neil george's profitable investing | - v . 29, n . 7 july 2018 buy … · 2018-12-06 ·...

(continued)

Good Economy, But the Market’s Missing ItThe US stock market should

be humming along right now. We have an expanding economy, low unemployment, low inflation, strong consumer spending and robust business investment. Rates are going up, but slowly, and only to a more normal level.

With economic growth and improved corporate profits, corporate bonds continue to rise in price. Demand for corporate bonds from institutional and fund investors continues. This means better terms for corporations to borrow against and then invest to expand.

And with the improved economy, tax revenues for states and local municipalities are up. This means less stress in state and local fiscal conditions, and further spending ability to improve local communities and infrastructure projects. And this is showing up in the form of the continued rise in municipal bond prices—which lowers their yield, reducing borrowing costs for tax-free issuers.

But as I pointed out in the June newsletter, the S&P 500 has been stalled out since February, plodding listlessly along in a trading range.

That doesn’t mean that there aren’t plenty of companies that are bucking the malaise of the market, however. My two new additions to our flagship portfolio in this issue have proven that they can deliver for investors.

July 2018

Vol. 29, No. 7

Dear Friend,The adage that it is a market of stocks, not a stock market, continues to ring

true. The S&P 500 index remains range-bound, refusing to respond to the strong fundamentals of the improving US and global economies.

Some blame trade tensions, but most of the companies affected aren’t likely to fail even from strong-arm negotiations over tariffs and other trade policies.

I continue to spot many companies that are above the fray of the general stock market. Whole industries continue to flourish and are rewarding share-holders with ample dividends and stock appreciation.

Success in this market starts with finding companies that have been proven to work even when the economy isn’t faring as well as it is today. In this issue, I’m unearthed for you two new recommendations from the financial sector with long track records of delivering for shareholders. Financial companies have always been a useful source of dividend income, but traditionally also come with risks, particularly when the economy goes awry. However, my new recommendations have delivered larger yields and returns that continue to dwarf the return of the S&P 500, and they’ve made it through some of the worst stretches for financials and for the market—including the financial crisis of 2007–2008.

We also continue to profit from the bull market that has resumed for petro-leum, real estate and specific segments of the bond market. I’ll continue to point out the best opportunities in these markets. Later in the issue, I’ll also show how another market segment that’s been maligned of late—utilities—is set for a rally, starting with a play in the segment that’s already a top performer for us, with even more to come.

Growth StrategiesStop Looking at the S&P and Focus on Strategy

The US economy is on the boil. This quarter, the economy is projected to expand at an annualized rate of 4%, making it one of the best quarters since 2014. This increase continues the expansion we’ve been enjoying for the past 10 years.

But that’s not bolstering the general stock market. The S&P 500 remains range-bound, as I wrote in the June issue. For many investors, that’s been a warning sign indicating trouble.

I admit that it continues to weigh on my thoughts as I guide you through the stocks, funds and ETFs in our portfolios. However, a modicum of worry is good to have when you’re looking at the markets, as it gives you pause before you might otherwise have become overly optimistic.

Market corrections can have a variety of different causes, so the key for me is to spot the cracks in the underlying economy before it’s too late—and hind-sight puts what went wrong, and why, in stark relief.

Buy What’s Proven to Work Through Thick & Thin

2 Profitable Investing | July 2018 | profitableinvesting.investorplace.com

Neil George’s Profitable Investing® (ISSN 2577-9311) is published monthly by InvestorPlace Media, LLC, 9201 Corporate Blvd., Suite 200, Rockville, MD 20850-3334. Please write or call if you have any questions. Phone: 800/211-8566. Email: [email protected]. Web site: profitableinvesting.investorplace.com

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So what are some specific areas I’m looking at where problems might be lurking?

First is the consumer. Consumer spending makes up the majority of the US economy, so a crack could occur with far-reaching effects. I’m keeping an eye on gasoline prices, which could potentially reduce disposable income for other spending, and car sales, which are an important indicator of consumer confidence. I also watch household formation, which drives a variety of consumer purchases like linens, furniture and appliances.

But by all indications, demand from households for goods and services continues to deliver strong and positive contributions to the economy. Even for the first quarter, traditionally softer even in buoyant economic times, the consumer made a significant contri-bution to GDP. Car sales picked up significantly into the closing month of the quarter, with overall market gains of 4.3%, and we saw household furniture up significantly as well, with gains of 0.6% and 1.0% for February and March.

As shown in the graph at the top of this page, spending over the past decade has remained a strong contrib-utor to broad economic expansion. The graph plots the percentage of consumer spending to US GDP over the past 10 years. You can see where the pullback of consumer involvement in the 2009 recession added to the troubles of the US GDP, followed by the bounce with the initial signs of economic recov-ery. And after what was a protracted recovery, consumers have been larger contributors to the economic expan-sion, particularly since 2016.

With employment conditions remaining very firm, consumer spending should remain on track. Add in wage growth, now in the upper 2%

range, and households have further cash to spend. Between this and the strong sales data I mentioned above, I’m confident that the second-quarter data for 2018 will show at least the usual bounce after the annual post-holiday slump (which you can see in Q1 of this year).

Next is business investment. Businesses respond not just to current demand for goods and services, but more importantly to projections for future demand. And as you can see in the bottom graph, in the US, business investment continues to remain on the

upswing, particularly over the past several quarters.

This is one of the more important gauges to look at if you’re hunting for a crack in the economy and the market.

If we begin to see a pullback in business investment, that would be a warning sign that the economy may well be set for a reversal. If sustained, this would lead towards weaker revenue growth and a softer general market.

But both consumers and businesses remain contributors to the economy. And as we saw in the first quarter’s company earnings reports, the contri-

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69.0US Personal Consumption Contribution to GDP

Consumers Contributing

Source: Bloomberg Finance L.P.

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Business Is Booming


Profitable Investing | July 2018 | profitableinvesting.investorplace.com 3

bution of consumers and producers resulted in a positive net for most in the market.

This should continue for the current quarter, and the next round of quar-terly reports will give me an idea of how much to expect as we move into the third quarter.

Credit is the next area of concern for the economy and market. But with bank lending improving and continued strong demand for corporate bonds, this remains a contributor to growth in the economy and supportive for the general stock market.

This why I also continue to recom-mend corporate bonds as the market continues to improve.

Look at the market for the past 12 months for lower-grade corpo-rate bonds. These bonds will give the warning sign of tighter credit. If

buyers turn to sellers, that will signal that credit is going away, threatening the economic expansion and business spending.

But as you can see in the graph above, the Bloomberg Barclays US Corporate High Yield index continues to rally.

Right now, my major bellwethers of the economy and business profits show positive signs. And even if the S&P 500 remains range-bound, for now the cracks are not showing up, even under close scrutiny.

Better Than the MarketWhile the general market may be

range-bound, there are segments that are gaining while also paying nice dividends. I’ll quickly review three sectors that I’ve been updating you on frequently, and then turn to a fourth that’s newly back on its feet.

I’ll start with the banks. With regulatory reforms, banks are finally getting back to banking rather than being consumed by compliance. The KBW Regional Bank index contin-ues to climb from its recent low last September, having so far gained 26%. One of the bigger beneficiaries is Regions Financial (RF) in the Total Return Portfolio. And I see a lot of further upside for this segment and this particular bank.

Next is the petroleum market. From upstream producers through the midstream toll-taker pipelines on to the refiners, the market remains on the upswing. And this is being reflected in the performance of our Energy Select SPDR ETF (XLE) in the Total Return Portfolio.

The ETF continues to be up from the low hit last August by 20.81%. And as I discussed in the June issue, the petroleum companies are still way behind the progress in prices for oil. This means more upside for this segment of the market. And this industry is heavily capital intensive, meaning that as it progresses, it also benefits other industries that provide equipment and services and drives further consumer spending with rising employment in the segment.

Rounding out the list is our real estate investment trusts (REITs). Since the low in February, REITs have enjoyed a strong rebound. This comes as the Tax Cuts and Jobs Act of 2017 (TCJA) is being recognized for its contribution to REITs with a specific tax cut for individual investors. The deduction of 20% of the dividend income makes the dividend yield all the more valuable.

Plus, with a rising economy, pricing power for rents and leases should contribute to rising dividend distribu-tions. And they remain cheaper, in that the internal rates of return on REITs’ properties, as measured by the capital rate (or cap rate), are below their longer-term averages.

Utilities Back on the ListUtilities were also sold off following

the passage of the TCJA and have been

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Credit Keeps Coming


Bloomberg Barclays High Yield Index

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MSCI US Utilities Index

Utilities Powering On



underperforming so far this year. The primary reason for the selloff was the belief that since regulated utilities rates are set based on costs and profitabil-ity, once the tax cut hit, their rates for service would be reduced to reflect the lower tax costs.

At worst, however, utilities’ profits for regulated businesses will be flat with the tax cut. Utilities with unregu-lated businesses units will see profits bolstered. For utilities with renewable power generation, subsidies and other inducements are providing further profitability, tax cut or no tax cut.

Not surprisingly, interest rates are a factor, as well.

The greatest fear is that the gradual climb in US Treasury yields could make utility dividends less attractive in comparison. This is so far largely unfounded, as utilities are offering significantly more attractive yields over Treasuries and should continue to do so even after rates reach normal levels and the Fed takes its foot off the gas.

Investors also fear that higher Treasury yields will lead to higher funding costs for utility companies. But this is an overblown concern as well, especially for power utes—strong consumer spending and employment should lead to higher power consump-tion and thus higher revenues.

This is all beginning to show up in the performance of the MSCI US Utility index, which has risen from its low in February by 8.69%, as the bottom chart on page 3 illustrates.

The key to all of this is that the economy remains supportive for the market. And even if the general S&P 500 stays stalled, there are market opportunities still getting underway.

Proven Growth and Income BuysMortgages Are More Than Just for Your Home

The mortgage market is one of the cornerstones of US economy. The majority of homes and related properties are bought and funded via

mortgage loans originated by banks and brokers. In turn, they are either held and owned by banks and invest-ment companies or they are packaged together to become bonds known as mortgage-backed securities (MBS).

Mortgage-backed securities are bought by insurance companies, pension funds and investment compa-nies. These investors, if they’re smart and disciplined, pore over the underlying mortgages to determine what’s happening for the collateral of the homes as well as the payment of interest and principal and project the likelihood of the owners refinanc-ing, paying the mortgage off early or (heaven forbid) defaulting.

If they aren’t smart and disciplined, then they might just go along with rating agencies’ reviews and traders’ recommendations. This is a recipe for disaster, as we all saw in the 2007–2008 financial crisis, which followed a period when careless mortgage speculation funded rampant expan-sion to the point of a bubble.

One of the best in the business of investing and managing MBS is MFA Financial (MFA). MFA is struc-tured as a REIT. Unlike more typical REITs, it holds mortgage investments instead of properties, but it avoids corporate income taxes by paying the majority of its income through to shareholders just like any other REIT.

MFA has consistently turned in profits for shareholders even during the 2007-2008 crisis. And even though

shares dipped briefly in the last broad stock market correction, it has been a strong and consistent stock for inves-tors. Since June 2006, MFA has turned in a total return of 388.13% for an average annual equivalent return of 14.11%, as shown in the graph below.

The company continues to generate a return that dwarfs that of traditional lenders, with a return on assets of 2.9%—lending banks usually generate returns on assets in the 1% range. And the return on shareholders’ equity for MFA is also healthy at 10.6%.

Despite the intensive skill levels of management overseeing MFA’s MBS portfolio, the general and administra-tive expense ratio to operating income is at a low rate of 21.94%, continuing to improve over the past four years by more than 50%.

Dividends are paid quarterly out of cash flows from the MBS portfolios and the underlying mortgages. And at a steady 20 cents per quarter, MFA generates a yield of 10.20%.

Yes, that is a big yield. But the company has a proven record of prof-itability and pays the majority of that profitability to shareholders (as all REITs are required to do).

I always ask what could go wrong. Well, there’s always the risk of failure at the management level, but a culture of risk control separates this company from its much lesser peers regardless of the comings and goings of indi-vidual managers, mortgage market traders and analysts.

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MFA Total Return Since 6/20/2006

MFA Financial (MFA) Delivers Through Thick and Thin



Obviously, shocks to the mortgage market, which could come in the form of a major spike in US interest rates or a major drop in real estate values, would also impact the company. But since it was tested by these conditions to the extreme in 2008, MFA should weather these threats well going forward.

The shares are also a bargain. Trading at just 1.03 times the book of MBS assets, shares are cheap not just in terms of the current value of the mortgages, but also for how they are managed by MFA.

A Smart Insider Play on Technology with Dividends

Technology is like alchemy. Whether it is transforming grains of silicon into the new must-have electronic gizmo or transforming industries with innovative ideas that propel services, technology spins nearly worthless rags into riches.

And the epicenter of much of the US and global technology sector can be found in the pleasant Silicon Valley town of Palo Alto, California.

Silicon Valley is where so many modern technologies have been conceived, developed and brought to eager markets, often creating billion-aires in the process.

However, for every tech titan who has created and built an impressive company, there are many more who never make it out of their parents’ garages.

This is where financial backing and guidance come in. A good idea can only become a good product if it can be brought to the market, and successful tech companies need good management as much as they need good labs.

One of the best companies special-izing in investing and guidance is Hercules Capital (HTGC), formerly known as Hercules Technology Growth Capital.

Based in the heart of Palo Alto, Hercules Capital is an investment company that focuses on financing and guiding technology companies from start to IPO.

It is structured as a business devel-opment company (BDC), which means that as an investment company it does not pay corporate income tax, but instead pays shareholders its profits on a passthrough basis.

The company has more than 350 current investments in varied groups of technologies. These include inter-net consumer and business products and services, clean and green technol-ogy businesses and drug development companies.

Hercules Capital has a long track record of participating in success-ful companies, including many currently found in its portfolio. You may recognize a few, including Box, the cloud-based storage company; Pinterest in social media; FanDuel in gaming/gambling; Sling Media in video streaming; Ancestry.com for history; and green energy companies like Brightsource Energy.

The company scouts out innovators in various stages of company devel-opment. Once HTGC has identified a company with potential, it creates financing to fund their development. But beyond making loans, HTGC also takes equity stakes in the companies, either directly or via warrants that allow it to cash in when companies complete their IPOs.

Hercules Capital has been in the business since 2004 and continues to gradually advance its revenues, with growth expanding at an average of 9.94% over the past three years alone.

Its operating margin is fat at 51.6%, and thanks to good funding for its own operations it has a net interest margin of 9.5%. (Net interest margin is the difference between what an entity borrows and what it earns, with a posi-tive value denoting profitability.)

The return on the company’s assets is 5.6%, which is sizable for a lending company, and the return on the compa-ny’s equity is a nice 11.1%.

Even though it is leveraged like any bank or financial firm, its debt to assets ratio of 47.6% is lower than most similarly leveraged institutions. Therefore, there’s less credit risk in Hercules, as it has more asset cover-age against its loans and debts.

The dividend is ample at 31 cents per quarter for a yield of 9.84%, which has been upped over the past five years by 4.4%.

And the returns for sharehold-ers continue to be impressive, as illustrated in the chart on this page. Over the past 10 years, HTGC has generated a total return of 246.08%, providing an average annual equiva-lent of 13.21%.

➤ What to Do Now: Buy MFA Financial (NYSE: MFA) for the Real Estate Investment Trust section of the Total Return Portfolio under $8.50 per share. To take full advantage of the tax benefits of the REIT structure, including the deduction of 20% of the dividend income MFA pays out, buy in a taxable account.

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Hercules Capital (HTGC) Does the Heavy Lifting



But for all this performance, Hercules shares are still only valued at 1.3 times its book value (in this case, a valuable book of loan and equity assets that would be very chal-lenging to replicate).

The biggest risk I see in Hercules is that it could hit a slump where its companies fail to develop or fall to other disruptive technologies. But with such a large number of different companies in diverse industries and markets, Hercules has a well-hedged collection of assets protecting its investors.

Total Return Portfolio

The general stock market remains stalled, but that doesn’t mean that there aren’t plenty of opportunities that are already showing signs of positive performance.

I made the case earlier in this issue that while the S&P 500 index might be stuck in a range, there are still broad economic conditions that will support higher prices, with consumers and businesses continuing to spend and invest.

However, new and threatened tariffs continue to muddy the waters for companies around the globe. I have a tough time seeing a full-on trade war involving major global economies. Rather, my view is that there will be more political bluster than action as we get closer to trade-related deadlines.

Most of the stocks in the Total Return Portfolio are relatively insulated from much of the direct hits related to the current and threatened tariffs.

The utilities in our portfolio serve their respective domestic markets,

including the British consumer base served by SSE plc (SSEZY). Our Toll Takers are largely domestic, but assets connected with Canada and Mexico and pipelines that connect with marine terminals for export may face complications. But in oil, at least, there is less risk for tariff interven-tion given the supply and demand for crude and refined products.

In the World-Class Franchises, there is some risk for retaliation. Apple (AAPL) might see challenges to its businesses with license restric-tions from China, and the same might be possible for Starbucks (SBUX). And Walgreens Boots Alliance (WBA) imports and sells a collection of consumer products that could see costs rise, threatening sales.

United Technologies (UTX) is already in the crosshairs of China, as it may have to re-file for approval to acquire Rockwell Collins with local regulatory authorities.

Our real estate investment trusts (REITs) are largely immune from trade actions.

Our Growth & Income Plays do face some risk. Hormel Foods (HRL), while predominantly in the US, does export some food products, although they are a small percentage of overall sales. McDonald’s (MCD) could see restrictions or regulatory retaliation, but that seems less likely as it would be for Starbucks.

Microsoft (MSFT) could see its products and services targeted, but I haven’t seen much on the horizon on this front. But consumer product companies like Nestlé (NSRGY) and Procter & Gamble (PG) could face higher costs on imported and exported goods. So far, these have not been subject to threats.

Two of our banks, Citizens Financial (CFG) and Regions Financial (RF), are focused on the US banking market. But the cross-border Toronto-Dominion Bank (TD) could possibly face threats to its financial products between Canada and the US.

Overall, I see less risk in the overall holdings from the trade tiff. But if a

full-on trade war were to erupt, then it could lead to a correction in the general stock market.

Overall AllocationsThe Total Return Portfolio’s general

stock and bond allocations remain at 60% for stocks and 40% for fixed income. I’m reducing the allocation in Indexed Equities from 22% to 18%. This should be done by reducing your holdings in iShares Core S&P 500 ETF (IVV) and in the Vanguard Healthcare ETF (VHT).

With the S&P 500’s range-bound trading, there’s less need to focus on the larger cap stocks that the iShares represent. And with some of the chal-lenges and risks facing the healthcare market, including pharmaceutical companies, the Vanguard ETF’s recent recovery gives reason to take some cash off the table.

I’m adding half of the reduced allo-cation to the Growth & Income Plays, bringing it up to 16% with the addi-tion of Hercules Capital (HTGC).

And I’m adding the other half to the Real Estate Investment Trusts, bringing it up to 10% with the addi-tion of MFA Financial (MFA).

Two Reviews, One SaleIn the Journal, I placed two portfo-

lio holdings on hold pending a further review. Both have seen corrections in their stock prices, signaling further troubles ahead.

Healthcare Trust of America (HTA) in the Real Estate Investment Trusts section has not turned around as many of its real estate peers have done. I see two challenges. First, the internal rate of return for the compa-ny’s property assets is lower than that of its real estate peers. Second, the REIT has an image issue, as investors fail to properly identify the potential of its office and outpa-tient properties, and ignore that its business is outside of the more chal-lenged hospital market. As a result, it’s more of a discount now, with the stock price currently valued at 1.66 times its net assets.

(continued on p. 8)

➤ What to Do Now: Buy Hercules Capital Inc. in the Growth & Income section of the Total Return Portfolio under $14.50. Use a taxable account—while most of the dividends have been taxable, the company has a history of passing through tax deductions to investors.


TOTAL RETURN PORTFOLIOStocks (60%)Indexed Equities (18%, down from 22%) Symbol T/TF

Entry Date

Fwd. Yield

Buy Under Comments

Energy Select SPDR ETF XLE TF 5/21/18 2.41% 81.00 With petrol market on upswing, oil companies are a great buy nowiShares Core S&P 500 ETF IVV TF 3/22/18 1.79% 271.89 Large US companies are lagging; reduce stake hereVanguard Health Care ETF VHT TF 3/16/16 0.98% 157.00 Drug stocks are less attractive; reduce stake hereVanguard High Dividend Yield ETF VYM TF 6/21/16 2.89% 83.50 Dividends provide better returns in a stalled market

Growth & Income Plays (16%, up from 14%)Citizens Financial CFG TF 9/8/17 2.07% 44.28 Bank benefits from rate and regulation changesCompass Diversified Holdings CODI T 5/21/18 9.25% 18.00 Great collection of high-cash-generating businesses that fuel solid higher dividendsHercules Capital HTGC T 6/25/18 3.89% 14.50 Palo Alto tech insider provides access to great new tech cos. while paying higher dividendHormel HRL TF 4/17/17 2.06% 34.00 Responding to changing meat demand from consumersMcDonald's MCD TF 3/7/18 2.50% 157.00 Too expensive and exposed to China trade retributionsMicrosoft MSFT TF 3/18/09 1.75% 105.00 Tech titan transforming from old to new and more successful business modelNestle NSRGY T 11/30/12 3.26% 75.00 Still concerned about packaged products; plus trade sanction risk Procter & Gamble PG TF 12/17/08 3.88% 70.00 More cost controls needed to reduce product pricing issuesRegions Financial CFG T 4/23/18 1.86% 20.00 Favorite regional US bank w/further upside expected aheadRoche Holding RHHBY T 4/1/16 3.89% Sell Lacking traditional management of pipeline and existing productsTD Bank TD TF 3/10/15 3.55% Hold Benefits less from transformation of US banking market

Real Estate Investment Trusts (10%, up from 8%)Digital Realty Trust DLR T 2/9/18 3.83% 111.00 Great value in REITs; great opportunities in cloud marketEducation Realty Trust EDR T 1/31/18 4.66% Hold Takeover offer may leave too much cash on the table; hold for nowHealthcare Trust of America HTA T 9/11/15 4.99% 27.00 Given its discounted price, buy with REIT recoveryMFA Financial MFA T 6/25/18 6.94% 8.50 Better than banks at managing mortgages for yield and gains. Tanger Factory Outlet Centers SKT T 3/17/17 6.94% 24.00 Well-run REIT that keeps bucking retail routW.P. Carey Inc. WPC T 1/3/14 6.34% 67.00 Great higher-yielding REIT priced at bargain prices

World-Class Franchises (6%)Apple AAPL TF 12/29/15 1.56% 162.00 Increasing competition may threaten phone and tablet salesBerkshire Hathaway BRK.B TF 6/15/11 — 191.00 History of performance going to be challenged with new incoming managementSchlumberger SLB TF 5/23/13 2.69% 67.00 Great oilfield services firm, but it has competition; buy on pullbacksStarbucks SBUX TF 2/8/18 2.10% 55.00 Stock expensive, like its coffee and food offeringsUnited Technologies UTX TF 8/6/14 2.25% 116.00 Further fallout from GE association; it needs to justify business mixWalgreens Boots Alliance WBA TF 4/7/17 2.42% 67.00 Pending Dow Jones membership a plus

Toll Takers (6%)Buckeye Partners BPL T 8/21/06 13.00% 43.00 Pipes are in demand, and stock has pricing powerEnterprise Products Partners EPD T 2/22/05 6.08% 27.00 Prime pipeline passthrough with long term history of payoutsKinder Morgan Inc. KMI T 11/28/14 4.91% 18.00 Regular corporate pipeline stock for petrol reboundPembina Pipeline PBA T 8/14/12 4.84% 34.00 Rising demand for pipes brings more profitsPlains GP Holdings PAGP T 3/10/17 4.83% 26.65 Great crude oil focus with export benefits

Utilities (4%)Aqua America WTR TF 8/13/09 2.47% 31.00 Limited pricing power limits upsideNextEra Energy NEE TF 9/8/08 2.84% 167.00 The power company to buy right nowPG&E Corp. PCG TF 4/18/08 — Hold Liabilities keep rising from lawsuitsSSE plc SSEZY TF 3/7/17 8.14% 18.00 Serves local British market and dishes out nice yield

Fixed Income (40%)Cash (10%)Synchrony Bank high-yield savings account — 7/31/15 1.55% — Call 866/226-5638 to order

Intermediate Credit Bonds (11%)DoubleLine Total Return Bond Fund DLTNX TF 7/22/14 3.23% 10.55 Good value for low bond market risk, plus yield

SPDR Interm-Term Corp. Bond ETF SPIB TF 4/21/17 2.82% 38.00 Lower bond market interest rate risk

Multisector Bonds (10%)Osterweis Strategic Income Fund OSTIX TF 4/19/18 3.95% 11.67 Top team of analysts for prime bond plays

Preferred Stocks (5%)iShares US Preferred Stock ETF PFF TF 3/9/17 5.86% 38.00 Easy access to great market sector in preferred shares

Municipal Bond Funds (4%)Blackrock Municipal Income BLE T 4/23/18 5.69% 14.58 Discount is narrowing, buy as you canNuveen AMT-Free Credit NVG T 4/23/18 5.91% 15.15 Still discounted with high yield; tax free and exempt from alternative minimum taxNuveen Municipal Credit NZF T 4/23/18 5.89% 15.00 Buy this well-run muni fund while it’s still at discount


Given its deep discount in the stock market, I see HTA as a buy again on a pullback to $24.05 a share or less.

Roche Holding (RHHBY) had been a long-term success story for inves-tors due to its management of its drug pipeline and maintenance of its existing products. But lately, both advantages are under threat. The pipeline is less full and faces competition from highly targeted and very expensive experimen-tal cancer drugs, which brings too much risk right now. And its existing product sales have stalled out with meager revenue growth.

Roche has outlived its usefulness to us, so I recommend selling it and using the proceeds to buy shares in Hercules Capital and shore up your weighting in the other areas I’ve high-lighted this month.

Renewed OpportunityAs I mentioned earlier in the issue, I

see utilities (especially power utilities) further recovering and outperform-ing the S&P 500 for some time. As such, I recommend that you focus new money on NextEra Energy (NEE).

NextEra operates primarily in Florida, but also has assets in 30 states as well as in parts of Canada and Spain. While it does have traditional regulated forms of power generation, the real argument for buying the stock comes from its well-managed deploy-ment of renewable energy through wind and solar facilities.

NextEra continues not just to catch up, as other utilities are doing, but has even outperformed the S&P 500 over the past year. Profitability here is good and is further aided by incen-tives from local authorities as well as from national governments. NEE is a great buy under $167.00.

Late-Breaking REIT NewsOn Monday, June 25, as this issue

was going to print, Education Realty Trust (EDR), one of the REITs in our Total Return Portfolio, announced that it has entered into a definitive agree-ment to be bought by a cooperative investment between Blackstone Real Estate Income Trust (BREIT) and

Greystar Student Housing Growth and Income Fund.

The deal is for cash in the amount of $41.50 per share for a total of $4.6 billion (including EDR’s debt). The transaction still must be approved by a shareholder vote. The dividend, last paid on May 15, will be discontin-ued. However, if the deal isn’t closed prior to October 15, shareholders will receive $0.00435 per day in additional cash until the deal closes.

I’m disappointed in the terms of the transaction, as it leaves a good deal of cash on the table; EDR should be valued higher.

For now, EDR is on hold, pending further review of the deal. I’ll be examining whether or not there is the potential to oppose the transaction at the current price and terms during the run-up to and during the shareholder vote. There well may be more cash that might be extracted from the buyers.

I’ve been following a peer of EDR, American Campus Communities (ACC), which is valued a bit higher than EDR under various metrics. I’m now considering the company as a potential addition to the portfolio and will make my call soon in the Journal.

See my special June 25 Journal for more on this.

The Incredible Dividend MachineMa Bell Gets What She Wants

AT&T (T), a holding in Cycle B of our Incredible Dividend Machine, won the legal fight to acquire Time Warner (TWX) in a deal priced at approximately $46 billion in cash and debt repayments. The company has $29 billion in cash on its books and is set to tap into credit lines for some $27 billion. It’s also expected to come to an eager bond market to refinance the short-term borrowing.

The corporate bond market for quality issuers has eager institutional and fund management investors looking for yield that they can depend upon. This evidenced by the recent

sale of $21 billion in bonds from Bayer (BAYRY) that was placed last month to help fund the company’s acquisition of Monsanto (MON). And with yield spreads at fairly narrow rates, bond issuers are coming to a seller’s market.

Overall, AT&T’s debt will sit at $180 billion. But with the assumed current cash flows from the compa-nies, it is projected that the company will be able to pay down that debt by some $11 billion per year without any business changes or pickups following the acquisition.

This bodes well for the dividend coverage, which I continue to see well-defended even before the merged companies get to work to make the whole greater than the parts. The dividend currently sits at 50 cents for a current yield of 6.17%. And when the dust settles on the merger, the company should still compare well against the valuation of its peer (and fellow Cycle B denizen) Verizon (VZ).

Many are now griping about whether the company will make the best use of the content coming from Time Warner. But I continue to see that the vertical integration will provide growth for the company that’s been missing from its core operations of data and wireless offerings. AT&T is a great buy under $37.00.

Buyout BargainAnother merger that is still in the

works is for Andeavor (ANDV) in Cycle C. Marathon Petroleum’s (MPC) deal to acquire all shares of Andeavor at $152.27 sits at a premium to the current price of $130.48 by 16.70%. The deal’s regulatory hurdles remain low for now, with little perceived opposition given the little overlap in refinery and other assets of both companies.

The refinery market remains very attractive. The crack spread (a measure of the profitability of refined products like gasoline and heating oil against the original barrel of crude oil) continues to soar with rising demand. And with pipelines congested in the US with rising crude production, many refiner-ies are able to lock in discounts for crude coming from select US fields,


making the crack spread for that oil in particular even better.

In addition, stockpiles of refined products are down. This makes for even higher prices for refineries, and thus higher profits.

The intermediate challenge to refin-ers, including Andeavor and Marathon, will be regulatory reforms for ethanol. Federal law currently requires refin-ers to blend gasoline with up to 10% ethanol, a biofuel mostly made from corn, but allows refiners who can’t do so (due to technical or supply limita-tions) to buy government-issued credits to meet their obligation.

There continues to be a tug of war on Capitol Hill over reforming this ill-conceived legislation, which favors ethanol producers and corn famers at the expense of refiners and US gaso-line consumers.

Already, the Environmental Protection Agency (EPA) has issued several waivers for select refinery companies. And it could continue to do so if Congress delays or limits reforms to the ethanol mandate. If the reforms are passed, it will be a further windfall for refiners, including Andeavor and Marathon. But if they are limited, they are no worse off than under current rules.

Continue to buy Andeavor under $147.00.

Pipeline PowerUS crude production continues to

advance, which puts the pipelines that deliver both rude and refined products through their networks in the driver’s seat. In just the Permian Basin alone, production is up some 1.1 million barrels per day over the past 18 months. And while takeaway capac-ity is up, with two new pipes coming online in the region, there remains further need for additional capacity.

This continues the story that the pipeline companies have strong pricing power and that cash for dividends is ample. Continue to buy our two pipe companies in Cycle B with Magellan Midstream (MMP) under $70.86 and ONEOK Inc. (OKE) under $70.77.

Tax Cut Finally ClearOur REITs had a tough time at the

start of the year due to the misconcep-tion that the corporate tax cut delivered in the Tax Cuts and Jobs Act of 2017 (TCJA) made the REIT structure less relevant. But as I’ve been writing, the TCJA also provided a tax break for REITs that allows individual inves-tors to deduct 20% of taxable dividend distributions for REIT dividends.

This bit of great news was initially lost on the market, but has started to receive more notice from individual investors and their advisors. As a result, since its February 8 low, the REIT market, basis the Bloomberg US REIT index, has turned in a total return of 10.74%.

Continue to use the discounted market as an opportunity to lock in great prices for our REITs—buy Realty Income Corporation (O) under $56.00, Easterly Government Properties (DEA) under $21.54 and Ventas (VTR) under $61.00.

Model Mutual Fund Portfolios

As I’ve mentioned, particularly for many of the bold-faced names in the S&P 500 and Dow Jones Industrials, the general stock market continue to trade in an up-and-down range, as it has since the initial correction in late January and early February. This is confounding, given the better

The Incredible Dividend MachineCycle A (January, April, July, October) T/TF Buy UnderBCE Inc. (NYSE: BCE, 5.7%) T $42.31 Cisco Systems (NASDAQ: CSCO, 3.1%) TF $46.00 Kimberly-Clark (NYSE: KMB, 4.0%) TF $114.00 Merck (NYSE: MRK, 3.1%) TF $57.00 Mondelez International (NASDAQ: MDLZ, 2.1%) TF $43.00 PPL Corp. (NYSE: PPL, 5.8%) TF $33.00 South Jersey Industries (NYSE: SJI, 3.4%) T $33.94

Cycle B (February, May, August, November)AT&T (NYSE: T, 6.3%) TF $37.00 Colgate-Palmolive (NYSE: CL, 2.6%) TF $61.00 General Mills (NYSE: GIS, 4.3%) TF $48.00 Magellan Midstream Partners (NYSE: MMP, 5.4%) T $70.86 ONEOK Inc. (NYSE: OKE, 4.5%) T $70.77 Realty Income Corp. (NYSE: O, 4.9%)* T $56.00 Verizon (NYSE: VZ, 4.7%) TF $51.00

Cycle C (March, June, September, December)Andeavor (NYSE: ANDV, 1.8%) TF $147.00 Dominion Energy (NYSE: D, 5.0%) TF $72.00 Easterly Gov’t Properties (NYSE: DEA, 5.3%) T $21.54 Main Street Capital (NYSE: MAIN, 6.0%)* T $39.00 Pfizer (NYSE: PFE, 3.7%) TF $33.50 Public Svc. Enterprise Group (NYSE: PEG, 3.4%) TF $47.00 Ventas (NYSE: VTR, 5.7%) T $61.00

*Monthly dividend payer

➤ What to Do Now: The table on this page lists the stocks that make up the three cycles of the Incredible Dividend Machine with their yield, their buy-under price and whether I recommend investing in a taxable or tax-free account. To build an income portfolio that will entitle you to a dividend check every month, make sure you own at least one stock from each cycle, starting with the stocks I highlighted in this issue.


fundamentals of improved consumer spending and business investment and, of course, lower corporate tax rates.

This up-and-down pattern may well continue through the doldrums of the summer, potentially made worse by the trade war narrative that’s becom-ing pervasive in the financial press and from individual companies.

At the same time, US real estate continues to rebound, with REITs gaining attention. Armed with better internal rates of return on underly-ing properties, as measured by capital rates that are above more recent aver-ages, and benefiting from investors’ better understanding of the tax bene-fits of REITs in individual accounts, REITs like the ones in our portfolios continue to rally.

To gain more from the market, both in price gain and income, I’m raising our real estate allocations across the mutual fund and ETF portfolios. To fund the increase in allocations, I’m reducing slightly the weighting of the general stock market and general stock market dividend funds.

This will protect us from any near-term downward risk in the general stock market while providing a way to cash in on the still-cheap real estate market that’s on the ascent, a state I see it enjoying for some months to follow.

All of the funds in our model mutual fund portfolios are best held in a tax-advantaged account like an IRA.

All In the Family The allocation changes start with the

Fidelity Fund Family. I’m decreasing the iShares Core High Dividend ETF (HDV) from 30% to 27%. This ETF has general exposure to the leading

stocks of the S&P 500 index. In addi-tion, I’m reducing the Fidelity Large Cap Value Enhanced Index Fund (FLVEX) from 9% to 7%.

This allocation reduction will allow us to add an additional 5% of the overall portfolio to the Fidelity Real Estate Investment Fund (FRESX), bringing it up to 15% from 10%. In addition, after reviewing the merger of the Fidelity Strategic Income Fund (FSICX) with the Fidelity Advisor Strategic Income Fund (FADMX), I’m continuing to maintain the new fund in the allocation.

In the T. Rowe Price Family, I’m following a similar allocation change. I’m reducing the Equity Income Fund (PRFDX) from 20% to 18% and reducing the Value Fund (TRVLX) from 17% to 14%. The resulting allocation reduction of 5% will now be added to the Real Estate Fund (TRREX), which will bring the allo-cation to REITs from 10% to 15%.

Then in the Vanguard Family, I’m reducing the High Dividend Yield Index Fund (VHDYX) from 30% to 27% and the Global Equity Fund (VHGEX) from 10% to 8%. The resulting 5% will be added to the Real Estate Index Fund (VGSIX), bringing its allocation to 15%.

Fund Supermarket PortfolioLike the All in the Family port-

folios above, the Fund Supermarket Portfolio is also getting a reduction in its near-term exposure to the general stock market with a reduction in the Vanguard High Dividend Yield Index Fund (VHDYX) from 32% to 27%. The 5% proceeds will be added to the Vanguard Real Estate Index Fund

(VGSIX), bringing its allocation from 10% to 15% of the overall portfolio.

In addition, as I continue to mention in monthly issues of Profitable Investing and my twice-weekly Neil’s Journal, I see further upside in corporate bonds, with strong demand from institutional and fund investors, as evidenced by larger-scale buying of new issues from US and European companies. This will benefit our holding in the Osterweis Strategic Income Fund (OSTIX), which stands at an alloca-tion of 12%.

Hassle-Free ETF PortfolioOur strategic ETF allocation port-

folio will also reflect the change in direction from general stock market exposure further towards real estate. I’m reducing the general stock market allocation via the Vanguard High Dividend Yield ETF (VYM) from 32% to 27%. This will allow an increase in the REIT allocation via the Vanguard Real Estate ETF (VNQ) from 10% to 15%.

Ten-Minute Retirement Portfolio

There are a handful of changes in the Ten-Minute Retirement Portfolio. So, perhaps it might take a few more than just 10 minutes to complete the changes this month. First as with the other fund and ETF portfolios, I’m reducing general stock allocation in favor of REITs. This means we’re reducing the Vanguard High Dividend Yield ETF (VYM) from 34% to 29%. I’m increasing the allocation to the Vanguard Real Estate ETF (VNQ) from 9% to 14%.

Fidelity (800/544-8888) T. Rowe Price (800/638-5660) Vanguard (800/662-2739)Advisor Strategic Income (FADMX) .. 27% Spectrum Income (RPSIX) ...............29% High Dividend Yield Index (VHDYX) ..... 27%iShares Core High Div ETF (HDV)..... 27% Equity Income (PRFDX) .................... 18% Intermed.-Trm Inv.-Grade (VFICX) .... 17%Real Estate Investment (FRESX) ...... 15% Real Estate (TRREX) ........................ 15% Real Estate Index (VGSIX) ................ 15%Worldwide (FWWFX) ....................... 10% Value (TRVLX) ................................. 14% Total Bond Market Index (VBMFX) ... 10%Money market ...................................9% Global Stock (PRGSX) ...................... 10% Money market ...................................9%L-C Value Enhanced Idx (FLVEX) ........ 7% Money market ...................................9% Value Index (VIVAX) ...........................9%L-C Growth Enhanced Idx (FLGEX) .... 5% Growth Stock (PRGFX) ...................... 5% Global Equity (VHGEX) ....................... 8%

Growth Index (VIGRX) ........................ 5%

All in the Family Portfolios


The next change comes in how we access the midstream petroleum pipe-lines in the Ten-Minute Retirement Portfolio. As I explained in the Journal on June 19, the closed-end fund Tortoise Energy Infrastructure Corporation (TYG) has been trading at a steep premium to net asset value (NAV). The result is that it does not offer much of a value in what is otherwise an attractive segment of the market.

I’m replacing the fund with one run by Goldman Sachs that’s trading at a discount to its NAV while also enjoy-ing a higher dividend yield. So, in your Ten-Minute Retirement Portfolio, you need to sell the Tortoise Energy Infrastructure Corporation and buy the Goldman Sachs MLP Income Opportunities Fund (GMZ) with the same allocation of 7% of the portfolio.

You Have Questions, I Have Answers

I continue to enjoy your comments and questions on the Profitable Investing newsletter and the Journal as well as on the individual hold-ings in the portfolios. I encourage all subscribers to contact our team by emailing us at [email protected] or by calling us at 1-800-211-8566.

Here are some of the questions we’ve received recently, with my responses:

Q: What is the purpose of the Niche Investments, and how do they fit into the Profitable Investing port-folios?

A: The Niche Investments go beyond the core portfolios of Profitable Investing. They represent additional opportunities for subscrib-ers to capitalize on stocks for growth and for income, bonds and funds after they’ve invested in the recommenda-tions of the main portfolios.

As I’ve written in the June issue and the Journal, I’ve been going through the long list of recommenda-tions and making changes—placing some on hold, reinstating and updat-ing buy-under prices for others, and selling a handful, including recent sell recommendations for Tortoise Energy Infrastructure Corporation (TYG), the Altegris Futures Evolution Strategy Fund (EVONX) and the Kayne Anderson MLP Investment Co. Series F Preferred (KYN.PF).

Going forward, I will focus the list on the best additional opportunities. And I plan to add some new recom-mendations that subscribers can test drive with me in smaller sums. These may prove themselves and join the

main portfolios, as Energy Select SPDR ETF (XLE) did last month.

Q: You have recommended that Canadian companies such as Niche Investment members ARC Resources (AETUF) and Vermilion Energy (VET) be placed in taxable accounts despite the terms of the US tax treaty with Canada, which stipulates that Canadian companies don’t with-hold for qualified retirement account holders in the US. Why wouldn’t you recommend subscribers use a retire-ment account?

A: You are right that these compa-nies benefit from the treaty that shields US investors from dividend withhold-ing when held in qualified plans. But there are limitations to this treaty—Canada has a history of reversing tax treaties with little warning, as it did on a few occasions in the 2000s. There is also additional tax reporting that may have to be made under IRS section 965, which (as of the passage of the TCJA) may require investors to report foreign non-taxable income and pay taxes on it even in retirement accounts.

By recommending Canadian stocks for taxable accounts, I’m making the broadest call for all subscribers while

Fund Supermarket Portfolio

Vanguard High Dividend Yield Index (VHDYX)* 27%

Vanguard Real Estate Index (VGSIX)* 15%

DoubleLine Total Return Bond (DLTNX) 13%

Osterweis Strategic Income Fund (OSTIX)* 12%

Money market 11%Vanguard Value Index (VIVAX)* 10%Baron International Growth (BIGFX) 6%

PRIMECAP Odyssey Stock (POSKX) 6%

*Transaction fee charged by most discount brokers. You can avoid this fee by dealing directly with the fund sponsor.

Hassle-Free ETF PortfolioVanguard High Dividend Yield (NYSE: VYM) 27%Vanguard Real Estate (NYSE: VNQ) 15%SPDR DoubleLine Total Return Tactical (NYSE: TOTL) 12%SPDR Barclays Intermediate-Term Corporate Bond (NYSE: SPIB) 11%Vanguard Value (NYSE: VTV) 11% Money market 8%SPDR MSCI All-Country World ex-US Index (NYSE: CWI) 6%iShares U.S. Preferred Stock (NYSE: PFF) 5%iShares Russell 1000 Growth Index (NYSE: IWF) 5%

The Ten Minute Retirement PortfolioVanguard High Dividend Yield ETF (NYSE: VYM) 29%DoubleLine Total Return Bond Fund (DLTNX, $2,000) 17%Vanguard Real Estate ETF (NYSE: VNQ) 14%SPDR Intermediate-Term Corporate Bond ETF (NYSE: SPIB) 8%WisdomTree International Equity ETF (DWM) 7%Vanguard Federal Money Market Fund (VMFXX, $3,000) 7%Goldman Sachs MLP Income Opportunities Fund (NYSE: GMZ) 7%Osterweis Strategic Income Fund (OSTIX, $5,000) 6%Vanguard Short-Term Investment Grade (VFSTX, $3,000) 5%

also being cautious, as the rules are still potentially in flux. But remember, my recommendations are not intended as a substitute for a personal consulta-tion with a qualified tax advisor.

One Final ThoughtWhat Richard Band’s Studebaker Can Teach Us About the Market

I’ve always loved cars. As a kid, I amassed quite a collection of model and toy cars, and my parents still have plenty of photos of me washing and tinkering with our family cars while growing up. So you can imagine how very excited I was, shortly after meeting Richard, to learn of his treasured 1959 Studebaker Silver Hawk. The Studebaker was one of the most modern and sleek models of its era—a true beauty.

While Richard warned me about the cost of upkeep and repairs needed to keep it humming, it didn’t stop me from buying a classic car myself. I coveted the 1960’s Mercedes-Benz Pagoda Top roadster and found an opportunity to acquire one. Like Richard’s car, the Mercedes I bought was a great old car in need of some TLC and restoration.

In Richard’s case, that old Studebaker became a collectable classic that dramatically rose in value over what he originally paid for it as more and more folks in the market came to appreciate the model as Richard and I did. (An industry specialist, Hagerty Insurance of Traverse City, Michigan, now values the car at $45,000 or more.)

Richard’s view of the stock market, which he wrote about extensively in his book Contrary Investing for the ‘90s, was that it behaved much the same way. In it, he wrote that if you buy a quality portfolio of stocks, “the longer you hold your stocks, the lower the risk that you’ll lose money, regardless of how badly you may have timed your purchases.”

Today, my message to you is the same. When you spot quality, invest the time and the money. Over the long haul, that investment in quality is sure to pay off (like my old Mercedes, which I eventually sold for a profit). In this month’s issue of Profitable Investing, I’ve shared plenty of stocks, bonds and funds that are worthy of your time and your hard-earned cash and will grow in value with a measure of patience.

With the reliable dividend payers added to the Total Return Portfolio this month, you’ll be investing in quality, too. Start with MFA Financial (MFA) with its proven track record even during the worst financial market conditions. You’ll also want to add one of the most astute investors in tech-nologies of the future with Hercules Capital (HTGC).

Don’t forget to take part in some of our longer-term investments in industry leaders, including NextEra Energy (NEE), which continues to outperform its power utility peers with less risk. And W.P. Carey (WPC) continues to boost its dividend quarter after quarter while providing one of the best capital rates in the REIT market.

All My Best,

Neil George

NEIL GEORGE began his financial services career in 1987 with Merrill Lynch International Bank in Vienna, Austria and subsequently held

senior positions at what are now US Bank and globally-based Investec PLC. Neil’s long career has included stints as a bond trader and the manager of a fixed-income fund worth over $1 billion. An income hunter at heart, he’s also the former editor of several successful investment advisories dedicated to finding Wall Street’s best yields. Neil earned an MBA in international finance from Webster University in Europe and a bachelor’s degree in economics from King’s college. His market commentary and insights have been featured in the Wall Street Journal, Barron’s, Bloomberg, CNN and NBC.

Actions to Take This Month

1. Reduce your allocations to the iShares Core S&P 500 ETF (IVV) and the Vanguard Health ETF (VHT) in the Total Return Portfolio. (See p. 6.)

2. Sell Tortoise Energy Infrastructure Corporation (TYG) in the Ten-Minute Retirement Portfolio and replace it with the Goldman Sachs MLP Income Opportunities Fund (GMZ). (See p. 11.)

3. Sell Roche Holding (RHHBY) in the Total Return Portfolio. (See p. 8.)

4. Buy MFA Financial (MFA) under $8.50 and Hercules Capital (HTGC) in the Total Return Portfolio under $14.50. (See pp. 4-5.)

5. Buy NextEra Energy (NEE) in the Total Return Portfolio under $167.00. (See p. 8.)

SUMMARY

neil george's profitable investing | - v . 29, n . 7 july 2018 buy … · 2018-12-06 ·...

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