In general, low-priced stocks tend to face significant business headwinds, which exert pressure on the stock prices. Therefore, investors should pay special attention to the fundamentals of these stocks before purchasing them.
On the other hand, some of these stocks may have been punished unjustly due to temporary headwinds. As a result, they may be offering high return potential. In this article, we will discuss the prospects of three high-yield stocks that are trading under $10 and offering yields above 5%.
Whitestone REIT (WSR)
Whitestone REIT (NYSE:WSR) is a commercial real estate investment trust ( ) that acquires, owns, manages, develops and redevelops properties it believes to be e-commerce resistant in metropolitan areas with high rates of population growth. The trust currently owns 57 properties with approximately 5.1 million square feet of gross leasable area.
The properties of Whitestone are located primarily in Phoenix and Houston, with smaller allocations to other major cities in Texas. These areas have favorable demographics, such as income and economic growth. Whitestone believes that its investment properties are resistant to the threat of e-commerce thanks to the essential goods they provide.
Between 2012 and 2015, Whitestone acquired 2.465 million square feet of gross leasable area. Between 2016 and 2019, the REIT acquired 0.778 million square feet of gross leasable area. The decline in acquisitions is due in part to a focus on deleveraging. The leverage ratio (net debt to EBITDA) of the REIT currently stands at seven, which is excessive.
Management believes that post-pandemic investments in acquisitions, re-development and development projects can drive returns of at least 10%. Nevertheless, due to the ongoing deleverage process, we expect the REIT to grow its funds from operations (FFO) per unit by 3% per year on average over the next five years.
Whitestone has provided lackluster guidance for this year. It expects 2.5%-4.5% growth of same-store net operating income and FFO per share of 95-99 cents. The REIT forecasts an ending occupancy of about 94% and potentially higher bad debt of 0.75%-1.50% of revenue (versus 0.83% in 2022). It also forecasts general and administrative expense to rise by about 8% and interest expense to rise 19% due to the adverse environment of rising interest rates.
Due to the impact of high interest rates on the interest expense of the REIT, the stock has declined 31% over the last 12 months. As a result, it is currently trading at a nearly 10-year low price-to-FFO ratio of 9.5, which is much lower than the five-year average of 11.4.
Moreover, Whitestone is offering a 5.3% dividend yield with a healthy payout ratio of 49%. The company had maintained a payout ratio above 100% for several years in a row. Thus, it was forced to cut its dividend by 63% in 2020 due to the coronavirus crisis. However, the reduced dividend has a meaningful margin of safety thanks to the decent payout ratio. Overall, Whitestone is attractively valued right now. Whenever interest rates begin to decrease, the stock is likely to highly reward patient investors.
Gladstone Capital Corporation
Gladstone Capital Corporation (NASDAQ:GLAD) is a business development company ( ) that invests primarily in small and medium businesses. These investments are made via a variety of equity (10% of portfolio) and debt instruments (90% of portfolio), generally with very high yields. Loan size is typically in the range of $7 million to $30 million and have terms of up to seven years. The stated purpose of the company is to generate income it can distribute to its shareholders. It offers its distributions on a monthly basis.
The BDC sector is characterized by intense competition. Therefore, Gladstone does not possess any competitive advantages. In addition, the company is vulnerable to recessions, as some of its borrowers are likely to face liquidity issues during adverse economic periods. Indeed, Gladstone slashed its dividend during the Great Recession and has not restored it to that level yet.
Moreover, Gladstone is highly dependent upon funding costs and the spreads it can earn on its debt and equity investments. As the company borrows funds based on short-term interest rates, the steep increase in short-term interest rates since early last year has formed a headwind for the company. Nevertheless, Gladstone has maintained decent business performance so far.
Gladstone has exhibited markedly stable performance over the last nine years. The consistent business performance is admirable for a company that belongs to the BDC sector. On the other hand, Gladstone has grown its earnings per share by only 0.7% per year on average over the last nine years. Therefore, it is prudent for investors to keep their growth expectations at a minimum.
On the other hand, GLAD stock has become remarkably cheap in recent months. The stock has shed 25% over the last 12 months due to the strong business headwinds facing the company, namely an adverse environment of high interest rates and an economy that has greatly decelerated and may even fall into a recession. As a result, the stock is currently offering a nearly 10-year high dividend yield of 10.1%.
As BDCs distribute most of their earnings in the form of dividends, the payout ratio of 86% of Gladstone is reasonable for a BDC. However, the high payout ratio of Gladstone and its sensitivity to recessions render the dividend of the stock vulnerable. Nevertheless, thanks to its consistent performance record, Gladstone is attractive from a long-term perspective. In the absence of a severe recession, the company is likely to highly reward investors off its depressed stock price whenever interest rates begin to normalize.
The Gap (GPS)
The Gap (NYSE:GPS) is an American clothing and accessories retailer with 3,380 store locations in more than 40 countries. The company was founded in 1982 and operates six business lines: Gap, Banana Republic, Old Navy, Intermix, Hill City and Athleta.
Despite the popularity of its brands, Gap has incurred a collapse in its earnings over the last decade due to cut-throat competition. During this period, its sales have decreased only 3%, but its operating margins have become extremely thin due to competition. As a result, the company has switched from earnings per share of $2.33 in 2012 to a loss per share of -40 cents last year.
Even worse, The Gap is currently facing a perfect storm due to the surge of inflation to sky-high levels. Inflation has greatly reduced the real purchasing power of consumers. Hence, it has taken its toll on consumer spending. As a result, The Gap has provided guidance for a low- to mid-single digit decrease in sales this year. In addition, the surge of inflation has greatly increased the operating costs of the company. It is thus easy to understand why the stock has slumped 70% off its peak almost two years ago.
The Gap is currently offering a nearly 10-year high dividend yield of 6.2%, but its payout ratio is exceptionally high, at 102%. Given also the current business headwinds and the challenges that were facing the company even before the surge of inflation, the prospects of the company are uncertain. If The Gap experiences a recovery in its business, the stock will probably rally, but it is highly risky and speculative. Therefore, it is suitable only for risk-tolerant traders. The vast underperformance of the stock over the last five years (-66% vs. +55% of the S&P 500) is a testament to the excessive risk of the stock.
On the date of publication, Bob Ciura did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.