Last night I was chatting with friend who works as a financial adviser for one of the world's leading brokerage houses (I think their logo is of an animal) about all facets of investing. We went back and forth, dissecting our investing philosophies, covering topics such as how the Internet is affecting virtually all industries, today's market environment and, of course, the fiscal cliff. The talk naturally gravitated toward investment ideas. That's when he revealed an interesting fact: He is not allowed to invest in securities that trade for less than $6 a share, as they are deemed too risky.
I've always been aware that many investment funds have similar restrictions, but to hear it again just made me laugh out loud. I understand and appreciate the need for the investment industry to protect its clients, but no rule seems more ridiculous to me than the restriction to invest on the basis of an arbitrary number.
Does anyone remember Research In Motion (RIMM) back in 2010, when it was trading for $60? It was the must-own stock, despite the surges being made by Apple (AAPL). Then the shares proceeded to decline by more than 80%, and just a few months ago, shares in RIMM dropped to an all-time low of just over $6. At that price, RIMM was deemed too risky by many people who had raced to buy it at $60, $50 and even $20 a share.
While at times it may be true that low-priced stocks are susceptible to greater volatility than higher-priced stocks, volatility is not risk. How many of us would jump to buy Apple if shares dropped to $300 over the next few weeks? Those who define risk as volatility would conclude that Apple had become too risky. On the other hand, if one views risk at the probability of suffering a permanent loss of capital, Apple at $300 would be viewed as a tremendous investment opportunity.
Rentech (RTK) is one such opportunity that many funds won't allow to be purchased, because the shares trade for $2.82, even though Rentech has a market valuation of $622 million. Rentech owns just over 60% of Rentech Nitrogen Partners (RNF), a stake worth over $800 million, on the basis of Rentech Nitrogen's $1.5 billion market valuation. In addition, Rentech has more than $150 million in net cash on the balance sheet. Rentech Nitrogen currently yields 8%, which equates to an annual distribution of $120 million, over $70 million which goes to Rentech by virtue of its ownership interest in Rentech Nitrogen.
Another name worth a closer look is Universal Insurance Holdings (UVE), a Florida-based property and casualty insurance business. Trading at $4.92 a share, or $180 million market cap, it doesn't make the cut for most investment funds. As a result, you have a name that yields more than 7%, sits on over $350 million in cash and trades at a modest premium to book value. Some individual and special hedge funds have taken notice: Shares are up 23% over the past 52 weeks.
Interestingly enough, funds that are not allowed buy securities trading below $6, $10 or any other arbitrary number are more than eager to buy them once those price levels have been met. In other words, companies that don't qualify for mutual funds or other investment funds offer a big advantage to the individual or smaller investor. It's a chance to buy before the "smart" money comes charging in.
Just look at Motorcar Parts of America (MPAA) an auto parts supplier that was trading for $17 a little over a year ago. An acquisition hiccup sent shares plummeting to less than $4 a few months ago. Shares now trade for $6.40 but still remain out of reach for many professional money managers. Yet most of those managers will pile in if shares get to $10, providing earlier investors which another tailwind to price appreciation.