The Allure of Cheap Insider Yield

 | Feb 28, 2014 | 5:00 PM EST  | Comments
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One of my favorite stock screens combines two of the longest-running market anomalies. A lot of market factors can be arbitraged away over time or, like risk arbitrage and convert arbitrage, are just beaten to death with a flood of institutional money. Price-to-book value and insider buying, however, are harder to exploit since they are based on two things that do not disappear. Underlying asset value of the corporation and legal insider knowledge are permanent in nature, and really are not exploitable to a large degree by huge pools of institutional money. We can debate the underlying reasons for this, but the simple fact is that both have led to higher returns in the past, and I am sure they will continue to do so.

As you can imagine, there aren't many operating companies where both conditions exist right now. Insiders tend to buy when shares have declined in value; there aren't too many examples of that given that the market is at new highs. There aren't too many stocks trading below book value at the moment, either. However, I am seeing strong activity at business-development companies and real estate investment trusts that fall into the classification of alternative-income investments.

Gladstone Investment (GAIN) is a business-development company specializing in debt investments and equity securities, buyouts, recapitalizations, and changes in control investments. It invests across the capital structure, including mezzanine debt, senior debt and equity. The fund functions as a buyout fund and about 80% of its investments are in debt and 20% in equity. As of year-end, it had investments in 26 companies in 14 industries. The average yield on its debt securities is more than 12%, and the majority of that is paid out to shareholders. The company pays monthly dividends and yields 8.9% at the current price.  The CEO, CFO and COO have made open-market purchases of the stock in 2014. The stock trades at a small discount to the total asset value of the fund, so it is cheap enough to consider for long-term, income-seeking investors.

CorEnergy Infrastructure Trust (CORR), formerly Tortoise Capital Resources, owns midstream and downstream U.S. energy infrastructure assets subject to long-term, triple-net-participating leases with energy companies. It owns pipelines, storage tanks, transmission lines and gathering systems used to store or move oil and gas. After a recent offering, the stock trades at a small discount to the asset value of the fund and is currently yielding 7.6%. The proceeds of the offering were used to fund the purchase of a petroleum-products terminal in Portland, Ore., that is leased to Arc Logistics Partners LP (ARCX).  The company already owns pipelines, gas-gathering facilities and electric-transmission facilities that are leased out on a triple-net basis. In addition to the attractive yield, this fund owns a solid collection of assets that should increase in value over time. Four insiders, including the CEO, have been buyers the shares so far in 2014.

Fifth Street Finance (FSC) is a business-development company that lends money to middle-market companies in a partnership with private equity. Typically, the private-equity sponsor provides the equity, which Fifth Street typically complements with some or all of the debt to finance the transaction. As of the end of 2013, the fund had investments in 111 companies with a weighted average yield of 10.9%. More than 80% of the loans are senior secured loans, so they stand to get paid first if something goes wrong with a particular deal. The shares trade right at asset value and are paying a monthly dividend. The annualized yield is 10.2%. Four insiders, including the Chief Investment Officer and CEO, have been buyers of the stock in the past few months.

There aren't many cheap stocks, and not much insider buying activity, either. But when I combine the two factors, I find that the most activity is in alternative high-yield investments. These are very much private equity-type investments in nature, and I am a big fan of them for long-term income portfolios.

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