Lessons Learned From ARCP

ARCP always seems to find a way to be in the news.  Whether the company is acquiring a large amount of properties, selling assets, possibly spinning-off a segment of its business, etc., it always seemed the management team was pushing the flooring the pedal trying to improve the company.  Until recently (2nd quarter of 2014), this aggressive strategy kept the share price climbing and allowed ARCP to quickly ascend and compete with the large, established competition (O) in the industry.  And quite frankly, the success of the company, management’s aggressive nature, and the dividend were major factors in my decision to invest in the company.    However, as all ARCP shareholders know, the company has had a very difficult two-week stretch.  In this article, I will summarize what has transpired recently for ARCP and share what I have learned about dividend growth investing from this experience.

ARCP

 Week in Review

I will attempt to briefly summarize the last couple of weeks for ARCP since I am now one of many people who have written about ARCP’s accounting scandal.  Others have done a great job reporting on the matter, so I included links for the source articles if you are interested in learning more about a specific topic.  Last Wednesday, ARCP stock opened with a thud and the stock declined over 20%.  What caused this decline?  The company announce non-reliance on the last two quarterly filings due to the incorrect reporting of AFFO (A non-GAAP measure that adjusts the FFO for capital expenditures).  AFFO is a major non-GAAP measure that is critical in the evaluation of REITs because it is more reflective of a REITs operations than EPS, a GAAP measure.   So misstating this figure has some pretty serious implications.   As a result of the misstatement, the company’s CFO and CAO were terminated immediately and the regulators came knocking at the door.  So new details about the reporting will probably surface daily as a result of the government and independent investigations.  It sounds like we are in for a bumpy ride.

After this development, the market rightfully punished the stock and the value continued to share price plummeted.   As the week progressed, the bad news continued.  The typical class action lawsuits were filed on behalf of shareholders that saw their investments plummet by 30% and headlines doubting management continued to circulate the press.   This week, RCAS Capital Corp. announced it was terminating an agreement to purchase Cole Capital Corp. from ARCP for about $700m.  This original deal was big for ARCP because as the article states, it would help simplify the business model, make it easier to raise capital, and increase earnings visibility.   These events are not going to be the straw that broke the camels back; however, it adds another layer of complexity to an already complex situation for the remaining members of the management team that is trying to recover from the major accounting issues.

Lessons Learned

Again, that was a very brief summary of the recent events that unfolded.  As I continue to watch my market value plummet, I ask myself “Why would you have invested in this company in the first place?”  Believe it or not, there was a time not too long ago when ARCP was a the premier up and coming REIT.  The company was growing at a rapid pace and quickly ascended to become one of the largest single-tenant lessor.   ARCP also paid a monthly dividend that was greater that its main competitor O (At the time of my investment, ARCP was paying a 7% yield).  When I purchased the investment, management announced it was paying a $1/share dividend over the complete fiscal year, which represented about a 10% increase from the prior year (Yes, I did just perform a Dividend Diplomat Stock Screen in hindsight!).  Those were the major factors in my decision to invest in ARCP with an initial position of $2,500.   Instead of moping, complaining, or panic-selling due to this large loss, I would rather use this as a  great learning opportunity to grow as a dividend growth investor.   Buried within each losing investment are golden lessons that will help you, your peers, and whoever you share the story with grow as investors.  My last major loss, Best Buy, was instrumental in my growth as an investor.  With that being said, here are 3 lessons I am taking away from ARCP:

  1. Investors Cannot Predict Fraud.  Alright everyone, I’ll be upfront about something.  I already know this lesson very well.  You cannot graduate with an accounting degree without having this point or any fraud related matter drilled into your head.  However, in light of ARCP’s recent events, I think this is the most important point to reiterate to all investors out there because I do not want others to become discouraged.  It would be easy to quit investing and individual stocks and only invest in diversified mutual funds or ETFS.   As individual investors looking to perform research over individual stocks, we rely on information and analyses that are based off of financial statements and earnings releases that are filed with the SEC or annual reports/earnings transcripts produced by management.   The key here: we rely on statements produced by management for our decisions.  As a result of this reliance, we become susceptible to financial statement fraud.  I guess that is just an inherent risk with individual investing that we all assume when we open up a 10-K and begin our research.   Don’t become discouraged when the fraud becomes public and the stock price dives because others produced intentionally mis-leading statements to cover up the fraud.  Keep on investing, keep on researching, and keep on following your formula because you will find many more gems before you find another ARCP situation.
  2. Longevity of Dividend Growth is as Important as Dividend Growth.  This event is helping evolve my dividend growth investing strategy.  As a part of our dividend stock screener, we will review a company’s to ensure it is continuously increasing their dividend.    This could be a company that is a Dividend Aristocrat and has increased their dividend for decades or a company that has paid a growing dividend for less than 5 years.   ARCP fell into the latter category.  Since ARCP continuously increased their dividend, the passed this third metric and made it to the intense research round.   Why am I bringing this up?  Well, I am a buy and hold portfolio that likes invests in strong companies that pay a growing dividend (Read more about the power of dividend re-investing).   ARCP does not fit this mold because of the company’s short existence.  The company has simply not had enough time to establish a proven dividend growth strategy.  How many financial storms have they had to weather since they began paying a dividend in 2011?   Has their dividend ever been threatened and management still committed to increasing a dividend?  I don’t know, but we will soon find out. In contrast, I could have invested in ARCP’s rival O which has paid an increasing dividend for 18 years.  If my investing strategy is to invest in companies committed to growing their dividend, shouldn’t I focus on companies with a longer, more proven dividend growth track record?  From now on, I will make sure to assess the longevity of dividend increases as a part of my research process.  Let me know your thoughts on this point, I am very curious how everyone else factors in the longevity of dividend increases vs. recent dividend history.
  3. Try to Remove the Current Yield from the Investing Equation. Let me first start with a disclaimer ot this point.  I have a minimum dividend of greater than the S&P 500 for my current investing strategy.  Why expose yourself to the risk of owning an individual stock when you could diversify in a mutual fund that pays a greater dividend?  At least that is my thought process.  To begin this point, once the final stocks you are considering are above your minimum  yield, try to remove current yield from the equation.  I was caught eyeing yield when deciding between ARCP and O.  Both were comparable companies that were becoming the market leaders in the single-tenant leasing industry.   As I continued my research, I could not overlook ARCP’s significantly higher yield and that played an important part in my decision.  If I would have ignored the yield and focused solely on fundamentals and metrics, I most likely would have chosen O over ARCP.  This is due to many reasons and in hindsight, here are a few: ARCP was showing a negative net income at the time of investment, O was proven in the industry while ARCP was just finding its way, ARCP was involved in many major transactions in a short period of time that could potentially backfire, and so on.   Again, my personal strategy is to build a reliable, growing dividend income stream.  Without focusing on yield, I think O would have been a better fit for this strategy.   However, at the time, I simply could not overlook the higher-yield ARCP.   The rest is history!  My investing strategy will once again be altered to reflect this lesson.

Summary

Investing is an evolving art.  There is not one investor out there that has not made a mistake.  Don’t EVER let anybody tell you that.   The most important aspect of sustaining a major loss is to learn from your mistakes, figure out what went wrong, and make the necessary changes to ensure you won’t make the same mistake again.  ARCP has taught me a lot.  I will now place more emphasis on the number of years a dividend has increased and try harder to remove the current yield from the equation.  I am a much better investor today than I was two weeks ago, and that is worth more than the several hundreds of dollars I have lost due from ARCP.

What lessons have you learned from an investment loss?  Did you almost invest in ARCP and decide not?  If so, share why you passed on the company?  If you already owned ARCP, did you sell your shares in ARCP?  What do you think about my three takeaways?  Agree or disagree?  Let me know all of your thoughts.  They will only help us all as investors!

Bert

 

Facebooktwitterredditpinterestlinkedinmail

8 thoughts on “Lessons Learned From ARCP

  1. I was looking at ARCP a few months back when I had some capitals in the RRSP account. I decided not to invest in ARCP simply because we already own a number of REITs in our dividend portfolio and didn’t feel comfortable to invest in REIT that does not have proven history compared to other more established REITs. Although all the numbers look good, I trusted my intuition. I guess that paid off.

    It’s important to learn from any experience. Looks like you’ve done that.

    • Tawcan,

      Thanks for stopping by! This has definitely help me grow as an investor. ARCP isn’t a bad company at all, I just would have made a different investment in hinsight if I reviewed points 2 and 3 of my article. Now I can apply these points to future investments. It sounds like your intuition has proven you well. That was one of my main takeaways and I will definitely consider how long the company has been successful and the longevity of dividend growth.

      What did you choose to invest in over ARCP?

  2. The thing about experience is that it gives you the results first and the lessons later. ARCP is looking interesting though. The accounting issue seems to be minor. They revised numbers weren’t drastically off the reported numbers. And in the end, the company owns real assets that produces tangible cash flow. It’s trading below book value at the moment.

    The only concern is that this definitely hurts ARCP credibility so it’ll be very difficult for them to raise capital to grow at attractive rates. The company will probably not grow at the pace they did previously.

    • The company’s growth will now slow down and improve the long term financial situation.
      They need to focus and fine tune the properties owned. Additional large purchases are
      Not in the best interest of the company and investors. At the present price ARCP IMHO
      Appears to be a good investment. They own good income producing properties many of
      Which were purchased below value and many that have increased in value. The company
      Needs to cut expenses and slow down. Good luck to all.

    • Henry,

      As always, thanks for stopping by. I hope people didn’t take this as a I am very down on ARCP article. Even with the accounting error, it is still a strong company with a great portfolio of assets. The fraud wasn’t with non-existing assets, just the calculation of a non-GAAP item. Do you own any shares of ARCP?

  3. Bert,

    I’m not quite sure I agree with all the lessons here. I most certainly agree with the first lesson – we can’t predict fraud. Fraudulent accounting isn’t relegated to new/high-growth companies like ARCP. Waste Management, Enron, and Tyco are some infamous examples. Such is one of the many risks we take on as an investor. ARCP was a high-risk stock but I felt, and still feel, the risk was priced in.

    But I don’t think you should ignore yield completely. I consider it as part of the valuation of a stock. If a stock historically yields 2.5% and all of the sudden yields 3% because of a drop in the price, you might have an opportunity on your hands. Chasing yield and sacrificing quality, however, is a different story. But I’m not quite sure that’s what happened here for investors. ARCP had (and still has) a huge portfolio of high-quality properties. Take out the RL deal, and it’s extremely comparable, if not better, than Realty Income’s.

    So I’d hate to see people drawing a broad brush here or jumping to conclusions. I’m quite sure that if the accounting scandal had never broke that many investors would be very happy and it would be business as usual. To use the accounting scandal to try and draw conclusions about investing mistakes might be a mistake in itself. It would be like being an investor in Waste Management back in the day and then condemning all trash haulers or trying to pick out errors in your thesis when it was just a management screw-up.

    Just my thoughts on it!

    Best regards.

    • DM,

      Thanks for stopping by. I appreciate your comments and feedback for the article. I understand where you are coming from regarding drawing broad conclusions from this accounting scandal. It would indeed be a mistake to condemn all other comparable stocks just because of an isolated incident. What happens at A does not necessarily impact B through Z. What happened at ARCP is not reflective of O or any other REIT for that matter. Just ARCP. I apologize if that point was not better articulated in my article, because I agree, it is very important as well.

      For me as an investor, whenever I see a substantial loss in my portfolio, I think it is important to reflect on the investment, assess my thought process prior to investing, and see if I missed a potential red-flag. Right now, I have a fairly large loss in my ARCP investment. So why not take a hard look at my investing strategy to see what went wrong? Maybe there is a flaw in my investing strategy that I should add to all of my future investments. That really is the point of the article, to demonstrate how I am evolving my investing strategy going forward.

      That’s where point number 3, chasing yield, comes into play. I think I mislabeled the third lesson from this article. It should have read (to steal your language) “Do not chase yield and sacrifice quality.” I agree with your second paragraph, you shouldn’t ignore yield completely. It should play a role in your investing decision since the ultimate goal is increasing your dividend income. The key point is honing in on the “Chasing yield and sacrificing quality” line that you mentioned in your. What I wanted to emphasize in this article is to make sure you have performed your research about the company and know that you are selecting two quality companies prior to factoring in yield. And you hit the nail on the head. We as investors have to make sure that we are investing in quality before considering the yield. Once you are comfortable with the current yield (i.e. it meets your minimum requirement), put the blinders on and focus on fundamentals. If you are torn between two great investments and current yield is the only difference between the two, great. However, if one company is great and one is average and the only better aspect about the average company is that it has a higher dividend yield, be careful. That was my logic when selecting ARCP over O. ARCP has a large, strong portfolio with a strategy to become the largest in its class. Management backed this strategy up and has been very aggressive to achieve this goal. However, as I mentioned in the article, looking back the one thing that jumped out to me was that ARCP had at the time (And still has) negative earnings. I understand that FFO is the metric to use when evaluating REITs, but one company was showing a negative GAAP earnings and one was showing a positive and has shown positive earnings consistently over its history. While making my final decision, I let the current yield cloud my decision and I overlooked this fact that I would normally place higher reliance on. In hindsight, I think I selected an average company (with potential to be great) and a higher yield over a great company with a lower yield. Each investor has different means for determining if a company is a quality company, so whether ARCP is a great, above-average, average, investment will ultimately be up to each individual investor. In hindsight, without considering current yield, I would have rated the company differently. Another item I wanted to add was that when I made my decision, O was not up 31% YTD like it is now. It was around the $40 mark, so I wouldn’t have been purchasing it at the current premium levels.

      I hope I am not painting this a generic, broad conclusion. I think I had a serious misstep in the evaluation of a company at the time of a purchase for reasons 2 and 3 of my article. I want to use my ARCP experience to evolve and strengthen my investing strategy. At the end of the day, my focus is on building a strong, reliable, growing dividend stream. I don’t want anyone to think that I am convinced ARCP is a terrible company. There are many great things about the company and as you mentioned, the company still has a very strong portfolio of assets. In hindsight, I think O would have just been the better purchase for my portfolio based on the facts that were available at the time of the purchase. This is in lieu of the current accounting scandal. The scandal is just what prompted me to take a hard look at my investment decision because I am now showing a large loss.

      Again, thanks for stopping by and the comments. I hope this provides a little more light on my thought process.

      Bert, one of the Dividend Diplomats

Leave a Reply

Your email address will not be published. Required fields are marked *