Sunday, October 04, 2015
How to deal with the idea of 15% yielding "unicorn" yield stocks.
Investment moats struck blogger gold again with an article on keeping cash around for that 15% yielding stock. To me, this article borders on financial pornography, but it does so in two good ways : Firstly, Driz'zt did not insist that 15% yields exists, he merely suggests that a prudent investor hold some cash in reserve should that day arrive. Secondly, he referenced my blog, so I would need to put in some effort to build on his ideas.
The main idea of my article is that a 15% yielding stock which would pave the way for your financial independence is a mythical animal much like a Unicorn. Most of the time, these yields are not sustainable and you are likely to be burnt if you build up a solid $50,000 just to plonk it on a yield stock that would collapse within the following 2 years.
Here are some of my points :
a) Don't wait for that Unicorn to arrive, it might turn out to be a Nightmare
Ok, this is D&D reference.
Driz'zt's idea is brilliant. You will need a cash reserve for reasons other than investments. But 15% yields is a rare event indeed. I was able to pick up some REITs at about 12% on average during the Great Recession which probably is the main reason why I am in Law School and not some harried Service Delivery Manager for a tech firm today. Some stocks which exceed 15% yield are like that for a reason - investors hate them because the yields are not sustainable. Investors remember various investment disasters like Omega Navigation, Macarthurcook Property Securities Fund, Babcock and Brown and FSL.
Investing into these disasters always starts with an intention to capture ridiculous yields. I have plenty of scars to show as I remain quite a yield pig myself even today.
b) Better to save your cash for a general bad economy rather than wait for a Unicorn to arrive.
One way to improve Investment Moat's central thesis to consider when the markets are bad and then capture a number of cheap stocks to ride the downturn.
But what is a bad economy ?
I have some concrete suggestions for the retail investor. You get a bad economy : When banks are yielding 6% or when telcos start yield 7%.
These are good signals to act even when there are no 15% stocks in your radar.
c) Buy many warhorse stocks, don't wait for unicorn stocks to appear.
A good warhorse can give an investor plenty of mileage and looks almost like a Unicorn. It just does not have a magical horn.
When times are bad, what is a warhorse stock ?
You can observe a solid yielding counter like Croesus which other bloggers have been talking about. It current yields about 9+%. In a really bad market, it might yield 11%. This is a solid warhorse stock if that scenario occurs.
A fallen angel counter like Sabana REITs which yields 11% would also be a rare and positive market event.
I would even say DBS at 6% is a steal. The trick is to take your capital and buy all these warhorses at an average yield of 8-10%.
d) Employ some fundamental indexation when you build your portfolio.
The beauty of 100 shares per lot is that individual investors can start to weigh a stock based on market fundamentals. One idea to slant your portfolio warhorses is to weigh each allocation based on dividend yields.
Example : Market crashes - Cambridge REIT yields 12%. DBS Yield 6%. Your allocation to Cambridge should be twice that of DBS because it has a double it's yield.
This idea is consistent with the Kelly Criterion article I mentioned earlier. Bet more when there are more dividends but don't avoid low yielding blue chips in a downturn.
What is the result of adopting this article ? In a downturn, you get to lock in a more realistic yield of perhaps 8%. A $100,000 cash hoard would have a sustainable yield of $8,000. Enough to pay your electrical bills and lunch expenses.
Not exactly pornographic but would give you a reasonably happy ending.