Monday, March 19, 2012

Added 100 MSPRA at $18.9/Bought 35 CNO at $7.81 and 35 SEM at $8.37-Lottery Ticket Basket Strategy/

Both of the Lottery Tickets bought last Thursday were selected primarily based on P/E and P.E.G. ratios. 

1. Bought 35 of CNO Financial Group (CNO) at $7.81 Last Thursday-LT Category (Lottery Ticket Basket Strategy)(see Disclaimer): If this company was paying a dividend with over a 2.5% yield at the $7.81 price, I would have bought a 100 shares. No dividend is being paid however.

CNO Financial Group, formerly known as Conseco, is an insurance company whose subsidiaries provide life insurance, annuities and supplemental health insurance. The operating subsidiaries include Banker's Life and Casualty, Colonial Penn Life Insurance Company and Washington National.

Company Website: CNO Financial Group
2011 Annual Report: CNO 12.31.2011 10-K
Profile page at Reuters.
SEC Filed Press Release on 2011 4th Quarter earnings

For the 4th quarter of 2011, net operating income per diluted share was 22 cents compared to 18 cents in the 4Q10.

The Annual Report shows at page 44 net income of $382.5 million in 2011 or $1.31 per diluted share, up from 99 cents in 2010 and .45 cents in 2009. However, on an operating basis, the net income for 2011 was 76 cents, up from 65 cents in 2010. CNO reported 47 cents per share in 2011 net income for a "valuation allowance for deferred tax assets", and 31 cents per share in 2010 for that same item. I would ignore that item and focus on the net operating income number. I would pay attention to net realized gains and losses from investments, but the primary focus has to be operating income.  

The following information comes from YF Key Statistics page on CNO:

Trailing P/E=5.96
Forward P/E=9.86
Five Year Estimated P.E.G.=1.23
Price to Sales=.45
Price to Book=.37 

CNO Financial Group rose 5 cents to close at $7.84 in trading last Friday.

2. Bought 35 SEM at $8.37 Last Thursday-LT Category (Lottery Ticket Basket Strategy)(see Disclaimer): I own 1 Select Medical Holdings senior "subordinated" bond.  Bought 1 Select Medical 7.625% Senior Subordinated Bond Maturing 2/1/2015 at 98.21 (August 2011 Post).

Select Medical Holdings operates specialty rehabilitation clinics and hospitals.  Profile

SEM recently filed its 2011 Annual Report with the SEC. Form 10-K As of 12/31/2011, SEM operated 110 long term acute acute hospitals, 954 outpatient rehabilitation clinics, and 9 inpatient rehabilitation clinics. A list of the hospitals can be found starting at page 40 of the Annual Report. For 2011, the company reported revenues of 2.804 billion, up from 2.39 billion in 2010, and net income of $107.846 million or 71 cents per share. The 2010 E.P.S. number from 48 cents on a diluted basis.

I discussed SEM's 4th quarter earnings in Item 3 SEM (2/29/12 Post). I mentioned at that time that the common shares were under consideration for a LT purchase. I do not want to commit more funds due to the firm's leverage.

For the 4th quarter of 2011, Select Medical reported net income of 25 cents per share, six cents better than the consensus estimate, on $714.441 million in revenues. SEC Filed Press Release 

The current consensus for 2012 is for 89 cents per share, and 92 cents in 2013. I would like to see the 2013 number go over a buck but would be content with 89 cents this year.

The following data comes from YF Key Statistics page on SEM:

Forward P/E (2013)=9.09
Price to Sales=.43
Price to Book=1.48
Five year Estimated P.E.G.=.84

3. Added 100 MSPRA at $18.9 Last Thursday (see Disclaimer): This brings me up to 250 shares of this non-cumulative equity preferred stock issued by Morgan Stanley (MS). This security pays qualified dividends at the greater of 4% or .7% above the 3 month LIBOR rate on a $25 par value. Dividends are paid quarterly.  Prospectus 

The applicable coupon now is the 4% minimum. At a total cost of $18.9, the yield would be about 5.29%, currently taxable at a maximum 15% for a U.S. taxpayer. 

This security does have a measure of inflation protection due to the floating rate provision. With the Jihads being practiced by central banks against savers worldwide, short term rates are likely to remain low, irrespective of the inflation rate until the central banks start to raise their short term benchmark rates, with the U.S. Federal Reserve being the most important and the leading practitioner of financial repression. When and if central banks allow rates to rise, and assuming inflation has become a problem too, then this kind of security could  start to increase its coupon in response. For MSPRA, the 3 month LIBOR rate would have to rise above 3.3% during the applicable computation period to trigger a higher coupon than 4%. Historically, before the current extended period of financial repression, a 4% or 5% three month LIBOR rate was not uncommon. LIBOR Rates History (Historical)

I discuss the advantages and disadvantages of this kind of security in Advantages and Disadvantages of Equity Preferred Floating Rate Securities. Given the many disadvantages, I view non-cumulative equity preferred stocks issued by financial institutions with some disfavor. 

While these securities are classified as part of a firm's equity, I view their bond characteristics to be more dominant than their equity features. From an individual investor's viewpoint, the equity features of MSPRA include the qualified dividend, the non-cumulative feature, and the perpetual term of the security. Unlike common stock, however, the owner of MSPRA does not have an equity interest in the business and really only has the dividend. 

Non-cumulative equity preferred stocks issued by financial institutions are hyper-sensitive to perceptions about the firm's creditworthiness. During the Near Depression, it was common to see this type of security, with a $25 par value, sell at less than $10 per share. (e.g. Bought BMLprg at $8.8Bought 100 ZBPRA at $7.8).

At its current price, I do view this security to be more attractive than several others issued by financial institutions, which are similar securities, including all of the ones that are Bank of America obligations and STIPRA. For example, BML-PL pays the greater of 4% or .5% above the 3 month LIBOR and closed last Friday at $20.53. STIPRA, issued by Suntrust Bank, closed at $20.79 last Friday, and pays the greater of 4% or .53% above 3 month LIBOR. According to (free service, registration required, the BAC equity preferred stocks are rated Ba3 by Moody's and BB+ by S & P, and the MS equity preferred is rated Ba1 by Moody's and BB+ by S & P.

My most successful round trip on MSPRA is captured in this snapshot:

2010 MSPRA 150 Shares +$962.97/100 Share Trade=+$839.29

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