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Thursday, July 11, 2013 - 13:00

Revealed: Buffett's 'Magic' Formula For Beating The Market

Thursday, July 11, 2013 1:00 PM

Whenever I need inspiration for a new stock idea, I think about Levi Strauss.

Yes, Levi Strauss -- the man who invented blue jeans.

As a scrappy European immigrant to the land of opportunity, Strauss went West during the California Gold Rush in the mid-1800s seeking his fortune. But he didn't go as a prospector. Instead, Strauss made his first fortune selling pickaxes, shovels and other supplies to 49ers in search of gold. His second and much larger fortune was made when he decided to make pants out of tent canvas, dye them blue with indigo and sell the durable outerwear to would-be gold miners.

Simply put, Strauss was an expert in finding trends and profiting from them.

This kind of savvy reminds me of a company I've followed for more than a decade now. I'm talking about Senior Housing Properties Trust (NYSE: SNH), a real estate investment trust (REIT).

And I like this company particularly now, because it's seizing a huge opportunity to make a lot of money.

Let me explain.

Every day in the United States, 10,000 people turn 65. As those people get older and need more care, they'll need somewhere to go. Senior Housing manages a $5.3 billion portfolio consisting of nearly 400 properties that include senior-living centers, skilled-nursing facilities, medical office buildings and wellness centers across 40 U.S. states.

Obamacare Headwinds? Fuggedaboutit
Considering the rapidly changing landscape of U.S. health care, it's easy to see why Senior Housing could face significant headwinds at first glance. After all, the largest portion of the nation's aging population still heavily relies on government subsidies such as Social Security and Medicare to help pay for senior lifestyle and care facilities. In this sense, a health care REIT would likely be negatively affected by slow government pay and the fiscal uncertainty of federal entitlements.

But that's not the case with Senior Housing. About 94% of Senior Housing's net operating income comes from private-pay properties. This means tenants pay out of their own pockets, rather than relying on a government subsidy or voucher system. So the company's dependence to government reimbursement (and the uncertainty that comes with it) is extremely limited. In addition, about 32% of the properties are multi-discipline medical office buildings with blue-chip health care tenants such as Stryker (NYSE: SYK), Boston Scientific (NYSE: BSX) and Quest Diagnostics (NYSE: DGX).

Strike Gold With The Golden Years
The U.S. population of 85-plus is growing at a much faster rate than the rest of the country's population, according to the U.S. Census Bureau. By 2025, the population of 85-plus is projected to grow by 25%. By comparison, the under-85 population should grow just 15% over the same period. Over the next four years, the 85-plus population is expected to grow 10% larger than it is today -- twice as fast as the under-85 population.

These undeniable demographic trends and the stock's consistent performance make Senior Housing a great addition to any retirement portfolio. It's already a core holding in many of my clients' portfolios.

The company has been expanding quickly. This past year, Senior Housing raised more than $650 million in capital market transactions and gained access to a $750 million unsecured credit facility. Despite this fast growth, it's been able to keep its balance sheet less leveraged than many REITs', with a debt-to-capital ratio of just 37%.

In addition, the company has performed consistently through the years. In addition to a growing stock price, Senior Housing has steadily raised the dividend from $1.20 a share in 2000 to a recent $1.56 a share, which brings the yield to just over 6%. Add that to capital appreciation, and you have a compounded annual return of 47% during the past 13 years. Not bad for a "lost decade" of investing...

The fact that REITs are required by law to pay 90% of their income as dividends to shareholders -- regardless of whether their share price goes up or down -- makes this an even sweeter deal.

Risks to Consider: Although the lion's share of Senior Housing is private pay -- which implies relatively affluent tenants -- tougher economic conditions or external circumstances such as inflation, could affect the company's pool of qualified prospects in the senior lifestyle and assisted-living segment. In addition, as part as their different tax structure, REITs don't pay income taxes. This means their dividends are usually fully taxable.

Action to Take --> I see Senior Housing as a long-term holding, especially if you are building a retirement, income-focused portfolio. This doesn't mean the stock can't perform well in the short term. Based on favorable long-term demographics and the company's history of consistency, a 12-month price target of $29 is completely reasonable.

P.S. -- Stocks like Senior Housing Properties are similar to a special group of securities we call "Forever" stocks. These are world-dominating companies that pay investors a fat dividend, dig a deep moat around their business to fend off competitors and buy back massive amounts of stock, boosting the value for the rest of the shares. They're solid enough stocks to buy, forget about and hold "Forever." To learn more about these stocks -- including some of their names and ticker symbols -- click here.

Adam Fischbaum does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of NYSE:SNH in one or more of its “real money” portfolios.