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.
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.
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:
- 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.
- 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.
- 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.
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!