Small investors have an advantage over big hedge funds and other professional investors: They don't have as much money.

Why is not having much money an advantage?  It allows us to invest in stocks that large investors simply cannot touch because of lack of liquidity.  If a stock only trades $50,000 worth of shares a day, a even a relatively small $50 million dollar hedge fund would have to buy all of the shares traded for two weeks just to allocate 1% to the stock, and would have to do the same if it were to sell.  As you can easily imagine, that would send the stock price rocketing (or plummeting when the fund sold), and remove much potential for profit.

If the big funds can’t buy a stock, they’re not going to spend any time researching it.  Likewise, analysts, who make their money selling their research to large investors, are not going to research it either.   With professionals out of the picture, it’s relatively easy for a small investor to gain an informational advantage: We just have to dig a little deeper than others.  The fewer investors who are paying attention, the easier that is.

That’s not to say that all (or even most) illiquid stocks are a good buy.  You still have to do some digging.  Yet unlike with more widely followed companies, the stock price can occasionally be much less than the value of the company, especially if that value is not yet shown on the company’s books. 

A Very Illiquid Stock

Which brings me to Power REIT (NYSE:PW.)  The stock’s average daily volume is about 1300 shares, or only $10,000.  With a market cap of $13 million, if a $100 million dollar hedge fund tried to allocate just 1% to PW, it would send the price skyrocketing as it attempted to purchase as much stock as normally trades in five months.  The fund would also end up owning over 5% of the company, becoming subject to extra restrictions on trading and disclosure.

With a stock this illiquid, even small orders of a few hundred shares can move the price five to ten percent, so it’s best to use limit orders to make sure you’re not paying a lot more than you expected.  Even limit orders will move the price over time, however.   That said, the current stock price of $8.10 is more than justified by the current 4.9% annual yield alone.  Which means the large upside potential I’ll discuss below is essentially free.

What Most Investors See

I mentioned Power REIT in my recent article on the possibility of Solar REITs, as well as profiling the company earlier this year.  I think the comments I’ve received are indicative of what most small investors see when they look at PW:

Personally, I consider a 5% yield attractive in the current interest rate environment, but it’s the litigation with Norfolk Southern Corp. (NYSE:NSC) that provides the opportunity to dig deeper than most other investors have.

According to Power REIT’s recent quarterly report and court documents, the substance of the litigation is this:

  • Power REIT believes that  NSC, and its sub-lessee, Wheeling & Lake Erie Railroad (WLE) are in default on their lease with Power REIT’s wholly owned subsidiary, Pittsburgh & West Virginia Railroad (P&WV.)   That leased property is 112 miles of railroad track and railroad property in Pennsylvania, West Virginia and Ohio, and is Power REIT’s main asset.  For the sake of brevity, I will refer to NSC and WLE collectively as the lessees from this point forward.
  • The lessees are seeking a judgment that they are not in default of the lease.   If they are not declared in default  they have the right to unlimited renewals of the 99-year lease on the current terms which are very favorable to them.
  • If the court declares the lessees in default, they would have to re-negotiate terms for using P&WV’s property.  In addition, a substantial “indebtedness” arising from tax payments made by P&WV on NSC’s behalf and asset sales of unused portions of the leased property would come due.  The court may also declare the lessees owe back interest on the indebtedness.  NSC has not provided access to the books which would document the size of this indebtedness, but it was carried (without interest) on P&WV’s 2009 tax return (prepared by NSC) at $15,517,325.  It has since increased to at least $15,882,651, according to an exhibit filed by Power REIT.  The lessees refer to this indebtedness as the “settlement account.”  The lease limits the size of this indebtedness to a tiny fraction of the size of the current settlement account.
  • P&WV believes that the lessees are in default for at least three reasons, which they state in their answer legal filing:
    1. Failure to pay specific P&WV’s legal fees which it believes the lessees were required to pay under the lease after 60 days notice.
    2. Failure reimburse P&WV in cash for Federal tax payments made under the terms of the lease.
    3. Failure to allow P&WV to inspect books and records regarding its property or inspect its track.

Payment of Legal Fees