How to Make Money in Stocks When Cash is King
We’ve all heard pundits refer to the first ten years of the new millennium as the “lost decade.” Folks who invested in a stock-index fund such as the DIAMONDS Trust Series ETF (DIA) at the beginning of 2000 and held it through December 31, 2010 saw a gross return of around zero. Factor in inflation and the real return drops to around minus 3% per year. In other words, cash was king and it would have been better to keep your money in bonds or in the bank.
Some experts, including Martin Pring author of a new book entitled Investing in the Second Lost Decade (McGraw Hill, 2012), believe that with high levels of debt, persistent high unemployment rates and economic turmoil around the globe, that there is a good chance that we will see another lost decade into the 2020s. Suffice it to say that this is not the kind of trading environment that gets a bull (like me) who eagerly awaits the next big rally, very excited.
So what are safety-conscious traders and active investors who aren’t interested in sitting on the sidelines to do in a “Cash is King” market?
Getting Paid to Play
When there is a better chance that stocks won’t be trading significantly higher in the next few months or longer, it’s important to find stocks that have a higher probability of outperforming when cash is king AND that pay you even if prices remain flat.
Defensive stocks such as utilities that can hold up reasonably well during weaker economies are one option but, if utilities stock prices stay flat, what sort of dividends do they pay? A recent check revealed annual dividend yields around 5% or lower for dividend-paying utilities trading on U.S. exchanges. Well-known names such as Duke Energy (DUK), First Energy (FE) or Allete (ALE) paid dividend yields around 4.5%. Edison International (EIX) is near the bottom of the pile and paid just 2.8%.
One sector that has been performing well this year has been real estate, specifically residential investment and commercial real estate. The combination of falling home prices and a high number of foreclosures have pushed many former or new would-be homeowners into the rental market and rents have been increasing in many areas of the country. Real Estate Investment Trusts (REITs) which hold either rental properties or mortgages on these properties have been doing very well as a result. Some also pay very generous annual dividends of 10% or more so investors get paid to own the stock even if it doesn’t go up in price.
Unlike trading short-term stock positions where the technicals alone often determine which stocks to buy and sell, finding defensive stars requires a good understanding of the fundamentals such as price-earnings ratios, revenues, current and forecasted earnings as well as dividends and dividend yields. Here are a few recent favorite stocks in which I’ve highlighted the key fundamentals that attracted me to them.
American Capital Agency Corporation (AGNC) – This REIT invests in leveraged mortgage securities and collateralized mortgage obligations (CMOs) which are guaranteed by government sponsored enterprises such as the Federal National Mortgage Association (Fannie Mae), Freddie Mac (Federal Home Loan Mortgage Corp) and Ginnie May (Government National Mortgage Association). As of July 10, 2012 the stock paid an annual dividend of $5.45/share for a dividend yield of $15.6%. According to VectorVest.com, the one-to-three year forecasted annual earnings growth rate is an impressive 23 percent. Growth to PE (GPE) which is the ratio of growth to the price/earnings multiple is also impressive at 3.5. Any stock trading above a GPE of 1.00 is generally considered undervalued. Sales over the last 12 months grew at a very impressive 212% and the company has a price/sales ratio of just over 7.
Investco Mortgage Capital Incorporated (IVR) – This REIT primarily invests in and manages commercial and residential mortgage-backed securities and loans. Earnings for the next 12 months are forecasted at $2.90/share and the company pays an annual dividend of $2.75 with a dividend yield of 14.75%. Its one to three year forecasted earnings growth rate is 13 percent with a GPE of 2.
Armour Res Enterprise Acquisition Corporation (ARR) – This company may have the most generous annual dividend yield of the group at 16.5% but it does not have significant operations so must be considered more speculative. The company intends to acquire through a merger, stock exchange, asset acquisition an operating business. It has a leading 12-month earnings per share forecast of $0.91, forecasted one to three year earnings growth forecast of 37 percent and a GPE of 4.6. It currently pays an annual dividend of $1.20/share.