3 High Income Stocks For 2011

I have here three high income stocks that very few people like right now. I hope to convince you to be one of the few.

 

Last year my newsletter, Jack Adamo's Insiders Plus had a 48% return versus 3.5% for the S&P 500. In the last five years our Model Portfolio delivered compound annual returns of 18.9%.We've beaten the market six of the seven years we've published. Our risk-adjusted return in that period has beaten the Wilshire 5000 by nearly fourfold. And we've never had a losing year. Not even during the debacle of 2001 - 2002. You don't have to take my word for this. Those statistics are from Hulbert's Financial Digest, an independent service that tracks the performance of over 200 investment newsletters. Insiders Plus gets a lot of leads from corporate insiders, and what we call "smart money."

 

They're brilliant investors with spectacular long-term track records, like Warren Buffett, Jim Rogers and Sam Zell. But a lot of what we do is just plain old common sense and good in-depth analysis.When you can act rationally and see the true value of investments while the crowd is reacting emotionally and without insight, naturally you're going to make much greater returns. Here I have for you three hight income stocks that pay high dividends. Regardless of whether we're in a bear market or not, each of these companies will send you a check every quarter. You don't have to worry about what the market is doing week to week.

 

Each of these high income stocks has also recently had what the average investor thought was a problem. That makes their prices lower, and their current yields higher. Our analysis shows that most of the problems are in people's minds. The actual facts are far more positive. In fact, we believe these high income stocks will trounce the market over the next five years, and they'll start doing it soon.

 

SAIL TO A LOW RISK 7% YIELD

 

Seaspan Corporation (NYSE: SSW) could be a poster child for what we do at Jack Adamo's Insiders Plus. The company is a lessor of container ships. Twelve percent of its stock is owned by insiders. That's a huge amount.Most of the companies in the S&P 500 are less than one-half of one percent insider owned.

 

Seaspan's CEO and founder, Gerry Wang, is well-connected and very familiar with the Asian markets. He has a smart, conservative philosophy for running his company. He only buys a ship if he has at least a five-year lease agreement already in place. Some of the leases are up to 12 years. This may limit the company's upside earnings potential if the spot market for shipping gets tighter, but it also protects it in downturns. It grows its profits by leasing more ships,not by taking chances on higher shipping rates that may not materialize.

 

The company currently has 29 vessels in the water and another 34 on order. All are on contract. Its fleet utilization rate is 99%. Seaspan has no risk from fuel prices or labor contracts. The shipper pays all crew and fuel costs.

 

HATES RISK

 

You might say Wang has a healthy aversion to risk. If you've seen what's happening on Wall Street lately, you know that a large part of the credit crunch stems from no one being sure if the party on the other side of a transaction will be solvent enough to hold up its end of the deal. Seaspan was very attuned to counter-party risk long before Wall Street got religion about it. The company only leases vessels to the 15 largest shipping firms.

 

Nonetheless, the crowd did what crowds do. The high income stock is down nearly 30% from its high, based on irrational fears and a lack of understanding of accounting and finance. Here are the facts:

 

The whole shipping industry has taken a beating in the stock market due to recession fears. But a recession―which I think is a done deal at this point―should have little or no effect on Seaspan. It has no exposure to short-term supply and demand, or spot pricing.With its entire fleet under long-term lease, it would take more than a recession to cut into its profits. A worldwide depression is more like it. Bankruptcies in some of the strongest companies in the industry would have to be filed for these contracts to be broken.

 

Is it possible? Sure, it is.And we might also get hit by an asteroid. But you don't invest based on remote possibilities;you invest based on rational probabilities. That's how you average 18% returns year after year.

 

ACCOUNTING ILLITERACY

 

The high income stock also took a hit recently when it reported a big quarterly loss on mark-to-market decreases in the value of its interest rate swaps.You should have seen the panicked articles on some of the popular investment websites.Absolutely idiotic.The "loss" represents the change in value of the company's long-term interest-rate hedges. Since interest rates are lower now, these swaps have less market value. Hence, the markdown.

 

But the swaps exist solely to stabilize Seaspan's interest expense on its fleet,making earnings more predictable. Cash flow is not affected in the least. They're already paid for, and there's no intention of selling them.Whether they go up or down, the company is going to make the same profit they budgeted. That's the whole point of hedging.

 

Excluding the swaps write down, EPS increased 17% for the year. For a stock yielding 7%, that's an implied total return of 24%.Over time, that should work its way to the bottom line. The company recently raised the dividend for the third time in two-and-a-half years; so, you may even do better than that.

 

MORE IGNORANCE

 

The latest bit of "bad" news that put these shares in the bargain bin is that the company raised capital. It took out a  relatively small loan to take advantage of lower interest rates and pay off higher interest loans, adding profits to the bottom line. It also did a secondary stock offering that increased share count by 15%.

 

The latter is something that often is not good news. It threatens dilution of shareholders' earnings. But, again, this is an instance where you have to look at the individual situation. It has been Seaspan's stated policy to pay out a high portion of its earnings in dividends.As a shareholder, I like this. I know I'm getting paid every quarter, regardless of what the market is doing.

 

The flip side of this, however, is that company expansion usually has to be done with new capital, rather than reinvested earnings. But Seaspan only buys ships when it has leasing contracts in place―presumably profitable ones, as past dividend increases indicate. Given this fact, it is safe to assume that if there is any earnings dilution, it will be modest and temporary. Those in the know seem to think so. Insiders bought $18 million worth of Seaspan in the recent stock offering. And remember: the company was already 12% insider owned.

 

If you're looking to get rich quick, this high income stock isn't for you. But with a current yield of 7% and longterm growth potential conservatively estimated in the 8% to 10% range, this is a high income stock that fits well in the portfolio of any smart investor who's satisfied to get rich at a steady pace and with minimal risk. I'm very comfortable in my belief that in the next five years Seaspan will deliver total returns near our five-year average of 18%.

 

SMART MONEY BUY: BANK WITH BUFFETT

 

U.S. Bancorp (NYSE: USB) is a great balance between solid current income and above-average long-term growth potential. The high income stock currently yields 5.1%. In the 20 years the company has been public its dividend has more than quadrupled. Share price growth has been strong too. The, stock has risen 80% in the last five years alone.With very few exceptions, that has outpaced all the so-called hot, high-tech darlings Wall Street fawns over.

 

Like most banks, USB is struggling lately. That can be expected to continue through the end of the year. But this appears to already priced into the high income stock. In fact, although the company recently reported a slight decrease in Q1 earnings of 62per share versus 63last year, the shares rose 2.8% the next day, bucking the downward trend of most banks. Compared to the disastrous results of its peers, this small decline in earnings was a home run. That's a testament to the company's savvy managers. USB steered clear of the toxic problems that choked most banks. Only 2.7% of its loans are subprime.

 

Full year net for 2007 was $2.43 versus $2.61, a managable decrease considering the climate for banking. Return on equity was 21.3%, and it repeated that achievement in the first quarter of 2008. The board approved a 6.25% increase in the dividend in December.Warren Buffett's Berkshire-Hathaway has been a big holder of USB stock, and continues to buy it steadily. Recent SEC filings show that in the fourth quarter of 2007 Berkshire increased its share of the Minneapolis-based bank by 3 million shares to a total of 75 million―4.4% of its shares outstanding, and up tremendously from its stake of 23 million shares just a few years ago. The Wizard of Omaha knows what he likes and why he likes it. We like it too. And though the remainder of 2008 may see some ups and downs, the high income stock will keep paying its 5.1% dividend until things pick up next year, and the long-term growth kicks in to provide a nice total return.We think that should be from 12% to 15% for years to come.

 

THEY DON'T GET PENN WEST; YOU SHOULD.

 

Penn West Energy Trust (NYSE: PWE) is another high income stock that has been beaten down by lack of understanding and overreactions. The company reported profits for 2007 down significantly from the prior year. However, here too, most of the shortfall was an illusion.

 

Because of a change in Canadian tax law, the company took a non-cash accounting charge for future taxes that it is not likely to ever pay.  The energy business is very capital intensive. Companies are continually investing in assets that build a future store of tax deductions from depreciation. Penn West already has enough of these credits to shelter taxes for years, and they'll keep accumulating more. These taxes only fully hit the bottom line if the company stops investing in equipment, leases, etc. Fat chance.

 

But let's assume for a moment that Penn West runs out of deductions, and the taxes become due. This could, theoretically, reduce cash available for payouts by 25%. Penn West is currently yielding about 13%.A 25% cut would still leave the dividend at 9.75%―there are very few places you can get such a high yield safely.

 

WIGGLE ROOM

 

Another important point to consider is that the company's current payout ratio is only 71%. The payout ratio is the percentage of earnings it distributes in dividends. If it is too high―some royalty trusts pay out more than 90% of their earnings a company runs the risk of having to cut the dividend if energy prices fall.With a payout of only 71%, and energy prices igher than last year, there's likely to be room to increase cash distributions in the year ahead, while still maintaining financial flexibility in the event prices fall.

 

Another knock on the high income stock is that royalty rates have increased in Alberta, where Penn West has a large portion of its oprations.What Joe Sixpack hasn't looked into is that the company uses advanced recovery techniques to get much of its output from low-production wells. This production is sheltered under Alberta's statutes,which seek to promote exploitation of these underutilized resources. There will be very little royalty increase for Penn West under the new rules.

 

The bottom line is that the distributions on these units are likely to remain high for at least another four or five years, and probably longer, even at last year's energy prices. If prices stick anywhere near this year's levels, the payouts will probably be higher―even after the tax increase―than they were before the whole brouhaha began. Total annual returns should be in the 15% to 18% range.