in revenues, while the Imaging and Printing Group reported a 5% increase. There is an issue about the revamping of the service segment to focus on more higher margined services, and some of the Masters of Disaster may be focusing on that issue. The company reduced operating margin for this segment to 13.5 to 14%, based on a ramp of expenses to secure higher margined business. Good or bad?   The LB understands tunnel vision. 

HP reported early due to the leak of a memo from the CEO Leon Apotheker, which was sent to the top executives, and later leaked to the press. Without question, the responsible executive needs to be fired for cause, but that kind of person is certainly not going to admit to such a flagrant breach of responsible behavior and fiduciary duty to the company.  

There were a host of downgrades following this earnings release. Just a few examples include the following: J P Morgan downgraded to Neutral from Overweight; Needham downgraded to Buy from Strong Buy; Barclays downgraded to equal weight: Caris downgraded to Below Average; Brean Murray downgraded to Hold from Buy; and CS downgraded to Neutral. For an upgrade, Goldman took HPQ off its Conviction Sell list and raised the rating to Neutral.

I read the S & P report, where the analyst reduced the rating to 3 stars from 5 stars and lowered the price target to $41 from $59.  That price target of $41 is based on the analyst's estimate of $5.05 per share in earnings for F/Y 2011 and $5.6 for F/Y 2012. Think about that for just a moment. This analyst sees softness in PC sales continuing through 2011. All of those rating changes effectively were made with HPQ trading around $36 to $37, and the future will tell whether any of those analysts have added any valuable input to investor decisions, or have led them astray.  

While the future is unknowable with any certainty, there can be a series of forecasts made about future earnings, ranging in degrees of possibilities and probabilities, based on currently available information. Some information is just unknowable. That does not mean an investor's expectation must therefore presume a continuation of present conditions for years to come, whether it be a slowdown in PC sales, lower margins in the service business and a few short term headwinds in the printing segment. The assumption that the future will look like the past is common one, and leads to a constant series of mistakes by so-called professional investors who are paid great sums of money in their often futile attempts to achieve mediocrity.

An individual investor has an advantage over the Masters of Disaster and assorted doofuses, who rule Wall Street and the Mutual funds, the ability to take the long view and to simply recognize that the value of a company is not dependent on a single snapshot in time.   The value being placed now on the future income stream of HPQ seems to me to be based on low probability forecasts, tunnel vision, inappropriate and frequently ridiculous valuations made by analysts acting with a herd mentality,  and an over reliance on short term matters unlikely to impact the future value of the company while ignoring or downplaying HPQ's important moats.

I will revisit this topic in a couple of years. For now, I asked myself whether a buy of HPQ at $36 is more likely than not to outperform the S & 500 average over the next two years, and the likelihood that a total return potential of over 20% could be achieved at some point within the next two years by buying shares at $36.  Without factoring in the dividend, a 20% return could be harvested at a price over $43.2 with a total purchase price of $36 per share. What are your odds that HPQ will exceed that price before 5/19/2013?  

2. Sold 50 HBAPRF at 22.44 (see Disclaimer): I do not find the floating rate equity preferred stocks attractive at their current prices. I am holding onto AEB and METPRA, bought during the Near Depression period at what would now be considered absurd prices.  I also currently own 100 shares each of MSPRA and STDPRB. I also own 50 shares in BMLPRH and 100 shares of BMLPRJ. The shares of HBAPRF were bought recently at $20.69.  

As noted in the preceding linked post, it was extremely odd that I was not permitted to buy this security in a Fidelity account, after Fidelity's brain trust placed it on the no buy list for all customers. (see also: Fidelity Brokerage Extends Denial of Trading Opportunities to Synthetic Floaters and Even an Exchange Traded Junior Bond DFP Fidelity Prohibits New Purchases of SIPs) I thereafter bought it with no problem in a Vanguard account.  Fidelity did permit it customers to buy HBAPRD and HBAPRG, two similar equity preferred floaters with guarantees however and did not seem to fathom the inconsistency in their position when I pointed it out to them. The policy of course has no rational justification and was promulgated by people whose ignorance may be their best feature.   One of the reasons for allegedly putting this security on the no buy list was its volume and bid/ask spread.  Yet, on the day that I attempted to place the order, the spread was just one cent, with over 300,000 shares in volume.  I was able to buy another stock, where I accounted for the entire volume for that day-100 shares.   

Prior to using the volume and bid/ask spread justification, their customer representatives were saying that their customers could not understand these securities. Possibly, one well-healed customer with a lot of sway, much further along in the brain dead category than the Old Geezer here at HQ, complained that HBAPRF was just too hard to understand. After all, it is a garden variety equity preferred stock that pays the greater of a guarantee or a percentage over the 3 month LIBOR rate and that is a lot for someone in an advanced stage of dementia to comprehend. 

I tried just for the heck of it to place a trade for HBAPRF last night and I received the same message as before:

Now I would have been permitted to buy HBAPRG which is a virtually identical security from the same issuer.  

3. Bought 50 PSEC at 11.2 in Regular IRA on Tuesday and 50 AINV at 10.8 in Roth IRA (see Disclaimer):  I currently own 200 shares of PSEC, a Business Development Corporation, in a taxable account. I have traded the stock, always in small amounts, in a regular IRA for about three years.

A BDC, like a REIT, has to pay out 90% of its net income to its shareholders to maintain its tax status.  Unlike a regular "C" corporation, the BDC is not taxed at the corporate level on the dividends distributed to the shareholders. While the requirement of at least a 90% distribution of net income will generate a higher than normal dividend yield during positive business cycles, compared to other corporations where federal taxes are imposed on income at the corporate level, the distribution requirement depletes capital for growth, thereby requiring the BDC to frequently access the market with share sales.  During the recent recession, many of these sales occurred at prices below book value.  

Another problem is that these firms loan money to companies who would have difficulty securing loans from commercial banks.  Many of the borrowers are not seasoned companies, or are mature companies that have fallen on hard times.  As a result, there is an usually high default rate. There interest rates charged by the BDC are frequently high too, often with some kind of kicker such as stock warrants, that enable the BDC to make additional money when and if the company goes public. 

As I have said repeatedly, the BDC is a disfavored asset class for the reasons discussed above.  The risks generally outweigh the benefits.  If the economy continues on a upward trajectory, however, which is a matter for serious debate, then many of these firms will possibly suffer less defaults on their risky credits and thereby have more "net income" to distribute to their shareholders. 

For PSEC, my prior trades in the regular IRA have at least been profitable which means that I was able to collect the generous dividend without suffering a dilution in total return due to a loss on the shares, which is easy to do with these companies:

PSEC 2011 Regular IRA

PSEC 2010 Regular IRA
Some of the prior discussions about this company can be found in the following posts:  Sold  50 PSEC @ 11.5 (January 2011 Post);  Bought  50 PSEC @ 9.97 in IRA (November 2010); Bought 50 PSEC at 9.5 (July 2010 Post); Sold 50 PSEC in Regular IRA at $12.16 (March 2010 Post);  Bought 50 PSEC at $10.48 (September 2009 Post).  These purchases demonstrate my reluctance to commit funds to this type of company and an unwillingness to totally ignore the BDCs.  I have also bought and sold several others including TAXI, HTGC, AINV, and ARCC. I currently own 100 shares of ARCC after selling 50.  Sold 50 ARCC at $17.7 

PSEC recently cut its dividend, another common occurrence with these companies over the past two years, while changing the distributions from a quarterly to a monthly dividend.   At the current rate, the dividend yield is close to 10.9% at my last entry point.  Prospect Capital Corp, PSEC Stock Quote As shown in the firm's last dividend announcement, the dividend is being raised monthly by a very small amount: Prospect Capital Declares the 34th, 35th, 36th and 37th Consecutive Cash Distributions of the Company

This is a link to the last earnings report: Prospect Capital Reports Operating Results of 38 Cents per Share for Quarter Ended March 31, 2011 The net asset value per share, as of 3/31/2011. reported by the company, was $10.33 per share.  

I also bought on Tuesday 50 shares in another BDC at $10.8, Apollo Investment (AINV), which has about at 10.3% at my cost.  I first mentioned AINV during the Dark Period when I made a purchase at $2.35. I am not a fan of Apollo's management who  to have a high opinion of their own abilities. (see e.g. Item # 6  AINV (February 2010 Post); Item # 4  AINV (April 2010 Post). 

Apollo recently had to announce a withdrawal of a senior convertible note offering:   SEC Filed Press Release

The last filed Form 10-Q, for the quarter ending 12/31/2010, shows a net asset value per share of $9.73.  The Form 10-Q for the Q/E 6/2007 shows a net asset value per share of $19.09.  Yes, the managers of this BDC believe, without any doubt in their minds, that they deserve their generous compensation for their superior prowess in managing other people's money.

4. MACYS BOND UPGRADE:  I do not own a bond originally issued by Macy's.  Instead I currently own one originally issued by May Department Stores that was later acquired by Macy's.  I have set up with Fidelity all kinds of alerts about my positions, and one of those alerts gives me notice of a rating's change in one of my bonds. Last night I received a notice that S & P had upgraded my May Department store bond to BBB-, the bottom tier of investment grade:

This 7.875% senior bond maturing in 2030 was rated junk when I purchased it recently.  Bought 1 Macy's Bond Maturing in 2030 @ 99.5.  I was surprised that I could buy that bond at 99.5, since similar bonds were being priced to yield far less.

On the day of my purchase, the 99.5 price was my limit price and the limit price for the seller of that bond.  Basically, the only way that I can complete a transaction for 1 bond is too hit the ask price.  And, the price is also quoted with the amount of bonds available and the minimum quantity that must be purchased set by the seller, So these numbers might be expressed as 220 (5) or 15 (1) at 99.5.  If I wanted to buy only one bond, I could not even enter a bid at Fidelity or Vanguard to purchase 1 bond when the minimum amount available for purchase was 5. So, I would have to wait for the minimum to drop to 1 before even being allowed to enter a buy order.

Yesterday, I took a snapshot of a bond purchase made at Vanguard who charges an outrageous commission of $50.  Fidelity is the only broker that I use where I can buy a junk bond at a reasonable commission.  The confirmation from Fidelity for all of the bond purchases do not include a line item for their commission.  Instead, at the time the order is placed, the price is increased by the amount of the commission.  Of course, I also have to pay the seller accrued interest on the bond.

This is a snapshot of my Fidelity confirmation for the May 2030 bond:

The confirmation includes a number of important details about the bond.  It was rated BB+ by S & P at the time. The bond is subject to a make whole provision which is important. The confirmation also shows my current yield and YTM based on my cost.  I had to pay the seller $28.44.  I subsequently received the semi-annual interest payment which included that sum and more.  I discussed in an earlier post how to treat the $28.44 paid to the seller in interest on my tax return when Fidelity includes that sum in my 1099.

The reason for posting the confirmation is show how much Fidelity charged in commission for this trade compared to the $50 that I have to pay to Vanguard.  I mentioned that I paid 99.5 for the bond and Fidelity shows a price of 100.3. The difference is their commission which Fidelity calls a "concession".   Whatever you want to call it, and I will just call it a brokerage commission added to my price, the commission comes to $8.  (10 x  $99.5=$995 my limit price cost for 1 $1000 par value bond compared to 10 x. 100.3=$1003  amount due after concession).  For those unfamiliar with bond buying, the price is quoted at 1/10 par value, so 1 bond purchased at 100 would cost $1000 before commission.

There is one other nit that I wanted to add.  Neither Fidelity or Vanguard price the bonds that I already own based on the closing price for that day. Instead, a third party service is used to price the bond.  This sometimes creates wide discrepancies, up and down, between the price shown in my account and the actual trades occurring in the market.  The third party attempts to price the bond based on some kind of rational model, based on similar maturities and ratings, possibly including some input derived from more actively traded bonds from the same issuer. And who is that rational person?   LB is not consulted about the rational price.

So, what is the current third party price of my May bond. The answer is 109.5:

Now, could I sell the bond for that price?  No, unlike other May bonds, there are generally no bids for this one. There is a small seller trying to unload a few bonds at 105.  I am not buying junk bonds at above par value and would not buy this one at 105.  I barely wanted it at below par. It gave me a better yield than the TC DKQ which contained another May senior bond, so I sold DKQ and bought the 2030 bond.  But, the 105 price produces a better yield than other bonds with similar maturities that are actively traded. I will never say that any of it has to make any sense.  The Rational Man postulated by economic professors and their Efficient Market Hypothesis are nothing more than snake oil, and it unbelievable that anyone takes these professors seriously.

ADDED 8:57 A.M.: Possibly, I had some influence on somebody out there. I noted that someone had bought 50 of the 2030 bond at 105 on 5/19 and the ask price is now at 110.5.

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