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Thursday, November 12, 2009

How To Buy Stocks at a 20% Discount from Current Price

There are a couple ways of buying stocks at a discount to their present value. One way is by investing in closed end funds, also known as CEFs, that are trading at a discount from Net Asset Value, also known as NAV. The NAV is similar to the book value of stocks. In other words the NAV is calculated by adding up all the stocks in the portfolio, and dividing that amount by the number of shares.

A closed end fund is similar to a regular mutual fund except that the trading price of the CEFs can fluctuate way above or way below the NAV. In addition, the number of shares is fixed. There are over 20 closed end funds that are trading at a discount of over 20% of their net asset value. Many investors invest in these discounted CEFs in the hopes that the gap between NAV and price per share will close.

One example is Helios High Yield Fund Inc. (HHY), which is a closed-ended fixed income mutual fund managed by Brookfield Investment Management Inc. The fund yields 6.5% and a based on its current price, trades at about a 20% discount from its NAV of 8.34.

Another heavily discounted CEF is Liberty All Star Equity Fund (USA) is a closed-ended equity mutual fund managed by ALPS Advisers, Inc. which has a yield of 6.7% and trades at a discount of over 19% of NAV.

However, there are plenty of risks. First of all, that gap may exist for years, and can even widen. Second, the gap could theoretically close but the stocks in the portfolio could drop, so still not gain. Third, and probably most important, is that many CEFs hold illiquid, private, or non-trading stocks, and the NAV is based on how the company valuates those shares, which may be a much higher value than what they could get if they tried to dump those shares. In addition, some may own real estate or mortgages.

Occasionally, you see activist shareholders come in and buy up a significant amount of shares of heavily discounted CEFs and force the liquidation of those CEFs, in order to realize the Net Asset Value. WallStreetNewsNetwork.com has come up with a downloadable Excel database of over 35 CEFs trading at a discount of at least 17% to NAV. Before investing in any of these, check out the CEF's web site to see what kind of stocks they own, and how many are illiquid private shares.

Author does not own any of the above.

By Stockerblog.com

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