There have been some recent developments over at American Realty Capital Properties (ARCP). First of all, on Monday, the REIT said Nicholas Schorsch, its founder and chairman, and David Kay, its chief executive, stepped down. Chief Operating Officer Lisa Beeson also resigned. The happened approximately six weeks after American Realty Properties disclosed accounting irregularities that erased more than a third from the company’s market value. Then the company’s credit rating was downgraded to a notch below investment grade by Moody’s. To many investors, those are new facts to take into consideration.
Prior to that, I did do some tax loss harvesting. I essentially doubled up my exposure in early November, bought a put, and then 31 days later sold the original shares and the put. I was expecting to essentially keep my shares and do nothing with them, but then decided to think about it again. In this article, I am going to outline my thinking for selling and against selling. Just as a reminder, just because I do something, doesn't mean it is a recommendation for you to act on. Everyone’s situation is different, which is one a one size fit all approach or article should be taken as advise.
1. The cost of capital will increase as a result of the credit downgrade. According to WSJ “Moody’s said the return to a stable outlook would require the resolution of the accounting issues and the timely filing of its third quarter and 2014 financial results. Missteps in resolving its accounting issues and other concerns could lead to another possible downgrade”
This would not be felt right away, but when significant amounts of debt need to be refinanced after 2016, this could be costly. Of course, if the audit does not uncover anything new, then chances are that financial statements will be submitted with the SEC, and the credit rating up for review. Thus, this could or could not affect anything. The nice thing is that in the short-term, credit should not be an issue, because maturities are stacked up and debt does not mature all at once but is spread out over time. In the long-run, access to credit could impede FFO.
2. There was an accounting problem, affecting FFO/share by a few cents/cents. Accounting errors do happen, but the problem with this error was that it was concealed, leading to departure of two key executives in October. While an error of a few cents/share is not that much, it could be an indication that financial reporting is not accurate. If the financials are not accurate, then whoever is putting their money in American Realty Capital Properties (ARCP) is speculating, not investing. Speculation is fine, but it is riskier since the person putting their money in something they hope is doing well, rather than objectively analyzing cold data. The uncertainty is definitely killing a lot of the investors out there.
3. The other reason for selling would be if the company lowered its dividends to shareholders. Given the high yield today, I believe that a dividend cut is already factored into the price. At a price of $8/share, a dividend yield of 6% would translate into an annual payment of 48 cents/share. As a dividend growth investor, I usually sell after the dividend cut is announced, in order to avoid situations where I stick to a position due to behavior failures as an investor. If things get better, and distributions resume their growth, I would get back in. However, if the dividend were cut, I would expect a lot of extra selling by investors and prices falling even lower potentially.
4. Another reason to sell is in order to harvest tax losses. An investor could sell, and buy back in 31 days. Of course, the stock price might go higher during that time period. Or it could go lower, making you feel/look like a genius.
5. For many investors, selling American Realty Capital Properties (ARCP) today is because they seem overwhelmed by the negative news about it. Many investors read all the news releases, then articles on popular blogs or Seeking Alpha and get worried. For some, they sell because they want to “sleep well at night”. In my opinion, this is a bad reason to sell, because most of the companies one holds on to, usually end up having some type of difficulty. While the problems of American Realty Capital Properties (ARCP) are large ( accounting errors (or even fraud), management shake-ups indicating more problems ahead), an investor should not be selling merely because things are tough and they are scared. If you want to sleep well at night, keep your money in FDIC insured CD’s. If one is unwilling to hold on to a stock falling by 50%, then stocks might not be the correct vehicle for them. Also, if one spends all of their time checking stock prices, news about companies they own, people’s opinions on them , or worrying, then maybe they are speculating and not really investing for the long term. However, if they sell because the new information changes their perspective about the company's prospects, they lose faith in management, or they believe the new information makes it difficult to hold due to unreliable financial information, then that is a valid reason to sell.
1. The Real Estate Investment Trust owns thousands of properties under long-term triple net leases. Payments are contractually scheduled to escalate over time, and almost all of the lease costs (rent, taxes, utilities) are paid by the lessee (the tenant). Since those leases are long-term in nature, it would be very difficult for the tenant to get out of them. Therefore, the majority of revenues from those leases are relatively stable. There are some revenues related to sales and management of non-traded REITs. With all the hoopla around the trust, a large portion of those revenues will be going lower. But still, the properties and leases are not going away. Those have a value.
2. The other reason for holding on to the stock is that the value of the properties under its ownership is potentially higher than the current market price. Of course, the value of those properties at $13.25/share was provided by David Kay, who has resigned from the company. So those numbers should be taken with a grain of salt. Assuming the leases are not made up, they should have a value that could be realized. I would say that financing a property that is leased under a 10 year lease might be easier, even if your credit rating is not stellar.
3. The third reason to hold is if one believes that the company would not go under. This is a belief that those problems that the company has are temporary of nature (despite the fact that management has really screwed up big time). A pass-through entity like American Realty Capital Properties (ARCP) would pay a dividend as long as it earns taxable income. Hence, an investor who only focuses on current weaknesses and projects them onto the future is doing what investors have been doing from the dawn of stock market investing – potentially missing the big picture by extrapolating recent losses into infinity. Investors tend to overreact to good news, and overreact to bad news. If the REIT is cleaned up, chances are it could deliver a nice stream of dividends to shareholders going forward.
4. Most investors now believe that Nicholas Schorsch was a toxic influence, hence his departure is actually bullish for the company. Most investors might not know about another REIT that Schorsch built up aggressively in the early 2000s -American Financial Realty Trust. The trust grew rapidly as well, but ultimately the growth was too quick again, and Schorsch was ousted. American Financial Realty Trust, cut dividends by 30% after he was ousted in 2006. The company was ultimately acquired in the next year by Gramercy Capital (GKK). The trust didn’t go under, as it sought to sell assets, reduce liabilities, and match dividends to revenues. The share price was flat for most of 2006 and early 2007, after which it fell by 50%. This was probably due to the beginning of the financial crisis. If interest rates start going up, and REITs in general lose investor appetite, this would be bad news for investors in the REIT.
5. The fifth reason is because most of sales that investors do are not optimal. I have reviewed the sales of companies I have done, and the subsequent purchases, and have found out that in most situations I would have been better off simply to hold on to the original company. Selling is difficult, and it does not mean to never sell. But if one sells when they are scared, they are essentially letting emotions run them. When things are bad, all you get is negative headlines and negative facts. The problem of course is that very often those get priced into the company. Inexperienced investors (myself included) tend to project recent headlines into infinity and sell. However, those experiences have made me think that a large portion of investing is based on facts and data, and the rest is based on personal experiences, biases and common sense. Sometimes however, it might make sense to ignore the data and have a belief that things could get better. I know that when I sold GE, I was expecting it to go under after the dividend cut, since many of the dividend cutters of 2008 went under. I also thought that BP had a lot of issues in 2010, which is why I sold after the cut. In reality, if a company can survive a crisis, it could deliver decent returns. Most investors lack the patience to hold a company stock that has a large loss. However, this is the price to pay for earning equity returns – volatility, uncertainty and negativity. I witness investors losing patience over companies like Intel (INTC), who failed to increase dividends. They sold, and then the shares went up and the dividend was increased – the company had merely experienced short-term weakness. However this weakness was projected onto the future into the potential demise of the company. Same was true for Apple (AAPL) in 2012 – 2013. Many investors, myself included, believed that the future is bleak, but they were proven incorrect.
6. The sixth reason is somewhat correlated with the fifth. It is the concept of opportunity cost. If I sold American Realty Capital Properties (ARCP) today, I would deploy the capital elsewhere. However, other triple-net REITs like Realty Income (O), W.P. Carey (WPC) or National Retail Properties (NNN) look pricey today. Hence, it might not make sense to buy them if I sold. In addition, even after a dividend cut, I could see how ARCP could still offer better yields than the above mentioned REITs and possibly faster distribution growth. (although it will be riskier). I could also purchase oil companies with the proceeds, like ConocoPhillips (COP), Exxon Mobil (XOM) or Chevron (CVX). However, energy companies like those sell a commodity whose prices fluctuate greatly. Hence their income is going to be more volatile and less dependable than that of a company like American Realty Capital Properties (ARCP) which has long-term triple net leases that are stable and growing over time.
When I purchased this REIT, I violated my entry criteria since I purchased a stock with only 2-3 years’ worth of dividend increases. I also chased yield, and did not really dig into the financials, which were not comparable due to the steep pace of acquisitions. Based on my experience of looking at/following financial markets for 16 - 17 years, companies that grow to fast or change strategies too quickly are dangerous and possibly run for the benefit of management egos, not shareholders. The rapid acquisition growth, lack of long-term track record, lack of comparable financials, prior history of Nick Schorsch with AFRT and fat dividend yield, was something that should have raised a red flag for me, yet I kept buying the stock on three occasions in 2013. Now we know that the financials are not very clean, and we have management shake-ups, which means that we might have bigger problems potentially under the surface. Selling the stock today would be the obvious choice, since I am now speculating of whether the company will do fine or not. I do not know whether the financials are fine or not, hence I cannot do an objective analysis of the situation. As Buffett likes to put it, this company is on the “too hard” pile. This is the pile of items to ignore, because based on publicly available information, it is difficult to make a decision. I would assume however that even if the financials are worse than expected, the nature of the business itself has a stable core of long-term triple net leases with dependable revenues. I believe that a large portion of uncertainty is already priced into the company. The dividend cut could lower stock prices – or it could not. What I am saying is that I made a mistake buying American Realty Capital Properties (ARCP) in the first place – hence by selling I am correcting that mistake.
Since my rule is to sell after a dividend cut, and I do expect a dividend cut, I am going to cut my losses there. If the REIT cuts dividends, but then starts raising them again, I would give it a second look. I would keep the few shares I have in an IRA account though, and have dividends reinvested. I am essentially disposing of approximately 80% of my exposure to American Realty Capital Properties (ARCP) (all the shares in taxable accounts). My way of monitoring companies is by owning a few shares in many, receiving alerts on press releases, annual and quarterly reports, and major news on them.
I am also considering selling, because I am realizing that the relentless increase in stock prices, have caused me to soften my entry criteria, in order to put capital to work. When I make my entry criteria less rigid, I am opening the can of worms to buy securities which look cheap, but which might lack in quality. If I compromise on the purchase side, then I am not really sticking to my original strategy, and then I am mostly hoping and speculating, rather than investing. When I buy a company like Johnson & Johnson (JNJ), I expect growth in dividends from a stable time tested company with a long-term track record. If things change, I know that dividends will be cut and I should sell. With a company like American Realty Capital Properties (ARCP) that I bought without requiring as much in terms of track record and management integrity, I do not have a good idea of when I should sell. This is because I didn't really have a good idea of why I bought in the first place. Thus when I don't follow my entry rules, I do not really have the edge, which is dangerous when it comes to investing.
Being too lenient is costly, as I have also been doing dangerous things like buying stocks on margin, in one of my accounts and also selling puts for premiums. Luckily, I have been profitable as stock prices have been rising on those endeavors. I believe the time to cut back on margin and options trading is now, so that I am in a better position to endure the next bear market. Being overconfident in my abilities, being more lenient on my investing criteria, speculating in derivatives and using margin could be the slippery start of a dangerous path towards financial destruction.
I am also in the process of selling approximately 80% of my position in Gazprom (OGZPY), covering almost all puts sold (except for BP, General Mills (GIS) and a General Electric (GE) expiring in 2015 and 2016). Those positions did not match my goal of generating a reliable dividend income that grows over time, and comes from a diversified portfolio of dividend growth companies. While Gazprom could be worth $15 - $20/share easily in a decade, it could also be worth less if sanctions are not lifted timely and Russia is further pushed into a second Cold War. My long-term investment goal is not to speculate on prices, but look for ways to generate sustainable income to live off in a few years. My near term goal is to de-leverage and reduce all margin activities and options selling to minimum in 2015.
For 2015, I will focus on maxing out my 401 (k), SEP and Roth IRA’s and HSA in the first half of the year. This should save me money on taxes, meaning I would have more money to keep to my name and invest. I have also cut recurring expenses like housing, transportation and auto insurance, which should also let me keep more money and invest. I am also going to be more stringent on quality from companies I invest in on a going forward basis.
Full Disclosure: Long ARCP, OGZPY, JNJ, GE, GIS,
- What should I do with American Realty Capital Properties (ARCP)
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