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Another Unusual Income Investment Paying Over 10%By
Tuesday, September 21, 2010
Income has never been more in demand.
As the writer of an income-focused newsletter, I should know. Not only have I welcomed more new subscribers this year than ever before, but our portfolio has soared in value. And every day, I get e-mails from the retired and soon-to-be-retired telling me how desperate they are for income.
The trouble is, income has never been harder to find. Bank accounts don't pay anything... and all the best high-income investments – like real estate trusts, pipeline partnerships, and high-yield bonds – are trading at such large premiums, I can't possibly recommend you put money in them.
Instead, I've had to look for income in more obscure places. In DailyWealth, we've already covered timberland income, income from mortgages, income from tax-lien investing, preferred stocks, insurance companies, and many others...
Today, I'm going to introduce you to a new income idea. With this investment, you should be able to generate minimum 10% returns a year from the stock market... safely.
Ben is a community banker Steve and I know from around town. And he's made a fortune building small local banks and selling them to big banking franchises at a profit. He's retired now, but he still keeps a portfolio of small bank investments...
"As long as a small bank doesn't try to get fancy," Ben once told Steve, "it can steadily grow its dividends. High income with growth, too... A portfolio of small banks is the perfect investment."
Community banks collect deposits, then lend the cash to local businesses and individuals. They pay a low interest rate to depositors, but charge a high interest rate to borrowers. The difference in the interest rates is called the "net interest margin," or "interest rate spread." It represents the bank's revenue.
Have you ever heard regional banking described as a "3-6-3 business"? You borrow at 3%, you lend at 6%, and you're on the golf course by 3 o'clock. Minus the golf, that's pretty much still the case.
Banks also collect fees when you wire money, bounce a check, or overdraw your account. The bank makes a profit for its shareholders if it earns more money from its loans and fee income than it pays in interest and operating expenses.
As long as the bank doesn't "get fancy," it should be able to use this simple business model to crank out 2% returns on assets and 20% returns on capital that are so steady, they're almost boring. If it retains half its profits to grow its business, and distributes the rest as a dividend, it can pay a solid dividend yield that rises every year.
Right now, community banks are as cheap as they've been in two decades, thanks to the ongoing housing slump and all the negative publicity in the newspapers. In my recent research, the community banks I've found that adhere to this "not fancy" business model mostly pay dividends in the 3% range and raise their dividends from 7% to 10% a year over the long term.
Assuming the stock price appreciates at the same rate as the dividend, a portfolio of these banks will generate safe, "boring" average annual returns of 10% to 13% a year.
The best community banks are the most boring ones. They generate high returns by keeping costs down instead of making risky loans. They keep large capital cushions. And they keep their lending discipline, even when other banks around them are going crazy.
To spot these safe banks, I look at the stock price. If it stagnated between 2004 and 2007 (when the rest of the industry went into a bubble) and then kept its value in 2008 and 2009 (when the bubble burst and many loans soured), you know it's a conservative bank. But if the stock price soared then crashed, you know it's an aggressive bank.
I also subscribe to Bank Director's Magazine. Each year, it lists the community banks by profitability, capital adequacy, and loan quality and then ranks them. The magazine calls it the "Bank Performance Scorecard." This list features all my favorite community banks, and it's a good place to begin your research. You can see the 2009 Bank Directors scorecard here.
It's not an easy environment for generating income. Investing in community banks is one solution. As long as they don't "get fancy," community banks are a reliable source of 10% annual returns. And they'll keep your money safe at the same time.
Good investing,
Tom
Further Reading:
Steve found another "brilliant" income opportunity in the banking sector. Right now, a few select banks are collecting government-guaranteed profits... and paying out huge dividends. "Only the government could accidentally create such a fantastic opportunity," Steve writes. "Take advantage of it." Learn how here: Where to Get 17% Interest – Safely.
"If you're using the large national banks... you're wasting money," Tom says. "There are hundreds of safe, well-managed banks out there that would appreciate your deposit... and pay you accordingly." See why regional banks are good for more than their stocks here: The First Thing You Should Do to Increase Your Income.
Market NotesAMAZING PRICE STRENGTH FROM A BIG "CHINA PLAY" Everywhere we look these days, we see pictures of how China is confounding the skeptics...
Like most assets, Chinese stocks enjoyed a huge rally off their panic lows of late 2008 and early 2009. China's benchmark stock index nearly doubled in just six months. Then, the overbought market began drawing big-name skeptics – like legendary trader James Chanos – who think China is a huge bubble ready to burst.
Most Chinese stocks did correct early this year... but have since displayed impressive price strength to resume their bull trends. For example, consider New Oriental Education (EDU)...
New Oriental is the largest private education company in China. The bullish case says, as China grows wealthier, it's going to pay up for more educational services. This makes EDU one of the highest-profile "China plays" on the market. As you can see from today's chart, the bull case is intact and the stock is soaring to new highs.
You can be a China skeptic all you like. But make sure to "mind the market." Right now, it's voting the China story higher and higher.
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