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A Question on High Yields

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February 14, 2008 – Comments (1) | RELATED TICKERS: DSU

Ok, I'm looking specifically at a high yield debt fund, BlackRock Debt Strategies Fund, DSU. They currently have a yield OVER 10% Wowee-Zowee! Put this stock in your portfolio and it's a sure fire few points for your CAPS score every year, right? Wait a second, something smells fishy to me...

How can a company currently showing an EPS of $0.40 a share pay a yearly dividend of $0.64...? This means that for ever $1.00 the company earns they are paying out $1.60. If this is a workable business plan, than sign me up! I'd love to be employed by a company with similar practices, like say where an employee's work yielded the company a value of $50,000 so the company paid the employee a salary of $80,000. That'd be awesome! (Sounds like our governments tax stimulus: "You didn't pay taxes? Ok, here's a $300 rebate check.)

The yield is 10.80% of the stock value, which currently priced at $5.57. Now, I expect most of you who would respond to this post will say something like, "But, the market will bring the yield ratio back into perspective by increasing the price of the stock so that the yield is more appropriate for the market, like 5 or 6%." But this argument doesn't fit in here. Because the real problem here is that the yield pays out more than the company makes. The writing on the wall here to me is either cut the yield or skip ahead in the book to Chapter 11.

Perhaps if they anticipated INCREDIBLE revenue growth they could say the yield is foward looking, but I don't think that can be the case on a debt oriented fund, you can only grow revenues so much when you are shrinking your overall investment capital by paying out yields that are too high.

My thoughts are that the only way to fix things are to cut the yield down substantially so that the capital is growing, not shrinking.

I assume that this yield is a sign of real trouble at the firm. If I looking at this from the wrong perspective, let me know.

1 Comments – Post Your Own

#1) On February 14, 2008 at 12:08 PM, FleaBagger (97.96) wrote:

You say right off the bat that this is a fund, but you analyze like it's a company. Two different things, my friend. (Okay, we're not actually friends, in all likelihood: we probably don't even know each other.) A company pays out dividends from its cash flow in order to attract investment and reward those that are financing the company in a less demanding way than bondholders. Funds pay out distributions (or dividends) from the dividends of the stocks/bonds that they hold, as well as capital gains distributions at the end of the year, which are taken as a dividend by Yahoo! Finance and Google Finance (Y!Fin and GFin), and probably every other computerized info service you might use.

What difference does that make, you well might ask. The difference is that figures for earnings and revenue and operating margin and many other valuation metrics for companies are worthless or confusing for funds. They are either other things crammed into those categories by witless software programs or they are unavailable.

How do I value funds?

One of the best ways to value a closed end fund (which I believe DSU is) is to look at the sector or strategy, and see whether or not it usually outperforms other funds in the same sector or strategy. Then decide whether or not you want to buy that kind of asset at this time (in this case I believe it's a leveraged fund of high-yield corporate bonds).

Now see whether it's trading for a premium or a discount to its net asset value (NAV), which might be listed as its book value on Y!Fin or GFin, but to be safe go to cefa.com (that is, Closed-End Fund Association), and look up the ticker. They will give you the NAV as well as other good-to-know info. If it's trading for a discount to NAV, say 10%, you're essentially buying $1.00 of stocks or bonds for $0.90. If it's trading for a 10% premium to NAV, you're paying $1.10 for $1.00 worth of stocks and bonds. It looks like DSU is trading for a slight premium.

But, as you may have guessed, it's more complicated than that. CEF's don't report their holdings down to the minute the way ETF's do. CEF's only report their holdings, I believe, every quarter. So you may or may not be getting the assets you think you're getting, and the underlying assets you get may be overvalued when calculating the NAV.

If the CEF has passed all the tests up to this point, there's still one thing to check out. On cefa.com, be sure to check out the fund's expense ratio (it's just like open-ended mutual funds in that it has managers and advisors and expenses and such). It seems DSU has an expense ratio of 3.16%, which I'm guessing is not unheard of for leveraged bond fund.

Happy Valentine's Day, and good investing!

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