High Yields in Slow-Growth World

(Bill Hall, editor of The Park Avenue Society and Weiss Family Million-Dollar Portfolio, is presenting the first of his weekly afternoon edition podcasts. Click here to listen. Below is an edited transcript of that podcast. Mike Larson’s afternoon column will return tomorrow.)

Hello, everyone. This is Bill Hall for Money and Markets. It is Wednesday, Aug. 27, and I am pleased to bring you my investment thoughts in this new, exciting podcast format. Today, I am going to give you some specific investments on how you can profit in a world where growth is hard to come by and stock valuations are full and lofty.

Indeed, taking a look at our first slide, we see that the growth in this most recent economic recovery is the slowest year-over-year growth that has been recorded in economic recoveries dating back to the 1950s. That means that we are indeed in a slow growth world.

(Note: Each year shown above indicates the start of an economic recovery.) Click for larger version

In our second slide we see, and I want to remind all our listeners that there are only three components for stock market returns. That is right. All stock market returns can be broken down into three specific components. The first is dividends, the second is earnings growth, and the third is change in the price/earnings ratio. That means how much people are willing to pay for stocks.

As an example, let’s take a look at our third slide, which shows the components of stock market returns in 2013. We see that in 2013 the market was up a whopping 32 percent and that was comprised of 2 percent of the return from dividends, only 5 percent of the 32 percent was from earnings growth, leaving 25 percent coming from a change in the price/earnings ratio. That means that the 32 percent return that was achieved in 2013, the vast majority of it, the biggest piece of it came from people just willing to pay more for stocks than they were at the beginning of the year.

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And while I do not have a slide on it, if we were looking at this same analysis for 2014, the current year, we would see that the stock market is up about 9 percent so far this year. Some 2 percent of that 9 percent is from dividends, 5 percent from earnings growth. That is 7 percent total, leaving the remaining 2 percent coming from the fact that people are willing to pay a little bit more for stocks right now in August of 2014 than they were at the beginning of the year.

So in my view, the market is fully valued and, therefore, returns can only come from one of two places. One is earnings growth and the other is in dividends and we have just seen that we are indeed in a slow growth world. So what do investors do to achieve returns in this market?

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Looking at this fourth slide you will see that if your risk profile permits it, I am recommending and suggesting to some of my clients that they consider BDCs or business development companies. You can find all about BDCs by taking a look at the website in the link that I provided on this slide.

But for our purposes today, think about BDCs, or business development companies, as doing what banks used to do and that is make loans to middle-market companies, to smaller, privately held companies, not the Johnson & Johnsons of the world but to a regional distributor of food or a regional distributor of manufacturing equipment.

So we are not talking about the mom and pops and we are not talking about the global giants. What we are talking about are regional, privately held companies. And historically banks have made the loans to those companies. Right now, business development corporations are making those loans as a result of the banks being out of the lending business for a variety of regulatory reasons. BDCs can earn large returns on their loan portfolios, which they then pass through to the investors in their stock.

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On our final slide you will see two of my favorite BDCs. The first is Ares Capital, the symbol ARCC. Ares yields 8.8 percent. That means it pays a cash-on-cash dividend yield of 8.8 percent. Ares is the largest institutional type holding in the business development corporation segment of the market. It is the one that all of the institutions own if they are going to own it. It is the largest and it has a well established track record.

Another one of my favorites in the BDC area is TCP Capital Corp., symbol TCPC. It yields 8.5 percent. It is a lot smaller than Ares. Its track record is not as long but it has got a great management group and it has got a relatively new loan portfolio which provides a lot of high quality collateral.

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Now, again, BDCs are not for everyone. They are risky type investments as you can tell from the yield that they have. But if your risk profile permits, I believe that you should consider them because dividends are going to become a larger source of total return going forward as growth becomes harder and harder to find.

This is Bill Hall signing off for Money and Markets. I look forward to speaking with you again next week.

 Best Buy Co. Inc. (BBY, Weiss Ratings B+) painted a depressing picture for investors after reporting disappointing quarterly results. “‘You cannot expect the same kind of growth rates that you saw a few years ago,’ “CEO Hubert Joly told the Wall Street Journal. The company said the holiday season would feature deep price cuts and lower sales as brick-and-mortar shops battle with online retailers for shoppers’ dollars. Overall, it was a pessimistic outlook for the electronics retailer, and it followed tempered-down forecasts by other big chains, such as Wal-Mart Stores Inc. (WMT, Weiss Ratings B) and Target Corp. (TGT, Weiss Ratings C+).

 At least we can be assured that one segment of the economy is doing well: Tiffany & Co. (TIF, Weiss Ratings C+), the world’s second-largest luxury retail jeweler, reported a 16 percent rise in net profit to $124.1 million in the quarter ended July 31. That was 96 cents a share, up from 83 cents a year earlier and topping analyst projections of 85 cents. The company has been revamping its offerings, adding new designs, upgrading stores and reshuffling management. Analysts said rising stock markets have given the company’s wealthy customer base extra money to spend on luxury items.

 With the giant Alibaba initial public offering coming closer to launch, investors are looking over their portfolios and could be selling off less-attractive stocks to make room for the Chinese e-commerce giant, Reuters reports. The IPO could top $16 billion and become the largest-ever tech offering. It is expected to launch as early as next month, with road shows starting after the Labor Day weekend. “Any company that didn’t meet expectations and give a rosy outlook is probably being considered as a sale candidate to make room for a name like this,” Jim O’Donnell, chief investment officer of Forward, told Reuters.

 In geopolitical news, NATO is planning to set a more-visible presence in Eastern Europe in the wake of the crisis in Ukraine, the alliance’s secretary general said in an interview with six European newspapers. Anders Fogh Rasmussen said alliance members plan to balance the pressure of not wanting to escalate tensions in the region with a military buildup while at the same time presenting a united front to demonstrate the ability to respond quickly to any blowups in the region. He said proposals ahead of a NATO summit in Wales next week anticipated the pre-positioning of supplies and equipment at new bases but that it would not infringe on the alliance’s agreements with Russia, which have prevented substantial NATO buildups in the lands that joined the alliance after the collapse of the Soviet Union. Ukraine is not a member of NATO.

What is your view on NATO’s reactions to the tensions between Russia and Ukraine? Should the Western military alliance increase its assets in the region to show a strong sign to Russia? Should NATO invite Ukraine to join the alliance?

Feel free to comment on these or any other issues by clicking here.

Best wishes,

Bill Hall

P.S. The wealthy investors I work with take the road less travelled. And there are a few other secrets that set the wealthy apart from average investors. In this FREE report, I’ll show you how to use them to grow your wealth in record time.

Bill Hall is the editor of the Safe Money Report. He is a Certified Public Accountant (CPA), Chartered Financial Analyst (CFA) and Certified Financial Planner (CFP). Besides his editorial duties with Weiss Research, Bill is the managing director of Plimsoll Mark Capital, a firm that provides financial, tax and investment advice to wealthy families all over the world.