UTF - Buy The Dip: 8% To 13% Yields Getting Too Cheap

2023-06-19 07:35:00 ET

Summary

• Buying stocks when their prices dip can be a good tactic for income investors, as it allows them to increase their income at a faster rate.
• TriplePoint Venture Growth and Cohen & Steers Infrastructure Fund are two stocks that have seen their share prices decrease recently, making them good buys on the dip.
• TPVG's strong cash flow and UTF's +8% yield and safe sector make them attractive options for investors looking to increase their income.
• I've been buying the big dip for my retirement portfolio.

Co-authored with PendragonY

One of the most common maxims in investing is "buy low, sell high." But in fact, investors often buy high and sell low. While in theory, these maxims are self-evident, in practice, people often don't act that way and, in some cases, do the opposite.

The stock market is one place where people act in ways that, in other circumstances, would be seen as irrational. When shopping in a store, one will often see a display where an item is offered at a reduced price. The whole purpose of the display is so that shoppers can find this reduced-price item, so they will buy it (even when they weren't previously considering purchasing that item).

In the stock market, there is a special order called a stop-loss order, where an investor can set up an automatic sell order if the price of a stock drops. Sure, this order is used to protect unrealized capital gains. However, if you think about it, using this order flies in the face of another investing maxim of "Buy when others are selling".

Another maxim in stock market investing is "Buy the dip!". Why is this a good tactic? Say there is a stock that trades at $10, has $1.20 per share in earnings, has good revenue growth, and pays $1 in dividends. If it drops to $9 because of factors that don't impact its earnings, revenues, or dividends, why would you sell it at $9?

• Would it not be a good deal to buy it at $9?
• Wouldn't a yield of 11% be a better deal than a 10% yield if nothing else, but the share price had changed?
• As an income investor, which is more important? That your 100 shares can now be sold for only $900, or that for an additional $100, you can buy $11 of income instead of $10?

Many investors look at share price declines in stocks that they already hold only as unrealized losses (or even as actual losses). For income investors, it pays to understand that even when shares you own decline in price, there is a potential opportunity to increase your income. Investing in the stock market involves risk, but it also involves reward. Your performance will be better if you look carefully for both and don't focus too much on just one.

Pick #1: TPVG - Yield 13.7%

Two questions are at the heart of the "buy on the dip" strategy. Do we want to own the company? In this case, TPVG is the first one.

TriplePoint Venture Growth ( TPVG ) reported net investment income of $0.53 per share, which is significantly higher than its newly increased $0.40 regular dividend. TPVG had $0.77/share in "spillover" or undistributed taxable income. Based on cash flow, TPVG is clearly outperforming the competition. However, the market did not see it that way, and the price fell dramatically when earnings were announced. This market movement presents an opportunity for income investors. Let's dig deeper into both the TPVG numbers and why the market might see things differently.

So, why the sharp drop in prices, despite the positive cash flow figures? TPVG has three portfolio companies that are seeking bankruptcy protection. Investors are afraid of bankruptcy and often sell at the first sign of it. But is this panic justified?

The TPVG Q1 earnings call is a good place to start to see if there is really any material problem for TPVG. TPVG management already knows of three bankruptcy filings, but investors might be surprised to learn that no loans are in TPVG's highest risk category of "red". Source

The risk rating is a measure of how severe a loss TPVG might expect, rather than a metric of how likely a default is. So, no holdings have red status because management doesn't expect a big loss on any position. TPVG usually takes the senior position when it lends to a company, which puts it in the best position to recover funds in the event of a default. In addition, TPVG will have a lien on specific collateral, like inventory or intellectual property, accounts receivable, etc. This collateral also enhances the recovery TPVG can expect.

TPVG's niche is investing in companies in the late venture growth stages. By definition, this means many of their borrowers are not cash-flow positive. They are reinvesting intensively to grow their businesses in preparation for an IPO and are frequently raising more capital from Venture Capitalists to fund their businesses. Understanding this, TPVG management enters these loans with collateral and other securities in hand to offset the inherent risks.

CEO Jim Labe answered a question on why TPVG was so optimistic about recovering their investment in the companies that filed for bankruptcy by giving those same reasons. While losses remain possible, TPVG's cumulative loss rate is 3% of commitments since its inception.

BDCs, unlike banks in most cases, can take on warrants and direct equity stakes to enhance their returns. TPVG's portfolio has expanded to have warrants in 107 companies and equity investments in 48 companies on top of their debt investments. Most of these investments are set to produce returns that will more than offset any credit losses.

So yes, we want to own TPVG. Now we need to figure out if the price is currently a good deal.

TPVG has, at times, traded at a significant premium to book value. Just last year, it was trading at a 20% premium and paying a lower dividend! With a book value of $11.88, TPVG is now trading at a slight discount.

When you can buy a high-quality BDC like TPVG at a discount to book value, you want to take advantage of that opportunity.

Pick #2: UTF -Yield 8.3%

There are two key points to consider to make buying on the dip work. The first is to buy when the shares have dropped below their long-term trend line. Currently, UTF is trading at a discount that is significantly higher than its 5-year average. This makes for a potentially good price.

Since March, UTF's price is down about 8%.

And looking at the share price relative to the NAV, we can also see that the price drop has exceeded the decrease in the NAV. So not only are the shares trading at a lower price, they are trading at a better value to the NAV.

The next key consideration to buying on the dip is to buy a great company. It isn't enough to just buy a company or fund that the market doesn't like. You have to buy shares in a company or fund that has good performance. Even though market performance and sentiment won't always reflect actual operating performance, the market will eventually grasp this. Before the market realizes it, investors should buy the shares.

So is UTF a good fund that has the operating performance that we want?

Service providers have contractual price increases that provide a high degree of inflation protection, with regulated utilities, energy pipelines, roadways, and airports at the top of the chart. Inflation protection is thus significantly increased in this sector for income investors.

Infrastructure companies maintain their profitability in both good times and bad and can share these profits with shareholders. We like the dividend stewardship from the sector and protect ourselves from the geographic and regulatory risks of individual companies through diversification.

Cohen & Steers Infrastructure Fund ( UTF ) is a CEF diversified across 250 holdings. This is a fund that invests in infrastructure, such as electricity, water, sewage, renewables, highways, etc. The fund's top holdings are highly stable businesses with tremendous competitive advantages in their respective domains. Source

UTF's distribution composition is variable. While recent months have a higher portion of Return of Capital ('ROC'), this shouldn't be a matter of concern considering Cohen & Steers have actively managed this fund and have demonstrated growing NAV and distributions since its inception in 2004. ROC is a concern when it is destructive over the long term, and UTF has ample history of not using destructive NAV to cover its distributions.

Looking at YTD performance, we can see that the total return on NAV for UTF exceeds that of the XLU Utilities Select Sector SPDR ( XLU ). This is yet more evidence that the ROC in the distribution has not been a destructive ROC and is fully covered.

With a +8% yield and a safe sector, grabbing UTF while the price is down offers a great buying opportunity for income investors.

Conclusion

Buying companies or funds when the market hates them, but their fundamentals remain strong is a great way to increase your income at a faster rate. The lower prices mean that your investment dollar buys you more income. And that increased income will give you more income to cover your expenses, offset inflation, or buy even more shares.

TPVG and UTF have both seen their share prices decrease from prior highs. That has mostly been driven by market sentiment or particular market fears that play less of a role than the market sees. This is why I am buying the dip for my retirement portfolio.

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