Dividend stocks are everywhere, but many just downright stink. In some cases, the business model is in serious jeopardy, or the dividend itself isn't sustainable. In others, the dividend is so low, it's not even worth the paper your dividend check is printed on. A solid dividend strikes the right balance of growth, value, and sustainability.
Today, and one day each week for the rest of the year, we're going to look at one dividend-paying company that you can put in your portfolio for the long term without too much concern. This isn't to say that these stocks don't share the same macro risks that other companies have, but they are a step above your common grade of dividend stock. Check out last week's selection.
This week, we'll turn our attention to a niche player in the credit services business, Medallion Financial (NASDAQ:TAXI), and I'll show you why this small-cap financier should be on every income investor's watchlist.
The financial meltdown
Obviously, it hasn't been an easy stretch for financial companies that originate and sell loans over the past five years. On the way down from the financial crisis, loan origination and debt servicing companies were hammered regardless of their size.
Citigroup (NYSE:C), for example, has laid off 75,000 people since the financial crisis, and Bank of America (NYSE:BAC) has also let go of 37,402 people. Both banks ran into trouble with their home mortgage portfolios as home prices plummeted and homeowners became unwilling or unable to make their payments. If that wasn't enough, they've also both been exposed to numerous civil and federal litigations with regard to their handling of mortgage originations and foreclosures. It therefore shouldn't be a surprise to see both still trading below their book value five years after the crisis.
But it affected smaller credit servicing companies and peers to Medallion as well. Ares Capital (NASDAQ:ARCC), a private-equity firm that specializes in rescue financing, recapitalizations, and mezzanine debt financing, lost more than 80% of its value during the financial crisis. In the fourth quarter of 2008, for instance, Ares saw collateralized-loan obligation offerings fall 85% while it noted there were two and a half times more liquidated loans sold at auction in the quarter than in the previous nine months combined! The end result was huge unrealized writedowns in Ares' debt portfolio and what's been a slow crawl back to where it is today.
The Medallion Financial advantage
The biggest advantage that the relatively small Medallion Financial possesses is its niche business: taxicabs.
Medallion's primary business is financing the purchase of taxi medallions in New York. You see, back in the 1930s it was a free-for-all when it came to taxicabs in New York City -- but there was one big problem: There were too many drivers and not enough passengers. To resolve this problem, the city issued only a certain number of medallions, which you need to possess to operate a taxicab in New York City. These medallions over the past eight decades have soared in value (they're worth around $1 million each), since the city has been reluctant to raise the number of medallions issued substantially, and small businesses and large fleets often need loans to get their hands on these medallions. According to Medallion and its subsidiaries, it's lent about $5 billion to the taxicab industry as a whole. In other words, purchasing Medallion gives you as an investor a chance to get in on that seemingly gargantuan charge of $2.50 for entry plus $0.50 for each additional one-fifth of a mile charge that NYC taxicabs earn.
The end result is that Medallion's loan portfolio is in far better shape than a number of its peers. I'll start with Medallion's robust net interest margin of 6.32% for the first six months of the year (which is achieved when you combine the results of its bank with the taxicab subsidiary). Most banks and financial institutions are middling, with net interest margins (the difference at which they borrow money and lend it out) somewhere in the 3% to 4% range. Medallion is significantly more profitable thanks to its lower borrowing costs.
That leads to the second key point: Medallion is successfully reducing its ongoing borrowing costs. A combination of fixed-rate and floating rate debt allowed Medallion to lower its cost on borrowed funds by a whopping 83 basis points from the year-ago period. That translates into a huge margin boost and somewhat explains why Medallion is outperforming its peers.
Loan portfolio quality is another differentiable factor. As of its most recent quarter, Medallion ended it with just 0.4% of loans 90 or more days past due. At this time last year, that figure stood at 1.1%. As credit quality improves, Medallion is able to deal less and less with the prospect of setting money aside for loan loss reserves, which results in beefier profits for shareholders.
Show me the money, Medallion
Perhaps the most impressive aspect of Medallion, aside from its niche business, is its dividend history. Medallion, having been profitable in every year over the past decade (which is an amazing feat given the enormousness of the financial crisis), has paid some form of dividend each year since mid-1996 and has divvied out $11.89 per share, or $195 million in payouts, over that time span. Although there was a modest hiccup in annual payouts during the financial crisis, things have once again picked up to record levels with seven quarterly dividend increases over the past 12 quarters and a 167% increase in annual dividend payments since 2004:
Based on its current payout, Medallion is set to reward shareholders with an $0.88-per-year stipend. For those of you who dislike math, that works out to a 5.9% annual yield, which, last I checked, would crush anything the U.S. Treasury had to offer and easily put inflation in its place. The other key point here is that this payout is sustainable. Medallion is forecast to earn $1.24 in EPS this year, meaning it's paying out just 71% of its projected earnings as a dividend.
The financial-services industry has literally dozens of dividend paying stocks to choose from, but few offer the niche product that Medallion Financial possesses in its loan portfolio. Because of this near-necessity product that's quite scarce, Medallion has developed a stream of recurring revenue and predominantly freed itself from many of the bad-debt concerns that other financial services companies are still dealing with. With a steady history of profitability and dividend payouts, I see no reason Medallion couldn't become an income investors' dream stock.
Fool contributor Sean Williams owns shares of Bank of America, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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