Have Patience for Smaller Names

 | Mar 13, 2012 | 2:30 PM EDT
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Along with the NCAA tournament and spring training there are two constant topics of conversation around Chez Melvin these days.

One is what I will call the state of trading. My friends and I are older and have been around the markets a lot longer than many of the young'uns manning the desks today. Among older traders there seems to be a very strong sense of frustration that the current liquidity-flooded world does not respond the way it has in the past. I am not a trader, but I feel their pain as I can clearly see how the liquidity and flood of short-term trading activity have changed the structure of the stock market.

The other is a long-running conversation about getting more income from investment portfolios in the new world of ZIRP.

I talked earlier this year about the dangers of yield chasing. So much money has been directed into the dividend darlings that I think it is best to stay on the sidelines right now. Many of the high-yield favorites have rallied 20% or so far this year and there is a real chance in my mind of locking in capital losses by chasing. It seems that every day I read at least one article or hear a pundit on the tube talking about the joys of dividend investing. This is a huge red flag to me as I am mindful of John Templeton's suggestion that to outperform the market you cannot do what everyone else is doing. Everyone is buying large-cap dividend payers, so it is best we do not.

What we can do in our search for income is continue building our list of smaller less well known dividend payers. There is no rush to buy even here, but we need to have a list of stocks ready to buy when the market does give us an opportunity at lower prices. When we get a strong pullback and we can buy dividend stocks below book value that is not the time to be doing research. That will be the time to be busy entering buy orders.

One that should be on your list is Solar Capital (SLRC). The business development company invests in leveraged, middle-market companies in search of high yield and capital appreciation. About 70% of the portfolio has been invested since the credit crisis and management feels this post-crisis portfolio has been underwritten well enough to have strong risk reward characteristics. Last year they invested $395 million in new and existing portfolio companies and received $338 million in payments and sale proceeds. Solar Capital has more than $300 million to invest as the economy continues to improve. The average yield on the $1 billion loan portfolio was 14.2% at the end of the year. And 99.4% of the loan portfolio was performing with just one $5.9 million loan classified as nonperforming. With a current yield of more than 10% this is one to buy when the market corrects.

I have done very well adding to my stake in California First National Bancorp (CFNB) in weak market environments the past two years. Although it is a bank and takes in deposits, its real business is equipment leasing. The company leases everything from high-end automated manufacturing systems and medical devices to dormitory furniture and school buses. The company takes in banking deposits via online, direct mail and telephone to provide low-cost funding for the leasing business. After a weaker-than-expected quarter this stock has sold off and is now trading at just 83% of tangible book value. If the shares fall below the 80% mark I would start scaling into the stock. With a current yield of 7.25% at today's prices it is one of my favorite income names.

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