Don't take on risk in a desperate attempt to capture a higher yield via an investment in a highly leveraged corporation. When most investors enter the supermarket of income investment opportunities, they head straight for the dirtiest, riskiest aisle. They focus exclusively on companies that sport high yields… like stocks paying a dividend yield greater than 10%.
In this aisle, you'll find conventional income investment ideas your broker probably loves… like highly leveraged real estate companies and oil-shipping companies. These companies generally sport low profit margins and require large and ongoing capital expenditures. Yes, there's a time to buy them – after they've gotten wiped out and fallen by 90%. But that's exactly when none of our subscribers will buy them, which is why my best advice is simply to avoid them. They're too risky and volatile.
Let me be a bit clearer about what kinds of income stocks I'd strictly avoid. I'm talking about low-margin businesses that take on enormous amounts of debt so they can pay shareholders substantial dividends. You'll know these companies because they require constant injections of debt financing to operate. This "high debt, low margin, high payout" business model works well until it doesn't work at all.
A good example of what always ends up happening to these companies is the commercial real estate collapse of 2008. REITs are collections of real estate assets bundled together and securitized. Boston Properties is one of the largest owners of office space in the U.S. Host Hotels & Resorts is a giant owner of U.S. hotel properties. Like most real estate concerns, REITs carry large amounts of debt on their books.
REITs enjoyed a steady bull market from 2003 to 2006. As America went wild for real estate, this bull run accelerated into 2007. Prices soared. Large real estate firms took on increasing amounts of debt to leverage themselves to the "boom times."
I knew the boom couldn't last. The most obvious signal the boom was ready to bust came when legendary real estate investor Sam Zell sold his company Equity Office Properties Trust to buy out firm Blackstone in the largest ever takeover of a real estate company (a $36 billion deal). It was a classic case of the "smart money" selling out to "dumb money."
In addition to numerous warnings in the Digest, we published this piece from Steve Sjuggerud about how dangerous commercial real estate stocks were. We knew investors were "reaching for yield" and in a dangerous spot.
The bust I knew would happen came in 2008. All the years of real estate investors collecting high yields were dashed in months. The Dow Jones REIT index plummeted 65%. As I predicted, the giant shopping mall operator General Growth Properties went bankrupt in one of the biggest bankruptcies in U.S. history. It was crushed by a mountain of debt.
The following five-year chart of the Dow Jones REIT index tells the story…
You might be thinking… "But Porter… that was just an unusual one-time event."
Trust me… these "boom and bust" cycles happen all the time in highly leveraged industries. They wipe out years of income payments earned by investors… and huge chunks of capital. They reinforce the saying, "More money has been lost reaching for yield than at the point of a gun."
Let me be clear: I'm not saying you can't make money in real estate stocks… and I'm not saying all REITs are bad… You can make great money in real estate stocks. But most folks are only interested in buying them at the wrong time and the wrong price. That's why most folks should simply avoid them altogether. Don't chase yields with dangerous, highly leveraged businesses.
Regards,
Porter
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