Just a Few Dribs and Drabs

To review this week’s market action is to basically yawn for a change.  Earnings season began but was tempered to a degree by economic news that questioned the robustness of the US consumer.  While the economy is still growing, the rate is slowing. My view remains that without a ‘real’ deal – skinny or otherwise – on the table between the US and China, both countries will continue to hobble along.

Meanwhile I did make one purchase this week that was a little unanticipated, but not totally unexpected.  I topped up my Legacy Texas (LTXB) holdings in preparation for the completion of the merger into Prosperity Bank (PB) which has received regulatory approval.  Currently I hold both sides of this merger, LTXB in a taxable account and PB in my IRA. Essentially I wanted to avoid assignment of an odd fractional share that I could do nothing with as the ratio is 0.875:1 (plus $6.28 cash). Assuming shareholder approval October 29th, the expectation is for the deal to close November 1st.  My current thinking is the new PB shares (and cash component) will be assigned to the taxable account. Subsequently, I intend to sell the old PB in my IRA replacing it with TD (to take advantage of the tax treaty).  After the dust settles, I will sell the TD in my taxable account. End result being more shares (slightly) of both PB and TD, no shares of LTXB and some excess cash.

I did hit the halfway point on my endeavor to replicate the grandkid’s trust (now liquidated, save one stock).  After I complete the transactions I’ll post regarding the rhyme and reason, but for now let’s say it’s to preserve all options regarding financial assistance as she begins the college application process. 

The strategy I’ve employed is to gauge the futures market for weakness prior to entering an order for market open as I decided to use M1 finance for the bulk of this replication.  For the most part, this has been a viable approach except of late there have been some wild swings going into the open. I’m unsure as to the why, but perhaps someone has identified the secret sauce regarding presidential tweets?

The effort remains ongoing regarding the directory update – primarily removing dormant entries.  It turns out I wind up spending more time than usual as my attention gets diverted by an interesting presentation or difference of opinion or a concept worthy of further review.  Examples of some of these include:

  • Dividends Diversify – in his review of the book Dividends Still Don’t Lie, the comment, “I did some searching on the internet for free services. But didn’t come up with anything that looked useful … Dividends Still Don’t Lie goes through how the calculations are done.  So it is certainly possible for a do it yourself investor to develop the calculations on their own.” garnered my attention.  Now the strategy discussed may be an anathema to a Buy and Hold type (my concern would be tax implications), the “tool” became the curiosity.  The best I could come up with was the Charles Schwab screener that could only analyze three of the book’s eleven metrics yielding fifteen possibilities for further manual research.
  • Finance Journey – the comments, “As a dividend investor, my full focus is on income than capital gain. Thus, capital gains or losses in my investments do not make any sense to me at least for now.” and “I do not convert dividends received from U.S stocks to Canadian dollar, and I use a 1 to 1 currency rate approach to keep the math simple and avoid fluctuations in my dividend income reports due to changes in the exchange rate.” were the culprits.  I trust the “full focus” does not exclude possible warning signals. For instance, many dividend cuts (income) are preceded by a falling stock price (capital gain (loss)). Likewise, the use of a 1:1 exchange ratio for simplicity sake risks masking the true portfolio performance. Personally, I (like ETFs) translate income from my thirteen foreign holdings to home currency prior to publishing results. Besides, if the full focus is income why distort currency exchange (which is a direct income factor)?
  • Finance Pondering is a relatively new blog from the UK that is in the process of ramping up in a thoughtful manner.  The insightful questions raised in this rollout carry the promise of one day being one of the standouts. Yet there is already one nagging question that I hope will be answered in the future – “Why Trainline?”.  To enlighten my audience, Trainline is a ticket booking company that charges a premium in exchange for convenience in what is basically a mobile app. My issues are, 1) it was a 2019 IPO (albeit one of the better ones), 2) KKR was involved (can you say monetize and exit strategy), 3) I question the nature of Brits to embrace premium services given the uncertainty of Brexit and recent demise of Thomas Cook.  

This weeks’ final thought is a potential black swan.  My concern is the expanding pockets of unrest appearing from Hong Kong to Chile to Spain.  Ignoring Turkey/Syria for now, just something I’m keeping my eyes on …

Delivering Alpha – NOT!

Perhaps I was anticipating too much based on hype and previous editions, but this years CNBC Delivering Alpha conference failed to deliver.  Come on, aren’t there any new and exciting things on the horizon to capture an investor’s fancy? Obviously not, as the VP’s message of a booming economy was sandwiched between short ideas and negative interest rate survival.  All interlaced with the drizzle of ESG investing and streaming concepts – in theory new and improved versions. Sorry, all this is old news, making me think CNBC has lost the concept of Alpha.  ESG has largely turned political (which introduces uncertainty) and the window of opportunity for nice gains in streaming closed about a year ago (about the time I added to my Comcast position).

Investopedia defines Alpha as a term used in investing to describe a strategy’s ability to beat the market – what most of us aspire for.  DGI investing generally attempts to quantify (and reduce) said risk while serving up a theoretically predictable outcome. My portfolio is a modified DGI strategy in that I attempt to introduce some Alpha to maintain my streak of beating the market as defined by the S&P index. I do this by introducing an underlying theme that I meld a portion of my portfolio into.  Past examples include Community Bank consolidation and the Rise of Fintech.

One that delivered Alpha to my portfolio this week was within the theme Transaction Processing.  On Thursday, Total Systems Services (TSS) was lost from my portfolio and replaced by Global Payments, Inc. (GPN)  via the consummation of their merger. TSS was a company that I seriously doubt was held by many other DGI enthusiasts.  To identify why, let’s run it through the illustrious Dividend Diplomat stock screener which addresses most – if not all – the conventional metrics most individual investors would use in decision making.  

Metric #1 P/E Ratio Less than the S&P 500

At purchase, the ratio was 19.16 and the S&P was 20.12.  A technical pass, although the Diplomats prefer a greater margin.

Metric #2 Payout Ratio of Less than 60%

At purchase, the payout ratio was roughly 22.95% (FY2016).  A definite pass.

Metric #3 Increasing Dividends

Here lies the major failure, which probably would have caused the Diplomats and most DGI purists to pass on TSS.  Their record is pitiful with two raises in eight years and the yield rarely exceeded 1%.


My take has always been to consider Total Return as the primary metric with a significant emphasis on Dividend Growth/Safety.  Although TSS’s dividend has been wanting, since I owned it it has delivered 30% average annual price appreciation with an additional 49% since the merger was announced, bringing my total unrealized capital gain to 390% plus a miniscule, taxable dividend.

Rather than reward shareholders directly, they chose to reinvest in R&D and growing the business which probably provided a greater return – and tax-deferred to boot.  The arguments against this approach are consistency and dependability. Additionally, this requires a level of trust in management. Granted, in some cases this depends on being in the right place at the right time as well – and this example is an extreme success story.  Yes, I do have several that I’m waiting on to pan out which is why I categorize this approach as speculative with only a small portion of my portfolio looking for the next emerging brilliant idea or better mousetrap.

Don’t get me wrong, I love my dividends.  In general, DGI provides a stable, consistent foundation.  But a little dash of Alpha through total return could be the difference in beating your index. As always, your views are welcome!

Analyst BullS#!T!

My friend Frankie posted an aptly titled piece (Beware the Broker BullS#!T!) on analyst’s actions awhile ago (along with a followup) which struck a nerve as my early investing career had several of the pitfalls mentioned.  While I did evolve to settle primarily on a modified DGI strategy, I have to wonder as to the due diligence exercised by some of the broker’s clients. In the US, there are some shops that are essentially pay for play schemes, meaning pay us money and we’ll cover your business.  One of these is Taglich Brothers (which has a clearing business relationship with Pershing, LLC in which I am a shareholder (BK)).  Taglich, through it’s press release with NXNN (a spec holding of mine) disclosed, “In October 2017, the company paid Taglich Brothers a monetary fee of $4,500 (USD) representing payment for the creation and dissemination of research reports for three months.  After the first three months, the company will begin paying Taglich Brothers a monthly monetary fee of $1,500 (USD) for the creation and dissemination of research reports.”  Unbiased?  Unlikely. Another take on them was provided by D/M/O.  Point of reference, Orchids Paper (TIS), mentioned in the article was formerly in my portfolio and subsequently filed for bankruptcy protection (I had sold prior to the filing).

Another angle on alternative strategies was brought front and center this week with the publication of Spruce Point’s analysis on Church & Dwight (CHD).  Spruce Point is a small, short focused firm similar to Muddy Waters Capital or Kerrisdale Capital that use Seeking Alpha, Twitter and other social media to broadcast their research.  Spruce Point takes a short position, runs a campaign and determines the traction being gained. In the words of the founder Ben Axler, “Because I run a small business, we don’t have a lot of time to waste going down rabbit holes where there’s a dead end,” he says. “I can generally sniff out a company pretty quickly.”  OK, then.  

I admit that CHD is richly valued and perhaps they overpaid for some acquisitions.  I also submit that Spruce Point is highly vocal for their smallish size. They have, however, been building a little bit of a track record in this bull market.  On first blush, it appears the Spruce Point results have been stellar thus far in 2019 with a by moving the market in their intended direction 77% of the time on the day their report is released – translating into an average market loss of their targets of 3.78%.  I would posit their gain is even greater as I suspect their investors and subscribers get a first look at the reports. My guess would be a 5-10% short term gain.  

As of Sept 7, 2019

In the shorting game, the real money is to be had by riding a target down, but to do so requires conviction, stamina and staying power.  Based on Ben’s comment, I doubt they are riding the targets down other than a select few high conviction ones. My reasoning being that they would be booking a loss for 2019 as their targets, in aggregate, are 2.88% higher post call.  The three that would have rocketed their results lost 49%, 26% and 25%. Conversely the three they should have exited quickly gained 86%, 51% and 12% for the longs.

Over the weekend Spruce Point has continued their campaign against CHD using Twitter to gleefully proclaim success as CHD has not chosen to engage in their antics.  Although some of Spruce Point’s issues have some validity, in large I feel they are overstated – essentially a headline grabber.  

One issue they raise is the use of factoring to manipulate results.  Possible, but it depends on whether it is recourse or non-recourse. Spruce Point also takes issue with an undisclosed UK acquisition.  My take is with sales in the £764,000 range this is negligible. The current year “slowing dividend growth” could be explained by prudence in digesting its last two acquisitions.  I suspect this dividend trend may be the new normal for a period of time if management executes on their goal of expanding their “power brands” to twenty.

In summary, they could very well be right. They could also be playing a manipulation game. If weakness intensifies my thoughts are that a buying opportunity may be at hand. Then again – I may be wrong 🙂

Investing in CBD

Subsequent to the passage of the Agricultural Improvement Act of 2018, signed into law December 21st, there has been a significant amount of speculation as to the rise of the market for CBD oils, edibles, supplements and derivatives. Migrating across the country are calls to create a system – or infrastructure – if you will, to enable this budding (pun intended) industry to grow and thrive. This bill clarified two gaps in prior legislation related to industrial hemp, namely removing hemp from the definition of marijuana and and creates an exception to the THC in hemp – essentially declassifying it as a Schedule I narcotic, as long as it has no more than 0.3 percent. Then the state has to enact processes – subject to USDA approval – before being legal. The most onerous of which is mandatory testing of the THC threshold.

In a role reversal of sorts, the new reality is that CBD is legal at a federal level with a hodge-podge of regulations at the state level with a degree of federal oversight. For the time being, one can assume differing laws depending on the state. This is also subject to change regularly. For purposes of this discussion, we’ll assume Texas is moderate – neither at the bleeding edge nor trailing the pack – as HB1325 was signed into law last month and retailers are already making an appearance – pending registration. Many – including myself – are attempting to identify ways to profit from these endeavors with no clear answers. DivHut (via a guest post) tackled this question and laid out a great foundation before withering away at the end. I do have to concur there may well be room to run in this space, the key being in what way – which we’ll explore a little further.

Retail is the obvious starting point with CVS and Walgreen are dipping their toes in the water while Amazon is marketing CBD-less hemp oil. The bad news, if any, is that any sales made by these giants would be negligible to earnings. This isn’t to ignore the mom-and-pop shops or franchise operations appearing, only that as a passive investor the options currently limited.

Manufacturing is the second area for research but winds up being the most convoluted depending on your interest, e.g., topical, edible, oil, prescription drug, THC or CBD, et.al. My approach is to categorize into two segments: Consumer and Cultivation. The consumer side being a product supplier to a retailer or consumer direct. Cultivation is a little trickier in that the Texas bill legalizes hemp farming and the sale and possession of hemp-derived CBD oil containing less than .3% of THC. Meanwhile growing hemp is not yet legal until the USDA provides guidelines and approves state applications. This could be considered a quagmire of sorts, but of a temporary nature.

Extraction and Testing is the final area to watch as this is where the heavy investment will take place. One piece of the Texas Law is, ” the laboratory must be accredited under ISO/IEC 17025 or other comparable standard. License holders may not use their own laboratories for state testing unless the license holder has no ownership in the laboratory or less than a ten (10) percent ownership interest if the laboratory is a publicly traded company.” Consider that most – if not all – of the law enforcement labs require upgrades to differentiate between now legal and still illegal products. Xabis, an independent lab, has forged a deal with Westleaf that includes equity based compensation.

So who currently has my eye?

  • Retail – Elixinol Global (ELLXF). Assuming this Aussie company can navigate through the FDA regs unscathed.
  • Manufacturing – Canopy Growth (CGC) – pursuing a license to process hemp in New York state
  • Testing – Eurofins Scientific (ERFSF)

All of which are highly speculative – so tread lightly and do your due diligence. Is this a space you too are looking at (additional suggestions are always welcome)!

Update 4 Aug 2019: On Aug 1 I initiated a position in Innovative Industrial Properties Inc. (IIPR), a REIT in the medical space.

Mexican Standoff

A confrontation in which no strategy exists that allows any party to achieve victory. As a result, all participants need to maintain the strategic tension, which remains unresolved until some outside event makes it possible to resolve it.

https://en.wikipedia.org/wiki/Mexican_standoff

On May 30th, the Trump administration announced stepped tariffs on Mexican imports under cover of the International Emergency Economic Powers Act. Once again it appears to have been a bargaining ploy using the American consumer and farmers as pawns in a game of Chicken as these were “indefinitely suspended” on June 7th – perhaps realizing the signature USMTA was now at risk by this action or the push back by the business community or the fact that Republican Senators realized they did indeed have a backbone (albeit, small).

While I’ve never been a huge fan of ETFs as my view is that an investor is consigning themselves to the average, my preference being to develop a thesis and buy individual companies in support of the idea – with the expectation being the return will be outside the norm (hopefully in a positive manner). That said, I realize ETFs can – and do – serve a purpose and as such I have five in my portfolio, one being iShares MSCI Mexico Capped ETF (EWW). This issue peaked at $44.54 on May 30th before bottoming at $42.64 on June 3rd which is precisely where my order to add executed. Yes, it was luck calling a bottom but it was also a validation of the Headline Risk concept.

One of the first analyses published was that of a short-seller, BOOX research. He does present a decent argument on all counts, save one. This was followed by Liumin Chen’s analysis which missed the same issue. To be fair, I’m now operating in hindsight – post Trump’s reversal, but I did spend most of last weekend forming my conclusion which was the negative tariff impact to EWW was overblown due to one factor. One where you can’t just look at the forest without reviewing the respective trees.

One uncertainty I have with BOOX is his view of a pending peso devaluation as that would likely torpedo any trade agreement and give rise to currency manipulator status. More important is the view that the Consumer Staples exposure is a negative. While it is true that this sector comprises 30.5% of the ETF, only one of the top ten (Walmart de Mexico) has significant Mexican domestic consumer exposure where US imports (tariffs) could be in play. The other two Staples either don’t interact with the US (Fomento Economico Mexicano) or has significant US operations in their own right (Grupo Bimbo with 22,000 US employees). My take is tariffs would slow – but not cripple – the Mexican economy.

Indeed there could be a silver lining for Mexican multinationals that do not import US products. Some brands at the forefront are Tracfone (America Movil), Groupo Mexico (Southern Copper) and the aforementioned Bimbo (Thomas, Entenmann’s, Mrs. Baird’s). Basically these entities could be repatriating US gained profits in inflated USD to Mexico as artificially depressed MXN. A possible spread play that is typically the province of banks and insurers – and an untended consequence that probably escaped the purview of the experts running this show. The icing on the cake? Cemex with 11 plants and 50 quarries in the US. What’s a good border wall without cement and concrete from a Mexican owned company paid for by US taxpayers?

So this is a contrarian play which – so far – is in the money. I believe the real pain would have been felt in the auto and produce industries which do have significant numbers of US workers. Hopefully this is a fire drill that won’t be reenacted any time soon.

Trump-Tied Banks

Headline Risk

the possibility that a news story will adversely affect a stock’s price

https://www.investopedia.com/terms/h/headline-risk.asp

As my readers are aware, for a variety of reasons I’ve had an affinity for the banking sector following the financial crisis. Outside the rants of a few of the current presidential contenders highlighting abuses against the ‘normal people’, this sector has been relatively subdued albeit with a major storm cloud brewing on the horizon. This formation hit my radar with the August 19th, 2018 article in the American Banker. Since then, I’ve been tracking the progress of this storm to either identify a manner to profit from the event, to see if it dissipates or if it evolves into a black swan.

This week, the storm finally arrived although I have yet to batten down the hatches. My sense of urgency to publish my findings only increased when I ran across a piece by one of our own, All About Interest, in determining a possible investment in Citizens Financial Group (CFG). My response was: Tending to err with an abundance of caution, I would dig much deeper on CFG. Their former parent had financial issues (hence the spinoff) and most recently has been the associated with Manafort loans (speculation is they are ‘Lender B’ in the Mueller report). Another bank with Manafort ties (BANC) last week cut their dividend by 53.8% – although this could be unrelated and pure coincidence. Basically pointing out a basic flaw in pure DGI screening methodology – Headline Risk.

  • CFG has had a troubled history probably due to its’ former parent, Royal Bank of Scotland (RBS) (IPO’d in 2014, fully divested in 2015)
  • CFG was apparently “Lender B” in the Mueller Report with questionable loans to Manafort (perhaps a coincidence, they issued $300m in stock as Series D preferred in January)
  • Another bank involved in Manafort loans, BANC, announced a dividend cut of 53.8% effective July (I can’t say if there is a correlation)
  • An indictment against another Manafort lender, Federal Savings Bank (pvt) CEO Stephen Calk, was unsealed after I posted my comment (alleging his personal actions to bypass standard loan processes resulted in a $16m loss to the institution)

Certainly enough thunder to keep me away from an investment in any of these. My count indicates the Trump 8 identified by the American Banker has more than doubled and now stands at 15 – some of which I’m invested in. I’ve basically categorized them into Questionable, Cooperator, Cautionary, Litigant in addition to the three Culpables addressed previously. This is not to imply any wrongdoing – only one of the barometers I use to assess relative safety and mitigate Headline Risk.

QUESTIONABLEhave issues that are unsettling to my investment philosophy

  • Sterling National Bank (SNL) – provided financing for Cohen’s taxi-medallion business
  • Signature Bank (SBNY) – allegedly lent money to real estate developers, (including Kushner’s family) that used improper tactics to push out low rent tenants. Ivanka served on the board between 2011 and 2013.

CAUTIONARYhave potential exposure but appear to be on the right track

  • First Republic Bank (FRC) – filed a Suspicious Activity Report (SAR) on flow through money related to the Stormy Daniels payment and a Columbus Nova payment (Russian Billionaire company)
  • Royal Bank of Canada (RY) – McDougal and Daniels payments were allegedly made through a City National account (now RY). It appears the SARS report was filed late probably found by RY through a merger related audit. They are also cooperating on Congressional subpoenas, although a deadline was missed. (own RY)

COOPERATORbased on the Bank Secrecy Act, which allows Congress access to financial information to search for money laundering (all owned except MS)

  • Toronto-Dominion (TD) – provided documents
  • Wells Fargo (WFC) – provided documents
  • Citigroup (C) – missed subpoena deadline
  • Morgan Stanley (MS) – missed subpoena deadline
  • JPMorgan Chase (JPM) – missed subpoena deadline
  • Bank of America (BAC) – missed subpoena deadline

LITIGATORSTrump (Pres., family, companies, foundation) suing to block release of information (lost the first round this past week) (none owned)

  • Deutsche Bank (DB) – Lawsuit under appeal by Trump
  • Capital One (COF) – Lawsuit under appeal by Trump

I can kind of understand the appeals related to his personal financials except where inter-related with SARS filings. In hindsight, this is perhaps a textbook case for use of a blind trust – which as we all know was not done.

In this group, TD has about 1.48% of my portfolio and RY about 0.58%. The others I own are about 0.25% each – therefore my exposure to possible downside risk is minimal. Of the ones not owned, the only one I would currently consider is FRC on weakness. The common thread being compliance to current laws.

Do you account for Headline Risk? Hope you all have a wonderful holiday weekend!

Tax Efficiency

I figured a little reflection was the order of the day as we recently completed tax season in the US, and yes, I had to pay for the first time in years. My initial take was Trump’s tax law did no favors to those of us on fixed incomes – rather tilting the scales to benefit the wealthy and to a lesser degree the working class – though there were winners and losers across the board. In preparation for next year’s fiasco, I’ve been attempting to ascertain some of the intricacies of the changes. Previously, I opined on the foreign tax credit remaining in place. Today’s revelation potentially turns conventional wisdom on REITs on its’ head.

Sage advice has typically been – with a few exceptions – REITs are best held in tax advantaged accounts, like IRAs. The new tax law adds a few wrinkles to this concept, which Justin Law outlines nicely. The essence of his piece is that Section 199A distributions now have a 20% deduction which may warrant a review how tax advantageous REITs are in ones tax deferred versus taxable portfolio. DGI darling Realty Income (O), recently reviewed by Tom at Dividends Diversify, could well be a poster child for this type of analysis as last year’s payouts were 77.1% Section 199A and the remainder Return of Capital. The delay in this week’s post was due to some difficulty in completing a review of the fourteen REITs in my portfolio.

Two of my REITs were excluded from this analysis as I have them classified as probable sales, Uniti as their dividend cut was likely a debt covenant issue and Lamar as their IRS reporting is not straightforward (the corporate filings differ from the filings on the shareholders’ behalf). As all of my REITs are in taxable accounts, using Justin’s generic template, they were first ranked by the new Section 199A exclusion.

  1. American Tower (AMT) 99.68%
  2. EPR Properties (EPR) 95.94%
  3. Washington RE (WRE) 91.89%
  4. Outfront Media (OUT) 86.10%
  5. Iron Mountain (IRM) 83.04%

The next tier combined Qualified dividends and Cap Gains as their tax treatment is similar (and not onerous):

  1. Duke Realty (DRE) 22.59%
  2. Kimco Realty (KIM) 18.29%
  3. Prologis (PLD) 17.33%

The one tier I need to keep an eye on is the Return on Capital with Vereit (VER) 86.17% and Crown Castle (CCI) 34.39%. This part of their distribution is tax deferred until sold or the cost basis reaches 0.

The ugly tier is the Section 1250 gains with a 25% tax rate.

  1. Spirit Realty (SRC) 49.2%
  2. Spirit MTA REIT (SMTA) 21.2%

I consider this to be a one-off due to the spin of SMTA from SRC. Kimco (26.94%) could fit in this category as well although my sense is that their portfolio repositioning is the culprit, but there are opposing views to mine.

Bottom line, I’m willing – even eager – to pay taxes. Yet the rules of the game reward those able to minimize the government’s share. While the key resides in understanding the nuances of the rules, I say, “Seek the rewards and let the games begin!”