RVT - Buffett Says Don't Do Dumb Things Buy These Instead

2023-07-14 07:35:00 ET

Summary

• Even geniuses have made costly mistakes with money.
• Humility and emotional intelligence are essential qualities for an investor.
• I am staying away from frenzies and I am buying these +7% yields to boost my passive income.

Co-authored with “Hidden Opportunities.”

When it comes to money, even the greatest investors have made terrible decisions. These poor decisions are certainly not made intentionally, but are the consequences of falling prey to emotions that drive the financial markets and impact the buying and selling decisions of investors:

• Fear and Greed

• Pessimism and Optimism

• Fear of Missing Out ("FOMO")

• Panic and Euphoria

The ruthless grip of the markets showed no mercy, even to some of the most powerful, wealthy, and influential people. Let us review a few investment blunders made by renowned individuals.

Cornelis van der Lijn: The Dutch Tulip Mania in the 1600s is a testament to the unforgiving consequences of misguided investments, highlighting the lasting impact of foolish decisions.

Cornelis van der Lijn, the Governor-General of the Dutch East Indies, was reported to have invested heavily in tulip bulbs during the peak of the tulip mania. Even someone of his stature and position was not immune to the allure of tulip bulb speculation. Like many others, he was caught up in the craze and suffered significant financial losses when the bubble burst.

Sir Isaac Newton , one of the greatest mathematicians and scientists of all time, was also known to be a cautious investor. Much of his money was tucked away in government bonds delivering regular income streams. But he failed to control his FOMO with the South Sea Company. Source .

Disappointed for missing out on the boom and tempted by his friend’s success with South Sea Company, Newton re-entered and suffered losses worth millions of dollars in 21st-century money.

Bill Ackman: A more recent example of dumb mistakes comes from the Valeant Pharma investment by the founder of Pershing Square Capital Management. Bill caused enormous losses for his hedge fund with an outsized position in the stock while failing to see several red flags in the investment, including the complicated operating model and the management team's competence.

Human beings are inherently greedy and impatient. There is no shortage of the dumb things we will see around us from investors letting emotions guide their decision-making.

"New things coming along don't take away the opportunities. What gives you opportunities is other people doing dumb things. The 58 years we've been running Berkshire, I would say there's been a great increase in the number of people doing dumb things." – Warren Buffett.

I am consciously avoiding the allure of hype and the intoxication of euphoria. Through my investment portfolio, I focus on gathering modest yet reliable dividends that support a humble lifestyle. Here are two picks that can help you do the same.

Pick #1: RVT - Yield 7.4%*

In several cases, businesses termed as small-caps are those operating in niche industries or underserved areas of the market. These companies often form a small but critical component within more complicated products, such as a component manufacturer for the iPhone or a Tesla. Small-cap companies command more pricing power than their size might suggest.

As a result of a combination of factors like:

• Higher barriers to entry

• Elevated switching costs

• Differentiated products and services.

Small-cap firms have strong pricing power and are better positioned to handle rising input costs and avoid negative impacts on operating margins. As a result, U.S. small?cap companies have tended to lead the market recovery following bear markets; notably, this sector has led the market recovery following eight of the past ten U.S. recessions. Today, we will discuss Royce Value Trust ( RVT ), a Closed-End Fund ("CEF") with roots tracing back to the Reagan Administration.

RVT currently holds 477 companies in its portfolio that the management team considers those with high returns on invested capital, strong fundamentals, and attractive valuations. RVT is attractively distributed across vital industry sectors led by industrials and IT, essential in the digital age where leading nations are poised to become self-sufficient. Source .

RVT has a unique negative performance penalty, where management takes no fees for any month in which the fund’s performance over the trailing 36-month period is negative. Similarly, management gets a bonus when RVT outperforms its benchmark index, the Russell 2000 (RTY).

RVT massively outperformed the S&P 500 (SP500) during the past bull market run, and leverage had nothing to do with it. RVT operates with a very mild 2% leverage, making it suitable for investors with a lower tolerance for market price volatility. This is simply from the time-tested phenomenon that value (particularly small cap) springs back stronger than the market due to its unique fundamentals and market position.

* The CEF’s variable distribution is based on 7% of the average of the prior four quarter-end NAV, with the fourth quarter being the greater of these annualized rates or the distribution required by the IRS regulations. Since RVT is a Regulated Investment Company ("RIC"), they are mandated to pay out most of their income and capital gains to avoid excise taxes. This is why RVT’s year-end distribution deviates from the distribution plan. Based on the Q1 & Q2 distributions, our calculation for September, and our projection for December, RVT sports a healthy 7.4% annualized yield.

Market prices rise and fall, and recoveries are enjoyed most by those with the patience and discipline to stay invested. While periods like the last 12-18 months have sorely tested every investor’s forbearance, this is when the best portfolios are built and defined. RVT trades at an attractive 12% discount to NAV and presents an excellent investment opportunity to collect sustainable distributions over the long term.

Pick #2: KEY Preferred Shares - Up to 7.8% Yields

Established in 1825, KeyCorp ( KEY ) has 190 years of operating history and is currently the 16th largest financial services and banking institution in the United States. KEY offers deposit, lending, cash management, and investment services to individuals and businesses in 15 states and manages $198 billion in assets. Source .

Two-thirds of KEY’s deposits are covered by FDIC insured or are collateralized. Notably, the bank has significantly scaled back its construction portfolio from the pre-global financial crisis with a 13% exposure in 2022 (down from 42% in 2008). KEY ended Q1 with an 84% loan-to-deposit ratio. KEY senior long-term debt carries an A- rating by Fitch.

KEY’s consumer loan portfolio comprises borrowers with very good credit and a higher concentration of consumer mortgage loans. Source .

KEY increased its common dividend by 5% to $.205 per common share in Q4 2022 and repurchased almost $38 million in stock during Q1 2023. Given market uncertainties, management said they would not be pursuing material share repurchases in the near term. KEY ended Q1 2023 with a Common Equity Tier 1 of 9.1%.

KEY’s $0.205/share common dividend annualizes to an impressive 8.4% yield. Investors must note that this was raised in Q4 2022, and the current quarterly payment came with a 73% payout ratio based on the Q1 net income of $312 million. KEY spent $228 million on the quarterly common dividend and $36 million on the preferred dividends. While the common stock boasts a terrific yield, we seek a safer investment higher up in KEY’s capital stack.

KEY has four classes of publicly traded preferred securities that pay Qualified Dividends and trade at deep bargain levels.

• 6.125% Fixed-to-Float Perpetual Non-Cumulative Preferred Stock Series E ( KEY.PI ).

• 5.65% Fixed Perpetual Non-Cumulative Preferred Stock Series F ( KEY.PJ )

• 5.625% Fixed Perpetual Non-Cumulative Preferred Stock Series G ( KEY.PK )

• 6.20% Fixed-to-Float Perpetual Non-Cumulative Preferred Stock Series H ( KEY.PL ).

The fixed-rate preferred KEY-L may be the best bargain at this time. This security carries a 7.8% current yield, offers 26% upside to par, and is eligible to be called in 2027.

KEY common stock has sold off steeply amidst uncertainties in the banking sector and currently trades at 0.7x book value. While KEY trades cheap and sports a massive dividend at a modest payout, we seek income slightly higher up in KEY’s capital stack. KeyCorp preferred dividends enjoy high safety from the bank’s operations and present attractive investments in this uncertain market. Up to 7.8% yields are up for grabs from this leading U.S. banking institution with almost two centuries of steady operations.

Conclusion

We encounter new market hypes every few years, driving greedy investors to make dumb mistakes. Whether it is the Dot-com mania, the cryptocurrency craze, the NFT madness, the EV ecstasy, or the AI obsession, for 400+ years, the global financial markets have ensnared investors with a multitude of pitfalls, exploiting the vulnerabilities created by human emotions. Nothing has changed, and investors still make the same mistakes in their quest to hit home runs. When financial markets offer the temptation of ever-rising values, not even the smartest people can resist.

At High Dividend Opportunities, we are not looking to hit home runs. Our goal is to have our investments produce predictable and reliable cash flows to sustain our lifestyle. Most importantly, we avoid placing all our eggs in one basket through adequate diversification. Our "model portfolio" has +45 investments targeting an overall yield of +9%.

Today's article highlights two exceptional dividend payers at bargain prices: RVT and KeyCorp preferreds. This selection represents just a fraction of the income investments within our extensive model portfolio. As Main Street eagerly chases the elusive "next big thing," I am steadily cultivating my income. What strategies are you following in these challenging times?

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