Monday, March 31, 2014

Update for Lottery Ticket, Equity REIT and Regional Bank Basket Strategies/RFMD/Bought in LT Basket: 30 ARCO at $9.03, 30 CYS at $8.58/Cash Flow Main Taxable Account 3/31

The weekly blog, normally published on Monday, is delayed for a day or two when I update these baskets. I am still working on it and will publish it tomorrow morning.

I will occasionally include in this monthly update a table of the recently launched Equity Common and Preferred Stock Basket. That table will also reflect positions as of the preceding Friday, including adds and deletions that have not yet been discussed to date since I am running 7 to 14 days behind discussing trades. Part of that delay is caused by leaving more comments at SA.

Last Friday's Closing Prices:
VIX: 14.41 -0.21 (-1.44%) : VOLATILITY S&P 500 (Bullish-Stable Vix Pattern)
Vix Asset Allocation Model Explained Simply
S & P 500 1,857.62 +8.58 (+0.46%)
TLT: $109.37 -0.62 (-0.56%) : iShares 20 Year Treasury Bond ETF
KRE: $40.61 +0.15 (+0.37%) : SPDR S&P Regional Banking ETF
VNQ: $70.03 +0.42 (+0.60%) : Vanguard REIT ETF
VWO: $40.28 +0.32 (+0.80%) : Vanguard Emerging Markets ETF
GLD: $124.56 -0.03 (-0.02%) : SPDR Gold Trust

The regional bank and lottery ticket basket strategies are updated on the last Monday of each month. The price shown in the following tables will be from last Friday.

I frequently use a basket approach, particularly with industry sectors, that will vary in size as to the number of components. The focus will be on the total return of the basket, rather than individual components. Some of the advantage to this approach include diversification and risk mitigation. I am not concerned about a few mishaps provided other components are doing better than I anticipated when I made the initial purchase. As noted previously, I have been surprised by some of best and worst performers in the regional bank basket.

I recently published a table of a recently initiated basket featuring equity REIT common and preferred shares. Stocks, Bonds & Politics: Equity REIT Common and Preferred Stock Table as of 3/5/14

1. Update of Lottery Ticket Basket Strategy 

The Lottery Ticket Basket Strategy uses a deep contrarian value strategy, appropriately characterized as catching a "falling knife". A common criteria for the stocks contained in this basket is a smashed stock price at the time of purchase and an ugly looking chart, though I may occasionally buy one who does not fit those common criteria. Any technical analyst would most likely have a sell rating on the stock.

See 2004 Study by the Brandes Institute: "Falling Knives Around the World" 

Selections are made primarily on statistical criteria including price to book, price to sales, forward P/E, cash per share and/or free cash flow. I spend anywhere from thirty minutes to an hour researching a potential purchase prior to purchase.

For many selections, I may be pessimistic about the firm's future, but not as pessimistic as the market. I will also occasionally see a ray of light at the end of a dark tunnel. Since I expect failures, which are inevitable and unavoidable in this kind of approach, I limit my exposure to $300 per stock plus any prior trading profits. 

After experiencing some success with this strategy, I now have a requirement that my total investment in all LT holdings can not exceed my total realized gains for this basket strategy. My total exposure is currently slightly under $6,000.

The name of the strategy aptly describes the risk. It is somewhat analogous in many cases to playing a hand of blackjack for the purchase amount knowing that the card count favors the house. It is a form of entertainment and an alternative to a casino visit. Based on the results to date, this strategy is far more likely to produce positive results even with the LB's skill at the tables. The primary purpose of the LT strategy is to entertain Right Brain, let it swing for the fences with up to $300, and to keep the Nit Wit from interfering with Left Brain's management of Headknocker's portfolio.

Snapshots of realized gains can be found at the end of the Gateway Post on this topic: Stocks, Bonds & Politics: Lottery Ticket Strategy: New Gateway Post

There were two additions since the last update discussed below and no deletions.

Net Realized Gains:  $14,159.98

No stocks were sold since the last update. Update for Lottery Ticket and Regional Bank Basket Strategies

Click to Enlarge:

Lottery Ticket Basket as of 3/28/14

The largest unrealized gainers are as follows, led again by AMOT:

AMOT +91.75%
Allied Motion Reports Results For the Quarter and Year Ended December 31, 2013

FCE/A +58.13% and FCF +44.33%
ING + 51.33%
RFMD 44.22%
Of the LTs bought within the past 4 months, RFMD is the only one having a large percentage upside burst so far, though the one discussed below in Item B has risen more than 10%. Bought as LT: 50 RFMD at $5.18

Both ING and FCE/A are eligible for a promotion outside of the LT basket, but I have not been interested so far in buying more shares.

A. RF Micro Devices (RFMD): RF Micro announced before the bell on 2/24/14 that it will combine with TriQuint Semiconductor (TQNT) in an all stock transaction. RFMD and TriQuint to Combine, Creating a New Leader in RF Solutions RFMD shareholders will receive 1 share in the new company for each RFMD share. TQNT shareholders will receive 1.675 shares.

RFMD's stock popped up on the news.

Closing Price 2/24/14: RFMD: $7.03 +1.22 (+21.00%)

RFMD was recently added to the LT basket. That purchase was a replacement for LSI that had just jumped on a takeover.  Bought as LT: 50 RFMD at $5.18 (12/31/13 Post)

Closing Price Last Friday: RFMD: $7.70 +0.01 (+0.13%)

B. Bought 30 ARCO at $9.03 (see Disclaimer)

Snapshot of Trade:

2014 Bought 30 ARCO at $9.03
Arcos Dorados Holdings Inc. Cl A (ARCO) is not from Tennessee and needless to say it is difficult for an OG, perched at a desk located in the SUV Capital of the World looking at the Bradford Pear trees blooming, to render an informed judgment about what is happening in South America.

When looking at events in South America over the past four or so decades, two pithy statements always come to mind:

"Those who cannot remember the past are condemned to repeat it"
George Santayana
Life of Reason Volume 1, 1905

"Insanity: doing the same thing over and over agains and expecting different results"
Albert Einstein

Mass insanity and collective amnesia, which only appear as psychological conditions, may be caused by some currently unknown prehistoric parasite that inhabits the water supplies down south.

This company is the largest McDonald's franchisee in the world in terms of sales and number of restaurants. It operates in 20 countries and has over 1900 branded McDonald's restaurants throughout South America and the Caribbean. ARCOS DORADOS

And it is rapidly growing revenues at a far faster rate than the Big MAC U.S. stores. In the third quarter, same store sales rose 12.6% in local currencies compared to .7% growth for McDonald's U.S. Arcos Dorados Reports Third Quarter 2013 Financial Results

There are some issues which in my mind justify the Lottery Ticket classification.

ARCO's stores are in South America, where all kinds of problems have a way of cropping up, ranging from hyper inflation in places like Venezuela and Argentina to emerging market currency plunges. The governments in Argentina and Venezuela are without question openly hostile to business.

While the policies of those two governments lead to inflation, the populist leaders are able to convince gullible and uninformed voters that a McDonald's franchisee is actually responsible for rising costs of a Big MAC Combo meal.

Back in January, Venezuela  was suffering from 56% inflation and shortages of essential products due to what can only be described as idiotic government's policies. The government will not take any responsibility, of course, and instead blamed the "parasitic bourgeoisie" who were simply passing along the price increases caused by the government's policies. ARCO was forced by the government to lower the price of the Big MAC Dual Combo by 7.5% Bloomberg

Someday, it is conceivable that the voters in several South America nations might come to the realization that most of their problems originate from the policies followed by their elected leaders, with Venezuela and Argentina just being the two worst examples of grossly negligent and inept politicians infesting those countries currently and over the past century or so. I seriously doubt that will ever happen.  Did you know that the GDP of Argentina was close to the U.S. in 1913. Business Insider

After my purchase, the company reported 4th quarter results. Arcos Dorados reported that "net organic" income grew by 25.5% on a "systemwide sales increase" of 10.6% Y-O-Y, with adjusted EBITDA rising 20%. The GAAP numbers for all of those items were lower due to currency exchange. GAAP E.P.S. was also hurt by a one time charge of $10.8M associated with a bond redemption and other special items. Including the negative items. GAAP E.P.S. was reported at $.15 per share and revenues.

That earnings report is discussed in a Seeking Alpha article.

I left some comments to a recent SA article about Arcos Dorados: Seeking Alpha

Friday's Closing Price: ARCO: 10.07 +0.07 (+0.70%)

C. Bought 30 CYS at $8.58 (see Disclaimer): CYS Investments (CYS) is a paper REIT, otherwise known by most as a Mortgage REIT. The stock went ex dividend for a quarterly distribution of $.32 after my purchase. CYS Investments, Inc. Board of Directors Declares First Quarter 2014 Common Stock Dividend of $0.32 Per Share, and Preferred Stock Dividends

Snapshot of Trade:

I managed to exit this one at a much higher price, realizing a profit of $3.43 on the shares, now viewed as a victory. Sold 50 CYS at $13.33 (December 2011). I have a small realized loss on an existing 50 share position in a cumulative equity preferred issue: Bought 50 CYSPRA at $25.2-ROTH IRA

CYS Investments (CYS) is a Mortgage REIT, a highly leveraged enterprise that borrows boatloads of money short term and uses those funds to buy longer term securities, hoping to make money on the spread difference. I am leaving more than a few points out in that description, but that is close enough for a Lottery Ticket discussion.

For investors familiar with what happened to Mortgage REITs in 2013, their dangers were on display, as their share prices cratered, dividends were slashed, and net asset value per share declined substantially, a trifecta of horrible news, largely in response to the rapid and steep rise in rates staring last May. Things have calmed down some now and Mortgage REITs have rallied this year. Still, I have seen enough from last year to assign CYS to the LT category.

CYS had a quarterly dividend of $.6 per share in 2010 and its last declaration was for $.32. CYS Investments, Inc. - Investor Relations - Dividends & Splits

Assuming no further cuts, or increases, which would be an absurd assumption to make, the dividend yield at the current quarterly rate would be about 14.92% at a total cost of $8.58.

Link to 4th quarter earnings release: 8-K (net asset value per share of $9.24 as of 12/31/13 down from $13.31 as of 12/31/12; interest rate spread at 1.89%; leverage ratio at 6.97 to 1).

I view Mortgage REITs as dangerous securities. The leverage ratio for CYS was 6:97:1 as of 12/31/13.

Closing Price Last Friday: CYS: $8.24 +0.02 (+0.24%)

2. Update for Regional Bank Basket Strategy:

This strategy is explained in my Gateway Post on this topic:

Snapshots of realized gains and losses can be found at the end of that post.

The dividend yield showed in this table is calculated by Yahoo Finance based on last Friday's close. My dividend yield for each position will be different based on my total cost numbers. In most cases, with FNFG and VLY being notable exceptions, my dividend yield will be higher.

I am not tracking reinvested dividends in the following table. The unrealized gains per holding do not include reinvested dividends.

Over the life of this basket strategy, I anticipate that the dividends will provide 40% to 50% of the total return. I am generally keeping my total exposure between $40,000 to $50,000.

I am currently about $5,000 below the lower end of that range, as shown in the table below (subtract total unrealized gain from total value shown)

As a result of profit taking over the past several months, I am currently well below my minimum $40,000 out-of-pocket investment threshold for this basket. I am not comfortable with valuations in this sector. The price declines over the past few weeks brought a few near the upper end of my fair valuation range. Hopefully, I will see a number of 10% to 20% corrections over the coming weeks that will provide far better buying opportunities in this sector. I have not been impressed with most of the 4th quarter earnings reports from regional banks. While net interest margin has not contracted much, it is yet to show any expansion either for most banks. Chart: Net Interest Margin for all U.S. Banks - St. Louis Fed

One ETF will own several of the small cap regional banks and REITs that I own now or have owned in the past: PSCF | S&P SmallCap Financials Portfolio

Net Realized Gains to Date: $15,808.58 
Dividends 2010-2013 (updated yearly only)= $6,623.72

In 2013, my dividend total from this basket totaled $1,932,93, up from $1,896.25 in 2012 and $1,660.57 in 2011. I will have to increase my current exposure significantly in order to exceed the 2013 amount this year.   

There were no positions sold or added since the last update. 

Click to Enlarge:

Regional Bank Basket as of 3/28/14
A. Huntington (HBAN): News about HBAN is summarized in this press headline: Huntington Bancshares Receives No Objection from the Federal Reserve for Proposed Capital Actions, Including an Increase of the Quarterly Dividend to $0.06 Per Common Share and the Repurchase of up to $250 Million of Common Stock

HBAN was originally part of the lottery ticket basket and was promoted to the regional bank basket which allowed me to acquire more shares.

Added 40 HBAN at $7.04Bought 30 HBAN @ 7.25 as LTAdded 30 HBAN as LT at $4.8

Closing Price Last Friday: HBAN: $9.86 +0.15 (+1.56%)

3. Update for REIT Common and Preferred Stock Basket:

This basket continues to expand, though there have been some preferred stock deletions under the current trading guidelines. The first publication of this basket was made on 3/5/14: Stocks, Bonds & Politics: Equity REIT Common and Preferred Stock Table as of 3/5/14 I am using a blended strategy of including both common and preferred stocks. I have also recently initiated a starter type position in VNQ which can be bought commission free in my Vanguard brokerage account

Click to Enlarge:

It remains to be seen whether this sector shift, which started in early September 2013, will work. Without question, more income will be generated with these securities than the MM fund used to fund these purchases. I have not bothered computing the yield, as the composition changes with adds and deletions (mostly adds). I suspect that the yield would be somewhere between 6.5% to 7% based on my cost numbers rather than current prices.

Adds Discussed to DATE Since the 3/5/14 Post:

Bought Roth IRA: 50 EPRPRF at $22.5, 30 EPR at $53.3/Bought:  300 Dundee International REIT at C$9.27 and 100 DLRPRG at $19.95 (3/17/14 Post)

Bought 300 Temple Hotels at C$5.85/Bought 50 CCGPRA at $25.13-Roth IRA and 150 CCG at $8.51-Taxable Account (3/24/14)

I also discussed again how my REIT and Regional Bank Baskets fit together in my portfolio design: Stocks, Bonds & Politics: REIT and Regional Bank Baskets

I may have already included snapshots of some preferred stock deletions using current trading guidelines in the relevant Gateway Post:

Stocks, Bonds & Politics: REIT CUMULATIVE PREFERRED LINKS IN ONE POST/Advantages & disadvantages

Given the relative closeness to par value, profits realized from REIT preferred stock sales will be slim, unlike some multi-baggers from the Near Depression era. I disfavor REIT preferred stocks. I am using them in this basket to generate slightly more income and hopefully to tamp down some on what has been more volatility in the common shares over the past few months. The preferred shares have benefited over the past several weeks by an unexpected decline in rates.

Two of the adds to be discussed were 100 shares to both my Cominar and CSG positions, and a paired trade involving an equity preferred floater and ARCPP to generate more income.


A Critical Component of Turtle Investing-Cash Flow Generation

Usually, I have a lot to discuss in the regional bank basket, but almost nothing for this update. I will simply use the extra space normally devoted to that basket to discuss what I would label as one of my fundamental long term investment approaches-the generation of a perpetually growing cash flow from dividend and interest payments which will be aggregated and then re-deployed in whatever appears to be the best income producing option then available, creating a compounding impact over a long period of time.

I took a snapshot of cash received in my main taxable account so far today. More will be received on the 1st. I will note the relevant aspects of this flow:

1. The flow is constant now, though most of the money will be received on the first and last business days of each month and mid-month.

2. There are a number of securities that pay monthly.

3. There are a large number of securities contributing to this cash flow generation. In this list, I noted plain vanilla common stocks, ETFs, bond and stock CEFs, bonds, preferred stocks, REITs and BDCs. No single contribution is important. I am focused on aggregate numbers.

4. Irrespective of my views about the market or the big picture opinions about the world in general, I will invest that cash flow no matter what. I am more concerned long term that my security selections will not result in a material number of bond defaults or dividend reductions during the worst of times, in which case I will have cash flow to buy when prices really get smashed as in September 2008 to March 2009:

Cash Flow So Far 3/31/14-Main Taxable Account (3 snapshots):

Click to Enlarge:

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