The Problem with Peak Prices and Record Low Yields:

  • In Seth Klarman’s Margin of Safety Book, he discussed the 1980s junk bond mania before it imploded
  • Back then many bonds were issued by companies that could not afford to pay the interest expense
  • That meant bond owners “claimed to have earned interest income in excess of profits earned by the underlying business”[1]

Klarman asserted this was “financial alchemy” and we are inclined to agree. The chart below shows that despite record low-interest rates, the market cap of firms that cannot afford to pay their interest expenses has never been higher

Stocks With High Dividend Yield

Before we jump into the list of stocks that we believe are among the highest risk in the stock market today, let’s take a moment to review some possible alternatives to investing in bonds. Specifically, investment portfolios that emphasize high quality and income from blue-chip stocks.

KCR’s research team has not been shy in citing the lessons of history. With government bonds, corporate bonds, and bond mutual funds all offering little in the way of yield and, often, lots of duration risk, we believe finding low-risk investments is uncommonly difficult today.

While there are products that offer simple solutions like the “dividend aristocrats” KCR is wary of these naive products. We believe that while the bond market is starving investors of income and safety, there are blue-chip common stocks that offer solid income at lower risks for long-term investors.

As the market embraces the mania for new stocks, like cleantech shares, at higher risk valuations, KCR believes there are terrific opportunities to buy stocks of proven and profitable companies. Our research on dividend investing is prolific. If you just go to our White Papers section and search “dividend” you will see a veritable wall of research. For specific recent examples please click here, here , and here for our Fort Knox stocks and other “tough” firms that pay you to own them!

We would be remiss not to confess that at today’s valuations, short-term investors may be in for a tough go of things. Stocks typically have long-run returns that are driven by the starting valuations as explained in our brief and brutal piece here.

Please find below on the types of investments we think are at the other end of the spectrum! We offer up a list of firms that are little more than “financial” alchemy in our view. Not only are they unable to pay their interest expense from their operating businesses, they trade at exorbitant valuations. We believe when the speculative mania underway ends, these are the stocks that will lead the stock exchanges lower.

Paying Interest Without Profits is a PROBLEM

Approaching 600 names we used some simple criteria to create a narrower list of firms. The below companies suffer not just from an inability to pay their bond-holders out of income but also:

  • The firm cannot pay their interest expenses now and also could not pay them prior to Covid-19
  • Traded at over 10x price to sales – historically a high-hazard valuation metric we briefed in The Rise of the Reckless
  • We excluded bio-tech
  • We only included firms over $1bn in market cap

Please be on the lookout for our upcoming take-aways from our much-cherished copy of A Margin of Safety Risk Averse Value Investing Strategies for the Thoughtful Investor by Seth A. Klarman. While certainly out of style, we are deeply grateful for Mr. Klarman’s teachings about the importance of avoiding investing fads and capital preservation.

We cannot be more emphatic: if you are new to investing and own these names please make sure you do your homework. Ask your money manager why they own them. As our work on the money managers during the internet bubble showed, the people generating the highest returns today may be taking outsized risks with your money. We strongly suggest working with a financial advisor who uses money managers or processes that are time-tested.

One of the things that strike us as most dangerous about this cycle is the role social media is playing in hyping up stocks of dubious merit. We discussed this risk in our Quick Take found here. Nobody knows when the music will end but if you read our take-aways of the works of legendary investors and historians like Seth Klarman or Galbraith, you will quickly see why we are so concerned.

There simply is nothing new under the sun. Manias like today are the rule not the exception. We hope our work helps investors step back, take a breath and slow their thinking and investing down. The quick riches of those around you will, based on hundreds of years of history, become quick losses. While prosaic and out of fashion today, we encourage prudence!

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  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra reading for anyone seeking out more information related to the topics above.

  1. Click the following to read more about What is Stock Speculation, Large Cap Core, Reversion Cycles Trading, What Is Mean Reversion
  1. Margin of Safety Risk-Averse Value Investing Strategies for the Thoughtful Investor, Seth A. Klarman, p. 60


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May 21, 2021 |

May 21, 2021

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