| Capture
Yields of Nearly 10% by Investing in Income Deposit Securities |
Published: September 26, 2006
It was greeted as "an oddball security from Canada" when it
debuted in December 2003. Wall Street pundit Richard Steinberg compared
this new security, inspired by the Canadian income trust, to "the
roach motel where you check in but you can't check out." Steinberg
thought investors wouldn't be able to easily trade this new type of
security since it was so different, and people at the time were still
favoring growth over yield.
Fortunately, not all portfolio managers sang the same tune. Bill
Shrier of CIBC World Markets, which helped launch the world's first income
deposit security (IDS), predicted the yield on these securities
would "beat the pants off" of just about any other investment.
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What makes income deposit securities so unique is they comprise one
share of common stock and one high-yield bond. In other words, about
half of the yield comes from common share dividends that can grow with
the company's cash flow. The rest comes from a high-yield bond that pays
you virtually guaranteed income. Shrier and others argued that if income
deposit securities offered yields of around 10%, then this would be
sufficient to overcome the skepticism that typically greets a new
security.
He was right. It has taken a few years, but in a market driven by fears
of slowing growth and flattening interest rates, the average income
deposit security has rallied to fresh 52-week highs. Although just four
income deposit securities are available on the U.S. market today, they
have surged an average of +26% in the past year -- more than doubling
the performance of the S&P 500 over the same stretch.
But share price gains are not their only attraction. These income
deposit securities also carry monster yields of up to 10%. That's DOUBLE
the average 5% yield on an investment-grade bond, and it's about five
times better than the 1.7% yield for the average stock in the S&P
500 Index.
Plus, all four companies are in defensive industries that should remain
largely immune to an economic slowdown. After all if a recession hits,
who is going to stop doing laundry, having a beer and a hot dog, or
talking on the phone? These are the types of recession-resistant
industries that these four IDS companies are involved in.
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Editor's
Note: Carla Pasternak's model portfolios focus exclusively
on investment opportunities with ultra-high yields. In fact, in each
of her monthly High-Yield Investing newsletters she
provides readers with an entire portfolio of stocks, funds and
preferreds that are delivering annual dividend yields of +10% or
more. That's right -- in order to even be considered for
inclusion in this portfolio, an investment
must deliver cash payments of at least 10% per year. Visit
this link to learn more about Carla Pasternak's High-Yield
Investing newsletter.
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Taxes
The dividends paid by an income deposit security may qualify for the
reduced 15% dividend tax rate, or they may be treated as return of
capital, which is not taxed until you sell the security. The interest
income is taxed as ordinary income, making the shares suitable for
tax-advantaged accounts.
Reporting the dividends to Uncle Sam is not hard. You receive two
1099-DIV forms and simply fill out one for the interest income and the
other for the dividend income.
The stock and bond are "clipped" together because they were
sold as a unit, but a nifty feature of these securities is that, through
your broker, you can "unclip" them, trade them separately, and
re-clip them at a later date. That also means you could hold the stock
in one account and the bond in another, and thereby utilize different
tax advantages.
In fact, if the bonds mature or are redeemed, the IDS would
automatically be separated and trade as common stock. At that time, the
company may decide to extend the maturity date of the bonds or simply
issue new income deposit securities with identical distributions. These
would be automatically exchanged for your old securities.
Valuation
As you can see, income deposit securities don't play by the same rules
as ordinary stocks, so you need to use a different set of tools to value
them. Take their price-to-earnings (P/E) multiples, for instance. The
average P/E for the group is an outrageous 115 times next year's
earnings! Before you turn away, remember that half the security is a
bond, and since bond prices have nothing to do with earnings, this ratio
is always inflated.
In short, we need to keep the lofty P/Es in perspective and instead
focus on the cash flow that powers these distribution machines. One
relevant metric for evaluating these securities is to calculate their
share price as a multiple of cash flow. On that basis, the group is
attractively priced with an average cash flow multiple of around 16 --
roughly on par with the S&P 500's average multiple of 14.
As we said, only four companies have issued income deposit securities in
the U.S. These include a food and beverage firm with a 9.8% yield,
and a laundry equipment company that offers a juicy 8.5% yield.
Throughout the remainder of today's article, we'll bring you an in-depth
look at these two firms, both of which could make excellent opportunities
for income-oriented investors . . .
Important
Note: Throughout the remainder of this article, we
provide a closer look at two of our favorite income deposit securities
(IDS). However, in order to view the remainder of this article, you'll
need to subscribe to our premium income-oriented newsletter -- High-Yield
Investing. After you subscribe you'll receive immediate
access to this full article, as well as our monthly High-Yield
Investing newsletter and a host of additional premium content.
Please visit one of the following links to continue...
Good investing!
Carla Pasternak
Editor
High-Yield Investing
http://www.StreetAuthority.com
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Carla
Pasternak draws on a variety of financial backgrounds to make profitable
calls on income-generating stocks for her readers.
Carla has
been employed in the investment industry for more than two decades. In
addition to her work as a writer for several other nationally recognized
financial publishers, her previous experience includes a position as
President of a well-respected investor relations firm. She has also been
writing shareholder reports for public companies (annual reports,
speeches, corporate profiles, slide shows, etc.) since 1980.
A highly
successful investment analyst, Carla specializes in high-yield,
income-paying stocks. In that pursuit, she's always mindful to select
companies that not only pay rich dividends, but that also have the
potential to deliver strong long-term capital gains.
On the
educational front, Carla holds both MBA and Ph.D. degrees. When she's
not watching the market, she's teaching business courses at the college
level and managing several million dollars in portfolio assets.
