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Published: July 13, 2009
As an income investor, tech stocks
don't fit your typical investing profile. The problem is most
tech stocks carry a low or non-existent yield.
Tech bellwethers are not known for their generous payouts to
shareholders. The current dividend payout for the S&P technology
sub-index is well under 2%. Google, Cisco and Apple, despite
their long and profitable history, have never paid a dividend.
IBM is comparatively generous, paying shareholders $2.20 a year.
Still, its yield is a piddling 2.1% at current prices.
Given this lack of payouts, does an income investor have to turn
a blind eye to the tech sector? The answer is an emphatic no!
Tech Hybrids Solve the Payout Problem
Exotic high-yield instruments known as CORTS, STRIDES, and ELKS
exist on these same bellwethers -- Google, Cisco, Apple and IBM.
They allow you to lock in double-digit yields of 10%, 11%, 12%
AND participate in the tech rally. And, the yields on these
vehicles are virtually guaranteed.
STRIDES, CORTS, and ELKS? What do these odd names stand for?
Strides--Stock Return Income Debt Securities. CORTS are
Corporate Backed Trust Securities; ELKS--the simple one--stands
for Equity-Linked Securities. You can see why they are known by
their acronyms.
Participate in the Upside
Each one of these oddball securities has their own quirks, but
they all allow you to participate in the current tech recovery
by tracking the gains of the underlying common stock.
Take for example, the Merrill Lynch Callable 12% STRIDES on
Apple (Nasdaq: AAPL) which trade on the New York Stock Exchange
under the symbol AVN. The STRIDES are paying a yield of 11.8% at
current prices, and they're also closely tracking the heady
share price gains of the maker of Mac computers and Ipods.
On March 6th, AAPL hit bottom at $82.33. The STRIDES, which were
issued at $25, traded at $16.39. As AAPL rallied from March into
mid-May, so did the STRIDES. APPL hit a recovery peak of $131.12
on May 5th. The Strides traded as high as $25.05. In other
words, Apple common rallied approximately +59% between March and
May. The gain in the STRIDES was almost proportional at +53%.
Here's why they move in lockstep. The STRIDES mature in
September 2009. At that time, they automatically convert to
Apple shares in the ratio of 0.18750778 per AAPL share for every
STRIDE held. So, when AAPL traded for $131.12, the STRIDE was
worth $24.59 (0.18750778 x $131.12). When you add the $0.75
quarterly dividend the STRIDES paid out during this period, you
get a total equivalent value of $25.34, slightly above the
$25.05 trading price.
Protect Your Downside
Of course, volatility cuts both ways. Income investors who have
not frequently ventured into Nasdaq's domain need to be aware of
both the risks and benefits of tech's share price volatility as
measured by beta.
The Nasdaq 100 index, for instance, has a beta of 1.14. That
means for every point the S&P 500 moves, the tech-heavy index
will move 1.14 or 14% more. Individual tech stocks can have a
higher or lower beta: Apple's beta is an enormous 1.58, CSCO's
1.26, Google's 1.17, while NYSE-listed IBM is a very placid
0.76.
Even so, the beauty of these hybrid products is they participate
in the upside of the common shares, but protect your downside
risk.
Let's go back to AVN. On August 13, 2008, just before the
financial carnage of last fall, AAPL traded at $180.00. The
STRIDES at that time were $26.93. From the August 13th peak to
March 6th low, AAPL shares lost -$97.67 ($180.00-$82.33) or
-54.3%.
Meanwhile, the STRIDES traded as high as $26.93 on August 13th.
Their peak to trough decline, however, was only -39.1%, so an
investor would have been relatively better off holding the
STRIDES rather than the underlying stock.
Return of Principal
Almost all the upside and not much of the downside -- how is
that possible? The beauty of these stock/bond hybrids is they
trade like stock but provide a double safety net of high yield
and return of some principal at maturity like bonds.
STRIDES and ELKS are similar, but STRIDES are generally issued
for two years and ELKS for one. I prefer the STRIDES because you
can lock in a high yield for twice the time of an ELK, and if
the underlying stock declines, it has a longer market cycle to
recover. Also, STRIDES typically make their payments quarterly,
whereas with ELKS it's semi-annually. However, not all stocks
have STRIDES; ELKS are a very close second.
Yield Safety
Payouts on these STRIDES and ELKS are considered senior debt
payments. They constitute a legal obligation for the company,
unlike dividends which are discretionary. As senior, unsecured
debt, payments and principal have a prior claim on the company's
assets above common and preferred stock, in case the company
runs into trouble.
STRIDES are a product of Merrill Lynch, acquired by the Bank of
America (NYSE: BAC); ELKS are issued by Citigroup Funding, a
subsidiary of Citigroup (NYSE: C).
For a while in the fall of 2008, there was some question about
the solvency of both banks, but since then they appear to have
been deemed "too big to fail." The question of their insolvency,
and hence their not making the debt payments on their STRIDES
and ELKS, now appears to have been taken off the table.
Both Citigroup and Bank of America are seeking to convert some
of their preferred share issues into common stock to raise cash.
Their STRIDES and ELKS, however, are not in question.
Good Investing!
-- Carla Pasternak
Editor
High-Yield Investing
P.S. -- In my July
issue of High-Yield Investing I compile a list of my
favorite ELKS, STRIDES, and CORTS with yields of 10.5%, 11.0%,
and even 11.8%. To get the names of the securities and more
information on High-Yield Investing
click here. |
