Seek Out Unconventional Yield Sources

 | Oct 17, 2012 | 1:00 PM EDT
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I have received a lot of questions and inquiries about unconventional yield ideas the last few days. The search for yield in today's market has to be one of the more frustrating endeavors for an investor. Those who need income to fuel retirement or other living expenses have had to turn to the equity markets to find income -- and for many of these folks it is a new experience. For the past few years, buying the higher yielding blue chips has worked very well for most income seekers. Now these stocks have been bid substantially higher and there are potential tax changes that could affect them negatively. I have always been a huge fan of what I call unconventional yield sources and now more than ever investors should consider using these securities to provide much needed cash flow.

Before I mention some of the other names I like, I want to make a few crucial points about buying unconventional income. First, it is critical that you buy lots of names in an unconventional yield portfolio. The vast majority of these stocks have worked very well for me over the years, but as we have seen with Common Wealth REITs in the past year or so, not all of them are winners. Some picks just will not work the way you wanted in the time frame you desire. Second, as with everything, make the market work for you and buy weakness when pulling the trigger in search of yield. Third, always try to pay less than the value of the underlying assets.

One REIT I get a lot of questions about is Arbor Realty (ABR). Given that almost all of the funds from operations right now come as a result of debt buybacks I have been asked how I value the company. I rarely use income statements as my sole valuation tool and in this case I do not use it at all. I value Arbor on assets and am incomplete agreement with management's assessment of total value.

On every quarterly investor call for the past couple of years, Arbor CEO Ivan Kaufman has explained his value of the company. In the most recent quarter he said, "Our cash position as of today is approximately $35 million not including approximately $22 million of cash collateral posted against our swaps. We also have around $125 million of net unencumbered assets, these assets combined with our cash on hand. Cash posted against our swaps gives us approximately $180 million of value. This is in addition to approximately $290 million of value between the equity in our CDO vehicles and our real estate-owned for a total value of approximately $470 million." I agree. As it is trading at a substantial discount to asset value with a cash dividend yielding above 7%, I think the stock is a buy on the current post offering weakness.

I also like Star Gas Partners (SGU) at the current level. This is a boring little company that provides home heating oil and propane. Most of their operations are in the northeast and they are the nation's largest retail distributor of home heating oil. Lower temperatures and stiff competition from cheap natural gas have kept a lift on cash flows and the stock price for much of the past year but the company still pays a nice 7.21% yield. If we get a colder winter as many are projecting for the Northeast pricing and profits should improve. This will never be the most exciting stock in your portfolio but Star gas should give you a comfortable payout for some time to come.

BGC Partners (BGCP) is one of the riskier unconventional income names in my portfolio right now. There is a very good chance they cut the dividend in the next six months. Even if they cut in half the stock will still yield over 7% so I think it is worth a small position in your income portfolio. The trading business, especially interest rate trading, has slowed with the continual quantitative easing moves by the Fed and that probably will not improve anytime soon. The real attraction here for me is the real estate consulting and brokerage businesses they have acquired in the past year. Eventually, the commercial real estate markets will improve and when they do BGC Partners should see a strong upwards move in earnings and share price. I would buy a little more here and still more if the stock declines on a dividend cut anytime soon.

Adding unconventional yield to your portfolio can help boost your portfolio cash flows as well as provide potential long-term appreciation. As always, do your homework, stay small and move slow in your search for income.

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