Co-produced with Beyond Saving.
The Internet has revolutionized investing. It is easier than ever for a young investor to save a few dollars and buy their first share of stock. With some brokers, they only need a single dollar and can buy a fraction of a single share. We also have sites like Seeking Alpha that offers a broad range of education and opinions on various stocks.
For those of us who had to save up several months worth of paychecks to even open a brokerage account, pay a high fee to make a single trade, another fee to sell, and do most of our learning through trial and error with our real money I am starting to feel like my Grandpa: "When I was your age, I had to walk to school - uphill, through the snow, both ways!" New investors have no idea how fortunate they are!
On the other hand, the internet gathered everything that people had to offer; the good and the bad. Fear sells - it is a well-known adage of advertising. It is why your local news will focus on things that might be dangerous to you, such as crime, storms, and pandemics. People will tune in to know what the risks are to them.
When it comes to investing, investors will often overreact to fear. What are investors afraid of? Losing money. Investors fear recessions, bear markets, fraud, and dividend cuts. The financial news is full of dire predictions about how horrible the future will be. Some have made a cottage industry of peddling fear about certain stocks.
To manage our portfolios, it is more important than ever that we are able to keep a level head, analyze the fundamentals of our investments, and filter out the noise to determine if it is an attractive risk for the expected reward.
Today, let's look at two picks that are trading at depressed prices because of the fears that investors have. The rewards are immense, with dividend yields of +13%.
Pick #1: MPW - Yield 13.8%
Medical Properties Trust, Inc. (MPW) has been the target of rampant "short reports" and active campaigns to discredit the company and management. They are often going so far as to allege outright illegal activity, suggesting that there is some active investigation from law enforcement and intentionally misrepresenting financial statements.
At HDO, we have been on top of these reports. As we do with any of our holdings, we read the report to try to determine if there is any validity to the claims. We've discussed them in our articles and chat threads. The problem is that as soon as you address one claim, a new one is made up. When you are not bound by being honest, it is much easier to make up new allegations without evidence than it is to prove those allegations false.
MPW isn't the only company that has been the target of such attacks. These types of "reports" aren't new, and they happen all the time. However, when you have a bear market where many stocks are naturally down 30%+, short reports tend to gain a lot more attention. When you have a holding that is down a lot, you are much more likely to listen to fear-mongering than if you have a holding that is up a lot.
It is the opposite of the "meme" hype we saw following COVID. The market was booming, and certain people realized they could use social media to campaign and boost the stock price of holdings they were long in. Now the market is falling, and social media is being used to influence stocks to the downside and boost profits for shorts.
Social media has changed much of the world, and investing is no different. And the laws and regulations have not yet caught up to the new technology. Clearly, nobody wants the SEC to crack down on some average person who makes a tweet about a company that is patently false, but that falsehood stems from an honest misunderstanding or lack of knowledge.
Similarly, if a company is actually perpetuating fraud, we do want people to identify it. However, I think contacting the SEC and district attorneys is a more appropriate course of action than tweeting it.
On the other hand, when someone is paying people to knowingly spread misinformation about a company for the express purpose of profiting from their short position, that can cause real harm to the company, even if they did absolutely nothing wrong - it is like accusing someone of a horrible crime. If people start believing it, the accused could have trouble finding a job, could be harassed, and could be ostracized. Even if there isn't a shred of evidence that they had anything to do with the crime, the rumor alone can have negative consequences.
MPW had enough and has now filed a lawsuit against Viceroy Research and the cofounders of Viceroy personally. The lawsuit is a clear refutation of everything that Viceroy has spent the past several months claiming. Specifically, the complaint focuses on the allegations of fraud, roundtripping, and other accusations of illegal activity. MPW wrote a letter to shareholders addressing the issue here.
This lawsuit is very similar to another short attack on Farmland Partners Inc. (FPI) that HDO author "Beyond Saving" covered and similarly concluded that the accusations in the short report didn't carry much weight. Ultimately, FPI sued the writer of that report and won in court. The all-time bottom for the stock price came within six months of the short report, and then it recovered to all-time highs.
Even as MPW is dealing with the sideshow, it continues to execute its business plan. MPW is just coming off of a major acquisition spree, and the focus for 2023 is reducing leverage and optimizing its portfolio. MPW made great strides towards that with the sale of its Australian properties for $1.2 billion AUD. These were highly leveraged properties as MPW bought them for $1.2 billion AUD with a $1.2 billion AUD term loan. This transaction alone will reduce MPW's debt by approximately 8%.
There is usually a kernel of truth to bearish arguments. For MPW, the truth was that they were overly concentrated in Steward, and their leverage was high - at one point, over 7x debt to EBITDA. These are both facts that management has been upfront about and stated their plan to resolve both of these issues.
The major acquisition spree was, in large part, an effort to reduce Steward as a percentage of their portfolio. The pending transition of the Utah properties will materially reduce MPW's exposure to Steward, on top of the sale of a JV interest in Steward's Massachusetts properties.
On the debt front, we highlighted last year how MPW was working debt lower. MPW has several liquidity events in their portfolio, including the sale of their Prospect properties in Connecticut and the repayment of several loans, including one from Steward.
The bottom line is that management told shareholders what they were going to do, and they are now doing it. CEO Aldag and CFO Hamner have been heading MPW since it was founded. They built up MPW over the years. They led MPW through the Great Financial Crisis, a difficult time for many REITs. They led MPW through COVID. They paid out $16.70/share in dividends and counting.
Since its inception, MPW was significantly outperforming the S&P 500 (SP500), with room to spare, until the price fell dramatically last year and into this year.
These types of selloffs are often fantastic opportunities to buy high-quality companies at a discounted price. MPW isn't doing anything different today than it did from 2005-2020. MPW has faced tenant bankruptcies and difficulties in the past and resolved those issues in a way that was favorable to shareholders.
We have noticed that many folks are commenting on how management is "bad" or "shady," yet there were none of those comments just a couple of years ago. Did management suddenly lose their touch after 15 years? We don't think so. The only thing that has changed is recent price performance and the fearmongering from short sellers.
MPW lays out the sketchy history of "Viceroy Research" in their lawsuit. And at HDO, we have done a very deep dive into MPW's financials, as well as read many of the "reports." In our opinion, the reports are without merit. That is why we have been buyers of MPW all along.
Pick #2: ECC - Yield 15.6%
Every once in a while, you get investment opportunities that provide excessively high yields. A yield that makes you look at it and ask yourself what you are missing. One such investment is Eagle Point Credit Co LLC (ECC). ECC is yielding about 15% at current prices - if you only count its regular dividend. ECC is paying out a supplemental dividend of an additional $0.02/month starting in April for at least the next 3 months and possibly longer. ECC ran into the "problem" of too much taxable income in 2022 and is now distributing that excess to shareholders. As a Closed-End Fund ("CEF"), they are required to distribute a majority of their taxable income. This is a "problem" we are more than happy to help them solve!
ECC invests in "CLO Equity" positions - these are Collateralized Loan Obligations. A CLO is an entity that buys up leveraged loans and then sells off tranches based on repayment priority. The Senior AAA tranche is sold for a high price because it is first in line, and all the other trances can't get paid until the AAA tranche is paid in full. Then each step down the line, the AA, A, BBB, and BB tranches get paid in order. Each collect what it is owed in full before the next level down can be paid. The "equity" tranche gets whatever is left over.
The equity tranches pay the highest yield in part because they carry the highest risk. If any borrowers default, it is the equity tranche that realizes the loss first.
However, another dynamic comes into play, and that is demand. The senior tranches have high demand from conservative institutions like banks and insurance companies. Demand for CLOs is driven by those institutions. The CLO managers are going to create more CLOs when there is high demand for the senior tranches. Yet every CLO will also have an equity tranche, which the manager will hold a portion of, but also has the desire to free up capital to create new CLOs. They are happy to sell them at a discount. This is where CEFs like ECC step in, buying up CLO equity positions and collecting extremely high yields.
CLOs focus on borrowers with "B" credit ratings. Source.
These are "senior secured" loans with a "first lien." Many borrowers are publicly traded, and you will see these loans typically reported as "term loans" on their balance sheets.
While the amount of principal owed to the "debt" tranches is fixed, a CLO is not a fixed group of loans. The manager of the CLO buys and sells loans, with certain restrictions meant to contain risks, such as a limit on CCC or lower loans the CLO can own.
As a result, when loans are trading below par, it creates an opportunity for CLO managers to realize excess returns. The majority of the underlying loans in ECC's portfolio are trading from $80-$100 (par is $100).
When a below-par loan repays, the CLO will receive $100, which it can reinvest into more loans trading at a discount. The excess returns created by this benefit the equity tranche. It offsets any realized credit losses when borrowers default and creates gains above and beyond the interest payments.
CLOs have a reinvestment period where they can take advantage of these variations with any principal that is repaid either at maturity or early refinancing. After the reinvestment period is the "repayment" period, when all principal payments repay the principal of the senior tranches until they are paid in full.
ECC management has been very clear that they prefer to own CLOs that are in their reinvestment period in this environment. ECC's portfolio currently has an average reinvestment period of 2.9 years, meaning that lower loan prices will generally help the long-term returns of their investments for several years.
Low prices are positive for buyers; loan prices are low, and ECC owns CLOs that are in their reinvestment period and are therefore buying more loans. ECC has been buying more CLOs while prices are low. At HDO, we are buying more ECC while prices are low.
Conclusion
Investing in equities carries price volatility risk. The price can go down whenever you buy a common stock, even if the company is performing well. Investors sell for various reasons, but fear is perhaps the most common. Sometimes they sell because of something they read. Other times they sell solely because the price moved.
At HDO, we focus on identifying opportunities that pay a high dividend. These are often stocks that other investors are selling out of fear for reasons that we see are unjustified. This is where we step in and buy the dip, locking in a higher yield for the long term. When the markets are down, our recurrent income goes up! And with time, the fear has a way of fading away, and investors start buying up shares again, pushing back up the price. This provides us with capital gains, in addition to having locked-in big yields.
- The arguments in the MPW short reports are not persuasive to us. MPW is a company that has been publicly traded and investing in hospitals for 18 years, with the same management. During that period, MPW increased its dividend from $0.17/quarter to $0.29/quarter. It went through some tough times with the GFC and COVID, managing to navigate both while providing market-beating returns to shareholders. 2022 was a tough year for hospitals, but it is something that MPW is more than capable of navigating.
- ECC invests in CLO equity tranches. These vehicles own senior secured loans with companies that have credit ratings in the B range. ECC benefits from lower loan prices while being first in line to be impacted by defaults. The combination of rising interest rates and the market's fear of potential defaults has created a situation where ECC has higher earnings and a lower price.
Both MPW and ECC are part of the "High Dividend Opportunities" model portfolio, which currently yields +9% and includes +45 dividend picks. I use this model portfolio as a base for my retirement account. My focus is on growing my income stream one dividend at a time, using a portion of my dividends to reinvest and grow my income further.
The fear of the market has created a unique buying opportunity to grow my retirement income even faster! This is where the dividends you collect come in handy, if you do not have extra cash. You invest those dividends to buy the dip. This is one of many great advantages of being an income investor!
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