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Two Stocks for Capital Gains Hunters

Marc Courtenay | Contributor
Tuesday, 4 Dec 2012 | 12:12 PM ET
Outside the New York Stock Exchange in lower Manhattan.
Oliver Quillia | CNBC
Outside the New York Stock Exchange in lower Manhattan.

I'm not just referring to gold or silver mining companies when I say I'm "prospecting" for overlooked gems in today's stock markets.

All that glitters isn't gold, and here are a couple of companies with the prospect for exceptional total returns.

On a recent fishing expedition through the oceans of investment opportunities, I came across two companies I'd forgotten. One of them I'd owned in the past. Because I waited until the price of the stock came down to my buy-limit price, I experienced an excellent total return outcome.

For those who don't know what a "total return outcome" is, allow me to explain. If I can find a publicly traded company that is profitable and gushes geysers of cash profits, I begin there. If that company also happens to pay a generous dividend to shareholders I get even more interested.

If I purchase the shares at a reasonable price and I'm able to hold the stock for 12 months or longer, I'm going to anticipate that when I sell that stock for a capital gain I will also have collected most of the annual dividends. The amount of those dividends plus the amount of the capital gains are my "total return outcome."

One way I accomplish this is by utilizing two important disciplines: position sizing and a carefully chosen trailing stop alert system that lets me know (via an email or text message alert) when the stock I own has moved a given percentage below or above the price for which I purchased it.

It's called a "trailing stop" because it follows the movement of the stock price and alerts me when that price has moved a predetermined percentage below my entry price or the highest price that the stock has climbed since buying it.

Let me introduce you to one of the examples of a stock that a total return investment prospector like me would be attracted to.

Prospect Capital is a business development company. It is a private equity firm specializing in late-venture, middle-market, mature, mezzanine finance, buyouts, recapitalizations, growth capital, development, cash flow term loans, and bridge transactions.

PSEC makes secured loans, creating senior debt, first-lien and second lien loans, mezzanine debt and equity investments in private and microcap public businesses. One of its most attractive qualities from an investors' perspective is that it typically invests across all industry sectors, with a particular expertise in the energy and industrial sectors.

More specifically, PSEC invests in oil and gas production, coal production, materials, industrials, consumer discretionary, information technology, utilities, pipeline, storage, power generation and distribution, renewable and clean energy, oilfield services, health care, food and beverage, education, business services and other select sectors. It spreads the risk to a plethora of valuable sectors.

It prefers to invest in the United States and Canada, thus reducing geopolitical risk. PSEC seeks to invest between $10 million to $250 million in companies with ebitda between $5 million and $150 million, sales value up to $500 million and enterprise value of up to $250 million. The company places itself as lien-holders or as senior lenders. This way, if the borrower defaults it may take control of the company.

PSEC finds investing partners to co-invest on larger deals. The firm seeks control acquisitions by providing multiple levels of the capital structure. PSEC was founded in 1988 and is based in New York City.

The current dividend yield based on a share price of $10.48 is a remarkable 11.64 percent. It can afford to be so generous because its investment objective is to generate both current income and long-term capital appreciation through debt and equity investments.

The firm seeks to maximize returns and protect risk for its investors by applying rigorous credit analysis to make and monitor investments. PSEC is a yield-oriented investor and has paid a continuous, regular dividend to its investors since inception.

PSEC is managed by Prospect Capital Management. PCM has been registered as an investment adviser with the United States Securities and Exchange Commission since 2004. PCM, its predecessors and affiliates have a 24-year history of investing in companies and managing high-yielding debt and equity investments, using both private partnership and publicly traded closed-end structures.

Selling at a little over 8 times forward (one-year) earnings, PSEC had stellar results in the quarter ending Sept. 30. Revenue growth (year-over-year) was an amazing 123 percent, and the quarterly earnings growth increased by 18.4 percent.

When you look at the trailing-12-months revenue-per-share trajectory you'd have a better feel for why CEO John Barry owns close to 2.7 million shares and why Vanguard Group owns 4.2 percent of the outstanding shares of PSEC (as of Sept. 29). I'd like to buy shares on a pullback to $10.16 or lower.

The second total-return, capital-gains generator I'm interested in buying is Armour Residential REIT, which invests in hybrid adjustable rate, adjustable rate and fixed rate residential mortgage-backed securities issued by or guaranteed by U.S. government agencies or U.S. government-sponsored entities.

These included MBS owned by Fannie Mae (Federal National Mortgage Association), Freddie Mac (Federal Home Loan Mortgage Corporation) and the Ginnie Mae (Government National Mortgage Administration). Thus it's really a mortgage real estate investment trust with a $2.1 billion market cap and a dividend yield of more than 14 percent per year.

On Nov. 1 the firm reported third-quarter earnings results that included a 17.9 percent annualized ROE from taxable REIT income, according to the company.

The one-year chart below speaks volume about why I want to own shares of ARR at $6.50 a share or lower.

With its greatly improved operating earnings yield, it's no wonder shares of ARR leaped almost 23 percent from its Nov. 15 intraday low of $5.70 to the recent price of $7.00 a share.

Buy these kinds of companies during a stock market correction and you may harvest total annual returns of 20 percent or more.

By TheStreet.com Contributor Marc Courtenay

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Disclosures:

At the time of publication, Marc Courtenay had no position in any of the stocks mentioned.

Disclaimer

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