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Tejon Ranch Co.
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Jubak's Journal
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| | Jubak's Journal
I'm insuring my portfolio with land
We cringe when our investments fall in value. So, why cant we insure them? Ive got some ideas on how to insure myself and some stocks I think will do the job.
By Jim Jubak
Americans insure their homes, their cars, their health, their kids and, increasingly, their pets. So why not their portfolios?
I intend to -- not with an off-the-shelf insurance policy, but by buying stocks that will balance my portfolio in case of economic calamity. I have five rules on how to buy the best stocks as investment insurance and why I think land stocks earn a best buy as long-term portfolio insurance right now. At the end of the column, Ill tell you which stocks I intend to buy and why.
Options are a basic form of insurance most investors are familiar with. For example, if you believe Nasdaq technology stocks are ready to crash in October, you can buy options that give you the right to sell the stocks in the Nasdaq 100 (QQQ, news, msgs) at some point in the future at something like todays price. If the index doesnt plunge, your options could well expire worthless. But still you might consider that premium justified because it protects your portfolio from a potential downside event and costs less than selling and then repurchasing a portfolio when you believe the danger has passed.
Unfortunately, the math isnt always so straightforward. Its often complicated by trying to assess the proper risk/reward ratio. In this instance, think of risk as the premium you pay and the reward as the peace of mind you receive in return. Its relatively easy to calculate the exact cost of buying the policy. Whats not so easy to assess is exactly how much coverage an investor receives for that premium. Nor do these policies have specific termination dates the way that term life insurance or options do. Instead, they rely on the investors own buy and sell decisions to decide how long to keep the insurance in force. And since most equity-based investment insurance isnt leveraged as options are and requires a substantially larger outlay of cash, the biggest cost with these kinds of investment insurance policies is often indirect: Its the opportunity cost of tying up a big hunk of your cash in an investment that might return little or nothing.
The 5 rules of investment insurance
Okay, so lets turn those observations into some rules for picking investment insurance.
Minimize your direct costs. Most investment insurance comes in multiple versions, each with a different set of direct costs. Pick the cheapest alternative for your purposes. For example, an investor interested in using gold as investment insurance can buy gold stocks, in which case the investor pays the usual commissions for buying and selling shares. Or that investor can buy gold shares in the form of an ETF (exchange-traded fund), a basket of gold stocks. Or that investor can buy real gold, in the form of bullion, which carries its own set of commissions for the sale and then costs for delivery or storage of the commodity. Or real gold in the form of the World Gold Councils soon-to-be-launched exchange-traded fund that will be linked to real gold in London and New York.
Make sure that you understand how the insurance that youve picked works. If you dont understand the mechanics of an ETF or are at sea with options, despite your best efforts at self-education, then that insurance policy isnt for you. Dont buy what you dont understand.
Pick investment insurance with the right time horizon. If youre interested in insuring against a market tumble in October, then an option that expires in months is a good fit. If youre worried that the dollar is headed lower over the next 12 months, then you need insurance with a longer life span. If youre looking to protect yourself against a return of inflation or rising interest rates sometime in late 2004 or beyond, then you need a policy with an even longer life span.
Minimize opportunity costs by picking insurance thats actually a good investment on its own. Opportunity costs are the potential returns you give up when putting money into an insurance investment. Sitting in an insurance stock thats going nowhere while you wait for a potential disaster isnt good investing strategy, especially if that disaster youre insuring against is potentially years in the future.
Be clear about what youre protecting against. As any insurance salesman will tell you, people are sold insurance on emotion. Make sure youre not one of them by being as specific as possible about what danger youre insuring against and picking an investment that will indeed pay off if that danger materializes.
Land as my inflation hedge
Okay, now let me show you why I think these five rules argue so strongly in favor of adding a land stock or two to your portfolio.
Start with the last rule and work backward.
My long-term worry is that inflation will resurge thanks to the money the U.S. Federal Reserve and the globes other central bankers are pouring into the worlds economy. Inflation of 2.2%, the August reading for the annual rate of increase in the Consumer Price Index, or 1.3%, the August annual rate for core inflation, just isnt compatible over the long-term monetary growth of 11% to 12% in the United States over the last three months.
Because of that, Im looking for an insurance policy that will pay off if inflation heats up again. Land certainly fits that bill. And land is very attractive as an inflation hedge because investors dont have to worry about the ebb and flow of supply. As the old saying goes, they arent making any more of it.
The companies that Im looking at -- Tejon Ranch (TRC, news, msgs) and The St. Joe Co. (JOE, news, msgs) -- have huge real estate positions.
- Tejon owns 270,000 acres that stretches from 60 miles north of Los Angeles almost to Bakersfield. To put that in perspective, thats a third of the size of Rhode Island.
- St. Joe is a bigger landowner. It has 900,000 acres in Florida, mostly in the northwestern portion of the state.
I think my opportunity costs for using land stocks as inflation insurance are extraordinarily low. One of the stocks that I like most even pays a dividend: The St. Joe Co. recently raised its annual dividend to 48 cents a share from 8 cents. That takes the yield on the stock to 1.4%. Thats better than the 0.93% yield on the 3-month Treasury.
But Im not buying these stocks for their yield but for their potential total return. Both are value stocks sitting on very undervalued assets.
You cant tell that by looking at the usual numbers. Tejon recently traded at $34.86 a share, but it shows a book value of $5.11 a share. The St. Joe sold recently for $32.64 with a book value of $6.29.
But these companies are carrying their huge land holdings on the books at prices that are decades old.
Uncovering the value
To see the value in these stocks, try this math.
Tejon recently agreed to sell 100,000 environmentally sensitive acres of its land to local governments and national conservation organizations that would protect that land from future development. Net land for full commercial development: 170,000 acres.
Next, the company has 14.5 million shares outstanding.
Lastly, divide the number of acres of fully developable and conservation land by the shares outstanding to see how many shares it takes -- and the effective price -- to buy an acre. At todays prices, it takes about 85.3 shares to buy a full acre. So, if you buy the stock now, youre buying in at a rate of roughly $3,000 per developable acre. The investor also gets the proceeds for the sale of each six tenths of an acre of conservation land. (Hard to say what the conservation land is worth, but St. Joe has recently been selling similar conservation land for about $1,000 an acre.)
Three thousand dollars per developable acre is a bargain. Consider: Home builder Lennar (LEN, news, msgs) recently bought Newhall Land and its 20,000 home sites 30 miles north of Los Angeles at a price that works out to about $30,000 a site. And that was still a bargain for Lennar, since the going price in the Los Angeles area can go as high as $100,000 a home site.
It may take investors in Tejon a while to see the full value of their land investment realized in the price of the companys shares, but the value is certainly there.
The same is true for St. Joe, where an investor in the stock can currently buy an acre for about $2,750.
The stocks have the right time frame for me
The next important advantage that these land stocks have as investment insurance is that they have the kind of long time spans that match the speed at which my inflation scenario is likely to unfold. Im not worried about inflation tomorrow or even in six months, but someday. And these companies will be sitting on their land, selling it off slowly, and creating value for investors when that inflationary period arrives.
You dont have to know anything very technical to understand the kind of investment insurance that youre buying here. If you understand the basics of common stocks, you understand the mechanics of this insurance. You know that youll make money as these companies develop and sell off their real estate, creating streams of profits that will be used to buy back shares and pay dividends. The price of the stocks will rise as well along with the increasing flow of earnings.
I calculate a 12-month target price for The St. Joe Co. of $38 a share. Thats about 16% above the recent price. My 12-month target price for Tejon Ranch is $41, a 17% gain from here.
You cant beat the transaction costs
And finally, I think land stocks are a relatively low cost way to add land as investment insurance. The transaction costs are certainly lower than buying real estate directly, and the liquidity is better for investors who might need to move assets quickly to cash and then back into land. Investors do give up the leverage that comes from investing directly in real estate with someone elses money from a mortgage. On the other hand, investing in these stocks does give an investor better diversification than most of us can hope for from a direct investment in a few properties.
So, with this column Ill be buying a hunk of California and a hunk of Florida with Tejon Ranch and The St. Joe, respectively. As insurance, mind you.
Changes to Jubak's Picks
Buy Tejon Ranch Co.
Im buying shares of Tejon Ranch Co. as a hedge against an eventual up-tick in inflation that will drive the price of land higher. And Tejon Ranch owns a lot of land: 270,000 acres that starts about 60 miles north of Los Angeles. I dont think Im sitting on dead money either. Tejon Ranch has just signed an agreement with the Trust for Public Land to protect (but still sell) up to 100,000 of the most environmentally sensitive of those acres. That should enable the company to step up its plans to develop the rest, including a commercial site along Interstate 5. At the October 1 price, shareholders are getting Tejon Ranchs fully developable land for about $3,000 an acre. My price target for these shares is $41 by September 2004. (Full disclosure: I own shares of Tejon Ranch.)
Buy The St. Joe Company
Another intermediate play on under-valued real estate and a long-term play on the return of inflation. At current stock prices, shareholders can buy an acre of the companys 900,000 acres of Florida land for about $2,500. The company thinks its short-term future is headed up too: it recently raised the annual dividend to 48 cents from 8 cents a share. My price target for these shares is $38 a share by September 2004. (Full disclosure: I will be buying shares of The St. Joe Company for my personal portfolio three days after this column is posted.)
New developments on past columns
Third quarter (and other) performance numbers
For the third quarter of 2003, Jubaks Picks gained 4% (after accounting for transaction costs). That compares to a 10% climb in the Nasdaq Composite ($COMPX), a 2% gain in the Standard and Poors 500 stock index ($INX) and a 3% rise in the Dow Jones Industrial Average ($INDU). For 2003 to date, Jubaks Picks shows a 25% rise compared to 34% year-to-date gain for the Nasdaq, 13% for the S&P 500, and 11% for the Dow.
The one-year figures look like this: 38% for Jubaks Picks, 52% for Nasdaq, 23% for S&P, and 22% for the Dow. And lest I forget, the three-year (really ugly numbers) are: Jubaks Picks down 40%, Nasdaq down 51%, S&P 500 down 31%, and the Dow down 13%. The life of the portfolio record from May 7, 1997, to September 30, 2003, for Jubaks Picks is a gain of 67%. During that same period, the Nasdaq is up 34%, the S&P 500 up 21%, and the Dow up 35%. As is my practice, I will update these performance numbers at the end of the next quarter.
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBCs Business Center most Wednesday nights at approximately 5:45 p.m. ET.
At the time of publication, Jim Jubak owned or controlled shares in the following equity mentioned in this column: Tejon Ranch. He does not own short positions in any stock mentioned in this column.
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