Last night I swapped emails with an associate who is thinking about retiring in a couple of years. He was wondering how to position his portfolio from purely growth mode to a mix of growth and income. I, naturally, brought out my soap box and began to preach the gospel of cash and community banks.
If I plan to start drawing dividends out in five years, I want to buy my dividends as cheaply as possible. I want to move to cash and wait for a steep correction to buy my dividends at a favorable price. The market has gone pretty much straight up for six years now, and I just do not see eight years passing between significant market collapses.
I am very much in agreement with Stanley Druckenmiller, who said at this week's DealBook Conference that after a long-sustained period of QE-fueled asset gains, the chickens will come home to roost. The legendary fund manager also said that he could see himself getting really bearish in the near term, but he could not see himself getting bullish. I agree, and while I have no idea when the chickens are going to show up, I am certain that they will. Furthermore, if I am investing for a growth and income portfolio to carry me through my life, then I am waiting for the big sale to aggressively deploy my capital. While there are a few small REITs and dividend-paying bargains, I think a growth and income portfolio should have a significant cash component today.
While that made sense to my associate, he questioned getting involved in small banks, as he was more interested in dividend-paying stocks. He wondered why I would suggest that he load up on these at current prices when he would just be selling them when he retires in a couple of years. After all, it is impossible to predict exactly which trade-of-the-decade stock will get taken over in the next two years and it didn't make sense to him to employ a growth-oriented strategy at this point in his life.
I reminded him that many community banks pay generous dividends right now, and are also cheap enough to qualify as long-term bargains. Best of all, community banks are just entering the sweet spot -- where most of the credit issues are in the rearview mirror and cash that was used to plug holes in the balance sheet can now be used to pay -- and increase -- dividends. Finally, it doesn't hurt that the possibility of a takeover is at a premium, which is equivalent to a decade of dividends.
Mackinac Financial (MFNC) is a great example of trade-of-the-decade dividend stock. MFNC has 18 branches in Northern Michigan with about $750 million in total assets. It is a stick-to-the-basics bank, with almost 70% of its loan portfolio in commercial real estate and single-family home loans. It does a good job of underwriting its loans, and nonperforming assets are just 1.38% of loans. The stock currently trades at just 88% of book value, so it is clearly a bargain bank at the current price. The stock yields 3.75% and the board raised the payout by 33% back in August. Several bank-stock specialists and activists serve as 5% owners, and insiders own 22% of the bank. Buyers of the bank's shares are earning a payout greater than a 30-year Treasury, with high potential of increased payout in the future. As a bonus, there is substantial upside potential for the stock price, as well.
Univest Corporation of Pennsylvania (UVSP) is another example of a solid, growth-and-income bank. It has 15 branches with about $2 billion in assets in Souderton, Pa., not far from Philadelphia. The bank has more of a business-oriented tilt, as slightly more than 50% of the portfolio is in commercial real estate and commercial and industrial loans. Management has done an excellent job of underwriting loans, as nonperforming assets are just 0.88% of total assets, right now. The stock yields 3.94% and trades at 1.1x book value. The bank is also buying back stock and repurchased 86,650 shares of common stock at a cost of $1.8 million under the share repurchase program. It still has more than a million shares to buy under the current buyback program. You get an above-average yield and management that has a strong record of rewarding shareholders. There is also solid upside-potential for the stock price.
Income-seeking investors should include trade-of-the-decade community bank stocks in their portfolio. They have enormous potential for strong dividend-growth and large upside potential as well as an above-average probability of a takeover that unlocks shareholder value.