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For Investors Who Crave Income With a Twist: Three Good
Alternatives to Bonds
By Michael Brush
September 1, 2005
While many investors worry that stocks are risky because of the strong
market rally since 2003 and all the potential threats to the economy, the
truth is that stocks haven’t been this cheap for decades – at least by some
measures.
Take the “Fed model,” for example, a tool developed by the Federal Reserve
Board for comparing the value of stocks and bonds.
The Fed model says that the yield on the 10-year Treasury bond should be
about the same as the next 12 months' earnings yield on stocks. You
calculate the forward earnings yield for a stock by dividing its forward
annual earnings projection by its stock price.
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Today, the earnings yield on S&P 500 stocks -- at more than 6.5% -- vastly
overshadows the 4% dividend yield on ten-year bonds. The distance hasn’t
been that big for decades. Put another way, stocks look as undervalued now
-- compared to bonds -- as bonds looked cheap compared to stocks in early
2000, or the peak of the stock market bubble when everyone hated bonds.
Despite this clear signal that stocks are a much better place to put your
money, many investors cling to bonds. They think bonds are safer. Or they
know that bonds have done well over the past few years, and they expect
similar gains.
These reasons don’t make much sense – since stocks look so undervalued
relative to bonds. Besides, bonds prices should decline as interest rates
continue to rise – making bonds risky. About the only compelling reason to
hold bonds is because you have to, for the income they throw off.
REITs
Fortunately for investors who need income but want exposure to further gains
in stocks because of underlying economic strength, there is another
alternative: real estate investment trusts, or REITs.
These are publicly-traded companies that operate pools of real
estate-related assets. REITs enjoy freedom from taxation at the corporate
level – so they can pass more earnings through to you in the form of
quarterly dividends.
Make no mistake, as high-yield instruments REITs can be hurt by rising
rates, too. And REITs have performed so well in recent quarters, many
investors think they are risky.
But when you see insiders buying lots of shares of REITs throwing off juicy
yields in the 6% to 10% range while decent underlying trends support healthy
fundamentals, it’s hard not to think of them as a great alternative to
bonds.
That’s the case with Ramco-Gershenson Properties Trust (RPT)
and Eagle Hospitality Properties Trust (EHP),
two REITs where insiders have been buying a lot of shares recently.
Ramco-Gershenson Properties
This company operates shopping center REITs. Its healthy annual dividend of
$1.75 (for an annual yield of 6.1% at the current stock price) looks fairly
safe because it is lower than the company’s funds from operations – a kind
of earnings per share for REITs – by a healthy margin.
“It is one of our favorite names,” says Philip Martin, an analyst who covers
REITs for Stifel, Nicolaus & Co. Ramco-Gershenson Properties runs
“community” malls where people go to buy basic goods at stores like Target (TGT),
TJX Companies (TJX)
or Home Depot (HD).
Because they sell a lot of staples, business at those tenants holds up
fairly well even if the economy weakens. “We are big fans of the community
shopping center REITs because historically they have created sustainable,
predictable cash flow streams through the economic cycle,” says Martin.
Ramco-Gershenson Properties also has malls in areas of above average growth
and income levels. The company is repositioning and upgrading some of its
malls, which is good for growth.
Eagle Hospitality Properties
Eagle Hospitality Properties runs about a dozen upscale hotels under brand
names like Marriott, Hilton, Embassy Suites, and Hyatt.
Thanks in part to strong business and convention-related travel, Eagle
Hospitality Properties saw revenue per available room – a standard industry
metric -- grow by 15.7% in the most recent quarter. That was the highest for
all hotel REITs. And it was double the industry average, says Raymond Martz,
the finance chief at the company. In the past year, Eagle Hospitality
Properties grew 40% by spending over $170 million on acquisitions.
The company’s dividend of 70 cents for 2005 (for a 7.1% dividend yield)
looks secure, since it is comfortably below Eagle Hospitality Properties
funds from operations.
Thornburg Mortgage (TMA)
A somewhat riskier – but higher yielding – REIT where insiders are buying is
Thornburg Mortgage. Thornburg, which manages portfolios of adjustable rate
real estate mortgages, pays an annual dividend of $2.72, for a juicy
dividend yield of 10.6%. Some analysts question whether Thornburg’s share
price can rise much. The company is earning less on interest from loans
because of adjustments it’s making to its portfolio in anticipation of
rising interest rates. But these analysts don’t question the safety of the
healthy dividend.
The bottom line: REITs are controversial investments now because they
have done so well in recent quarters. And as high-yield instruments, they
can suffer if interest rates go up too much. But I doubt interest rates will
increase enough to really hurt REIT investors, chiefly because inflation
will stay tame now that globalization and cheap foreign labor are putting so
much downward pressure on prices. Besides, insiders at these three REITs
have plowed anywhere from $440,000 to $600,000 into their own stock in
recent weeks. That’s a sign that all three are riding sustainable trends
that should keep them buoyant. I’d buy them all right now.
Disclaimer
At the time of publication, Michael Brush did not own or control shares in
any of the companies listed in this column. Mr. Brush is an independent
columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About
Insiders Corner:
http://www.investorideas.com/insiderscorner/. InvestorIdeas.com
Disclaimer:
www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not
affiliated or compensated by the companies mentioned in this article.
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