Bonds

I spent my entire career investing in public equities. Nothing complex. Just buying small companies for a discount to their implied intrinsic value. I’m a value investor so my goal is to buy undervalued assets under liquidation value. After figuring out liquidation value I model out the stream of cash flows for an indefinite period of time.

It sounds easy in theory, but buying undervalued assets, understanding the business model and knowing when to sell, is an extremely challenging task. Outperforming the market is possible, but it requires a ton of work, discipline and mental fortitude. There is a reason why excellent portfolio managers get paid so much.

Throughout my investing career I have only focused on public equities because I couldn’t really get a good return in any other security.

• I have looked at multi-family real estate deals multiple times, but could never get a return better than 10%. If I was going to take on debt to buy real estate and lever up, I need a better return than 10%, which is easily achievable through the S&P 500.

• Crypto wasn’t really around when I first started investing. You could buy it on the dark web to transact in drugs, guns and other illicit materials. But no one was trading bitcoin at the time like it was a security. It was a means to transact for goods and services.

• Bonds just didn’t seem sexy at all. Why would I invest in a corporate bond for a 3-4% yield when I can buy a basket of cheap net-nets? A 3-4% return is not why I got interested in investing. I got into investing to make 20% annual returns.

• I think I bought one preferred stock my entire life in a shipping company when I first started investing. I had no idea what I was doing and the company ended up being a fraud and going to zero. My $250 bucks in this preferred stock was a donut. Since then I have looked at some preferred issues, but in almost all cases, the common seemed like better risk/reward — plus I got voting rights in the common.

I bring up this topic because the world has drastically changed for any fundamental investor. For the first time in my life, there is actual yield in treasuries, bonds and other fixed income instruments and any serious investor should take note of the opportunity.

I decided to write about this topic when scrolling the Grit Alpha Telegram channel this morning. One of the members asked me my opinion on a name that I have covered for the past two years. The stock has sold off and they mentioned how it has a 5% yield and it might be good for bottom picking a value name.

In a world with zero percent interest rates, a 5% yield on a common equity would be incredible. Especially since this equity has zero debt and generates free cash flows, in every part of the business cycle. But in today’s world, you can now get a 5.22% yield on a three month treasury, and theoretically take zero business risk to do so.

What this means is we should seriously consider taking a hard look at fixed income securities as there is a real yield. Said differently, when interest rates were at zero, discount rates to underwrite an investment were ultra-low. I saw investors modeling sub-5% discount rates in some instances. With interest rates now 5%, investors are now modeling with 10% plus discount rates, because they can get a 5.22% risk free return in treasuries.

When I first got into investing I read Security Analysis by Ben Graham. It was a challenging book and many of the principals laid out in the text revolved around fixed income securities. When Graham first published Security Analysis, serious investors spent a significant amount of time analyzing fixed income securities, as you could get a great rate of return in them. Interest rates were not at zero and it wasn’t hard to find an A rated corporate bond with a 10% plus yield.

I don’t remember exactly what Graham said in security analysis, but he mentioned many times how fundamental investors should analyze and invest in a bond before the equity because you get yield and if the business goes bankrupt there is hope of some recovery in the bond. To invest in an equity over the bond you need significant upside.

Over the next couple of weeks I am going to start screening for corporate bonds with a 10% plus yield and limited downside.

Fixed income is a new frontier for me.

P.S.

I dropped the link for the Telegram channel for all members of Grit Alpha Pro below. Feel free to use this link if you want to chat with 500 other investors.