A very unusual special situation has CareTrust REIT (NASDAQ:CTRE) trading at a very attractive forward yield and significant growth prospects. So my Special Situations portfolio is stepping up to buy a slug of the stock.

The business and special situation
CareTrust was spun out of The Ensign Group (NASDAQ:ENSG) nearly six months ago, and it's done little but decline since then. CareTrust is a small REIT -- market cap of about $360 million -- that owns healthcare properties. Right now its portfolio is comprised almost exclusively of Ensign's former real estate, 143 locations, leaving the REIT exposed to entirely one operator. However, rent coverage is excellent and Ensign is one of the best healthcare operators around.

Nevertheless, the REIT has geographic diversity across its properties and intends to diversify away its reliance on Ensign. That diversification includes not only by tenant but also by geography and asset class, with CareTrust looking to expand into new medical property classes.

Can the REIT find attractive deals? That depends a lot on CEO Greg Stapley. While he's new at the CEO helm, he was an integral part of the team that made Ensign so successful. As he did at Ensign, Stapley will have to find good real-estate deals. He does have plenty of experience in the sector, having helped co-found Ensign in 1999, and counts 27 years in the acquisition, development, and sale of real estate.

While the company is positioned to grow, it's announced only one acquisition in that time, and it's been waiting for the required earnings and profits purge, which is slated to happen in December. That creates significant opportunity for us, as the company issues a huge special dividend.

What that effectively means is that CareTrust will pay out $5.88 per share, with about one-quarter of that in cash and the rest in stock. Because of special exchange rules governing such large distributions, the stock will go ex-dividend the day after the payment, which occurs on Dec. 11. Also note that this payout is taxable at ordinary rates, and this has a significant effect on the total return here, as I'll show below.

This payout drastically affects the price you're paying for CareTrust on a go-forward basis. At the current price, the company will have to issue about 6.2 million shares to cover the stock component of its dividend. That swells share count to 28.6 million. Now, how much will the company earn per share?

Run-rate guidance on funds available for distribution, or FAD, suggests that the company expects an annual run rate of $30 million. Adjust for the new share count, and that means FAD should come to about $1.05 per share going forward. At today's price, if you buy in a taxable account, you're getting the stock for about 9.5 times -- that's cheap! And you're paying little for future growth.

And what yield are you getting at today's price? The company has committed to paying out 80% of FAD. So that comes to about $0.84 per share annually. But the yield depends on your effective buy price and that depends heavily in this situation on your tax status.

In total, I think the stock is worth $15 in two years. That price implies less than 15 times FAD and a 5.6% yield -- about average for the sector and no heroic assumptions here.

Because of the taxable nature of the dividend, it's best to buy the stock in a tax-free account. In the tables below, I've included an illustration of how a 40% tax rate really ratchets up your effective buy price and lowers your total return, assuming post-conversion value is $15. Add in the dividend yield over that period, and you're looking at total returns of 67%, or about 29% annualized, if you can buy in a tax-advantaged account at today's prices.

Buy Price

Effective Buy Price (Tax-Free Account)

Effective Forward Yield (Tax-Free Account)

Effective Buy Price (Taxable Account)

Effective Forward Yield (Taxable Account)

$14

$8.12

10.3%

$10.47

8%

$15

$9.12

9.2%

$11.47

7.3%

$16

$10.12

8.4%

$12.47

6.7%

$17

$11.12

7.6%

$13.47

6.2%

To summarize, if you can buy in a tax-free account, you can get an 8.4% yield at today's price. In the table below you can see potential capital gains and how a taxable account really affects your total outcome here.

Effective Buy Price (Tax-Free Account)

Upside

(Tax-Free Account)

Effective Buy Price (Taxable Account)

Upside

(Taxable Account)

$8.12

85%

$10.47

43%

$9.12

64%

$11.47

31%

$10.12

48%

$12.47

20%

$11.12

35%

$13.47

11%

So that's why I like CareTrust at today's prices.

Foolish bottom line
My Special Situations portfolio is buying CareTrust, adding $2,000 -- or about 2% of the portfolio. The sizable, taxable dividend helps set up a compelling buy price, if you can get the stock in a tax-advantaged account. For more on CareTrust, follow me on Twitter: @TMFRoyal. And check out my dedicated discussion board. If the stock continues to drop from here without some kind of fundamental change, I expect that I will continue to buy more.

Jim Royal has no position in any stocks mentioned. The Motley Fool owns shares of The Ensign Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.