Question:
My friend is living off of his Social Security and a limited stock and fixed income portfolio. His search seems to usually be focused on a high yielding common stock. The most recent one he was considering is American Capital Agency Corp. (NASDAQ: AGNC) with an indicated dividend of $1.25 per year. The stock was recently trading between around $29 and $30 per share, indicating a yield of some 16 or 17%. Is this a good way to pick up investment income?
Answer:
Yes, dividend stocks are a great way to make up for an anemic bond market; however, you must trust in the dividend the stock is paying. American Capital Agency Corp. is a mortgage real estate investment trust (REIT), meaning its revenues are generated primarily by the interest that they earn on mortgage loans. While this particular REIT is operated rather conservatively, their leverage could be a problem. There is a great interest rate risk. The company essentially borrows money for the short term and lends for long term, and needs various hedging techniques to reduce risk.
This company has mostly fixed-rate mortgages in its portfolio, so if rates increase, the company could get squeezed. Every time rates increase, it limits their ability to pay the dividend. As their net operating income decreases, they can be forced to cut the dividend.
American Capital Agency is not a poorly run company, it is just inherently risky. Many investors see the high dividend, but do not realize how fragile it is. It is not like McDonalds Corporation (NYSE: MCD) where there is a constant cash flow.
Question:
Mid-cap companies seem to outperform large-cap stocks and—in my eyes—carry less risk than small-cap stocks. What do you think of this strategy?
Answer:
Investing solely in mid-caps does not offer the diversity we suggest for a well-balanced portfolio. It is true that they have outperformed both large cap stocks and small cap stocks over the last 10 years. Mid-caps tend to perform well coming from a market downturn. They did very well in our last market expansion, recovering to their pre-2008 levels.
Mid-cap is the natural progression of any business. Small cap companies are, generally, more volatile because they have less access to capital, less history and investors expect more when a small cap company issues debt. As they grow, the pressure tends to ease, and the companies become more stable.
Mid-cap stocks—companies that have between $1 billion and $10 billion in market capitalization—make up about 7% of the total stock market, as compared to large cap stocks that constitute about 75% of the market. However a mid-cap often doesn’t stay mid-cap for long. As they grow, they become considered large cap, which was the case with PACCAR, Inc. (NASDAQ: PCAR).
One mid-cap we like is Church & Dwight Company, Inc. (NYSE: CHD). If you are interested in more exposure to mid-caps, you may want to consider iShares S&P MidCap 400 Index (ETF) (NYSEARCA: IJH).
Question:
What do you think of H-P’s latest reorganization plans? I’ve always liked Meg Whitman as a business woman, but I’m unsure about this latest move. HP is about 1% of my portfolio. Should I sell?
Answer:
We believe Hewlett-Packard Company (NYSE: HPQ) holds some promise. CEO Meg Whitman has decided to reorganize the company, combining its personal computer and printing units. This is a move former CEO Carly Fiorina made in 2005, only to be undone six months later by CEO Mark Hurd. We believe printing is a dying business. Whitman’s move is a 180° change from the previous CEO who wanted to sell the PC business. We feel that to survive, H-P must become relevant either in the PC, tablet or cloud computing business. We suggest holding the stock for now, but suggest you should be prepared to sell soon.
Disclosures:
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing.
