The Rarest Security on Earth
Bulwarks of Stability
A Hybrid Security by any Other Name
Note from Cabot Wealth Advisory Editor Elyse Andrews: Are you looking for a way to really grow your money? How about the opportunity to turn $25,000 into $88,994? This knockout return is available from a rare security that combines stocks and bonds. Only eight of them exist. In today's issue, Carla Pasternak, editor of StreetAuthority's High-Yield Investing, explains what these securities are and how they work. The only question remaining is this: Why aren't they juicing the returns in your portfolio?
There are only eight of these securities in the world.
They carry an astronomical average dividend yield of 17.2%.
Let's not gloss over that number. In 10 years, a 17.2% yield can turn $10,000 into $48,896. As you can see, a high rate of return can provide an immense gain for your dollars.
These securities marry one common share and a bond issued by the company. The lion's share of the distribution is fixed interest income. The rest of your return comes from the stock dividend powered by the company's cash flow.
And that's before you ink even a dime's profit on the capital gain from the security.
As if all of that weren't enough, these investment vehicles have been bulwarks of stability amid the market turmoil of the last few months.
In fact, they have delivered impressive total returns (including dividends) of +9% so far this year, well ahead of the broader market loss of -12%, as measured by the S&P 500 index.
Double-digit yields and dividend safety often make an uneasy pairing in today's markets, but these securities are a rare exception. Part bond, part stock, these hybrid securities offer the security of a bond's fixed income and the growth potential of a stock.
For example, a rural telecom operator that has issued one of these securities pays a quarterly distribution of $0.42. Each security is comprised of one common share and a note issued by the company paying a fixed rate of 13%. The total distribution reflects a cash dividend $0.17625 per share and an interest payment of $0.24375 per note.
That's a lot to keep track of, so let's flip to the last page: The distributions together with share price gains have contributed to +27% returns so far this year. That makes a 17.2% dividend yield seem outright paltry!
Now, the stock dividend portion of the payout may go up or down--two companies raised their dividends this year, one slightly reduced it, the rest kept them stable. In any case, whatever happens to the dividend portion, the bond payment remains fixed, giving you an extra degree of security in volatile markets. All but two of these securities pay distributions monthly, which provides another layer of payment protection.
In addition, these companies throw off steady cash flow from stable, recession-proof businesses. One is the fifth-largest funeral home operator in North America, another is one of the top 40 local phone operators in the U.S., yet another distributes some of the best known brands of packaged foods in the country. They also count among them the fifth largest provider of school bus transportation services in the U.S., and the nation's leading manufacturer of heavy-duty transit buses.
The companies are industry leaders, but their publicly traded securities lie under the radar of most Wall Street analysts. That's partly because there are so few of them, but also because they originally were designed by Canadian investment bankers for U.S. companies seeking to tap the Canadian capital markets.
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In the early 2000s, these companies were looking for an investment vehicle that would provide a tax-efficient way to distribute their cash flow to shareholders, something like the Canadian income trust but better suited to American tax laws.
The result: A hybrid security that goes by many different names. We call them "income deposit securities," but they are also called "enhanced-income securities" or "income-participating securities."
Whatever name you use, they're essentially the same.
Like Canadian income trusts, they pass along to shareholders almost all their cash flow. Fortunately, however, these securities don't share the same fate of Canada's royalty trusts, which are doomed to disappear in 21 months. As the legislation passed by Canada's federal government now stands, companies that issued these securities are corporations not trusts. As such, they shouldn't need to convert to ordinary tax-paying corporations by January 1, 2011, like Canadian royalty trusts.
Two of these securities trade on major U.S. exchanges. The rest are listed on Canada's Toronto Stock Exchange and also trade over-the-counter in the U.S. A U.S. investor can trade Canadian-listed stocks with either the Canadian ticker or U.S. ticker.
The shares are more actively traded on the Canadian exchange, but Americans can trade online more easily with the U.S. ticker and save the cost of calling your broker. Canadian tickers will give you the most recent price in Canadian dollars, while the U.S. ticker gives you the last U.S. trade in U.S. dollars.
Thanks for joining me on the search for the world's best income opportunities!
Editor of High-Yield Investing
P.S. This rare type of security is one of my favorite investing ideas. I've been recommending one of these enhanced income securities to my readers since 2006. You can get the name of my favorite EIS, plus the names of seven others. All you have to do is click below.