Berko: This goof turns out to be costly
By Malcolm Berko Taking Stock January 18, 2013 5:44PM
Updated: February 21, 2013 6:18AM
Dear Mr. Berko: We bought 25 shares of Lucent Technologies Capital Trust, a 7.75 percent cumulative convertible preferred trust, at $542 a share, which you recommended last August. You said that it was very speculative but that the 14 percent yield was worth it if I could “afford the risk.” The $13,550 investment represented 1.2 percent of our portfolio, and we were comfortable with the risk.
We found a new broker last October (he talks about running for Congress), and he didn’t like Lucent Technologies. He said the interest payment was doubtful, so we sold it at $566, making a tidy $500 profit. With the proceeds, we bought 2,000 shares of Gabelli Utility Trust at $7.71, yielding 7.8 percent, and reinvested the dividends, which we couldn’t do with Lucent. He said Gabelli was safer and had less risk. But it’s down to $6.70, and we have a $2,400 loss.
Lucent Technologies now trades at $881, and we’re sorry we sold it to buy Gabelli Utility. Why is Lucent Technologies doing so well when its parent company, Alcatel-Lucent, is doing so poorly, and why is Gabelli doing so poorly when its generous dividend seems so stable? My broker says Gabelli has no debt, zero leverage and no interest costs. What’s wrong here?
Dear TL: Lucent Technologies (LUTHP — $881) was the mighty and prestigious research arm of American Telephone & Telegraph before the Justice Department dissolved the AT&T monopoly in the mid-1980s, thinking that increased competition would lower telephone rates. Today’s telephone costs are higher than ever, and the average family pays more than $120 a month for cellphone contracts.
Alcatel-Lucent, now LUTHP’s parent, is a French company with $20 billion in revenues that sells communications and network technology around the globe. Alcatel-Lucent (ALU — $1.66) has three problems: 1) It’s a French company, which is not good. 2) Its earnings are not dependable, and therefore 3) some believe that its survival is in doubt.
However, ALU has been in business since 1898. It has faced hard times in the past 114 years, and its survival is not in doubt. So there’s fair reason to believe the interest payments on LUTHP preferred are equally secure. Though your LUTHP position only represented 1.2 percent of your investible assets, it seems this clown needs to impress you with his knowledge about risk. That genius cost you a $7,500 profit.
Gabelli Utility Trust (GUT — $6.70) is a closed-end fund trading at a whopping 24 percent premium to net asset value. Few professionals would recommend a CEF at this dangerously high premium. This goof is dangerous to your wealth and eminently qualified to be a member of Congress.
And contrary to his analysis, GUT’s portfolio is 31 percent leveraged, to the tune of $51 million. But this leverage doesn’t represent borrowed funds because this money derives from GUT’s auction market preferred stocks. Every 60 or 90 days, these AMPS mature. So GUT must refinance $51 million at prevailing (auction) rates every few months, and those rates may be higher or lower than previous rates. Recently, these rates have been trending higher, and higher interest costs reduce GUT’s payout.
When your meathead reviews a financial statement, he should know that preferred stock isn’t carried as a debt (though it functions as a debt) and that preferreds pay dividends that are higher than bond interest. And though the GUT common stock dividend has been a steady nickel a month, the dividend slowly will begin its decline like the stock price, which five years ago was more than $10 a share. A huge 24 percent premium, a declining dividend and rising interest costs suggest GUT must move slowly lower.
Address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at email@example.com.