Wednesday, December 5, 2018

Inverted Yield Curve - Another blow to Seniors


Just when you think inflation will work in your favor, the yield curve threatens to invert.

  • Inflation exists for ordinary investors despite low interest rates
  • Low yields push income investors into higher risk investments 
  • An inverted yield curve is negative for banks and insurers but positive for stocks with solid debt management

Conventional wisdom suggests inflation is a hidden tax because it erodes your purchasing power.  In this case, conventional wisdom is accurate.  For instance, according to the official U.S. inflation calculator site,  a  $5,000 bond purchased at par 20 years ago in 1998 would cost more than $7,700 to buy today.

Annual Inflation Rate Chart


The Federal Reserve is in charge of regulating bank lending rates.  Theirs is a dual mandate to maintain a reasonable level of inflation and employment and in so doing, they use many metrics to determine if inflation exists.  Some of their measures include food and energy, some do not.  Some measure wholesale prices and some measure consumer prices.

Inflation exists for ordinary investors despite low interest rates


I measure my family's personal expenses and through nearly three 20 year cycles, I know that my expenses double every 20 years.  That computes to about a 3% annual inflation rate.  Yet during these nearly 3 decades interest rates on a government insured certificate of deposit have ranged from .5% to more than 20%.  A brief history of CD rates can be seen in here. https://www.bankrate.com/banking/cds/you-earned-how-much-a-brief-history-of-cd-rates/#slide=1

Cost of goods, cost of wages as well as cost of money weigh on inflation.  Why then is inflation considered so low that the yield curve which is the difference between a longer term bond and a 2 year bond and therefore flat when I know chicken and hamburger cost more.  Going out to eat costs more.  Luxury goods cost more.  Health insurance costs more.  Houses and when you can't buy a house or for seniors when you are done owning a house and want to rent or go to senior living, renting costs more.

Go back 20 years and look at your property taxes, your home owner's fees, your car insurance.  All are higher.  My point is that for individuals, inflation is a cruel tax but it is foreseeable and manageable.  The future is not as clear for income.

Inflation can work in your favor


When I state that I thought inflation would work in my favor, I speak as a person who remembers safe government insured money that paid 7%.  Just when we retired for the first time, our long term planning hoped for at least 50% of our portfolio earning at least 7% safe income.  Today safe government insured money pays barely 3%.   If inflation could deliver 7% in U.S.guaranteed investments, that would be a gift.

Successful seniors have everything paid for.  They do not need a new house. They are probably thinking of how to monitize that asset to go to a senior living facility.  If they need a new car, they have the cash.  We may need a new hip, but we are not in the asset acquisition phase of our lives.

Younger investors have the cash flow from working to buy things.  In this case, younger people need to plan their purchases carefully to avoid the negative effects of inflation until they get to the point where their money needs to create income to replace their earnings.   At this point in your life, it is good to have everything paid for already and ignore the inflation tax.

An inverted yield curve is negative for banks and insurers but positive for stocks with solid debt management


Our investment need is to create income from savings,  Today we need to invest in assets higher on the risk scale than U.S. guaranteed bonds.

Source Incredible Charts: Yield Curve


Real Estate and stocks are the few options we have.  If, however, the Federal Reserve continued to increase interest rates on, we could get closer to an environment where we could get competitive yields on government secured investments.   Investors who end up living off of the income from their investors will need to retire with income that grows because inflation will eat away at the earnings power of their income.

Many but not all people end up with multiple sources of income during retirement.  Social security, company pension plan, military pension, Uncle Henry's trust, or an inherited IRA.  Yet nearly every successful retiree will need income from their savings.   Where do you get that today?  Certainly not from a safe U.S. Treasury or even a G.O. (general obligation) municipal bonds.

Some investors chase yield and buy too risky an asset.  If you pay $115 for a municipal bond so that you can get 6% yield, you are fooling yourself.  In 20 years, as noted above, when that bond matures, you get back only $100 not $115 and in 20 years that $100 buys a lot less.  Do not chase yield in the bond space.

Stocks and Real Estate


Not all stocks work during periods of low inflation. For instance, the way banks make money is to pay less to their depositors than they can lend out.  There is where the yield curve hurts these types of stocks.  They just have so little margin for profit.

When inflation is realized in higher lending rates that will help banks and hurt people who need to buy assets but it will help savers.

S&PwithDividendvsHPIwith14percent_4
Chart courtesy of Bigger Pockets.  S&P is the S&P 500 index and HPI is home price index.


Today the stocks an income investor needs must pay a dividend greater than the 2 year U.S. Treasury, they need to make more money than paid out in the dividend.   Two other factors are in play, the dividend should increase regularly and their balance sheet needs to be pristine.

Avoid stocks that use a lot of debt to grow.  You can find growth stocks with no debt.  Garmin, symbol GRMN, is a good example.  You can find a lot of stocks with very manageable debt.  Intel and Apple have very little debt.  Pay attention to stocks with a lot of debt especially those who recently borrowed at very low rates.  It seemed like almost free money.  But if they did not lock in those low rates over time and have to roll that debt in a few years, they could face much higher interest rates and that will affect the stock's profitability.

I do not cover real estate in this blog but I do hold nearly 1/3 of our portfolio in income producing real estate.   For ordinary investors REITs (real estate investment trusts) can provide an investment opportunity if you do not want to own real estate out right.



Chart from Nareit illustrates the return on REIT's versus stocks.  Even here you can see the benefit of holding some real estate in your income portfolio. 

Summary

 

Until inflation can help us, we have no choice but to go up the risk scale for our investments.  Lets us do it with great care.


M* MoneyMadam









Monday, December 3, 2018

Four Corners Property Trust

Four Corners Property Trust, FCPT was a spin off from Darden restaurants, symbol, DRI, in November of 2015.   This was part of DRI's turn around action from an activist investor.  FCPT is doing well and this article shows it.

https://seekingalpha.com/article/4225921-four-corners-property-trust-breaking?app=1#alt1



M* MoneyMadam

Monday, November 26, 2018

Unilever Covered Call adds 3% to yield

Income investors know when the market is up, look for calls on your dividend stocks.  You can click on my Call Options page to learn more about call options.

Unilever for dividend and call income


Unilever, symbol UL, like Proctor and Gamble sells branded consumer goods.  All stocks in the space suffered but today UL is above my cost basis.   The point of this post is to illustrate how you can take a stock like UL that pays a 3.39% and increase your income by another 3%.

The way it works is to sell to another person the right to buy your UL shares at a strike price greater than your basis.  The call buyer pays you a non refundable premium for that option.

When you select an expiration date after the next ex-dividend date, it is highly likely you will receive both the dividend and the call premium as income.  This is not guaranteed.  If UL stock price soars, the call buyer might buy it from you before the next ex-dividend date.  You still get the nice gain and the call premium but you could lose the stock and the next dividend.

Calls Increase Income from your Nest Egg


I strive for an average income from my dividend stocks of 5%.   You could put all your nest egg in At&t (symbol T) or Ford (symbol F) and get more than 5%.  But, most of us need more safety and more diversification than just these two stocks.  I own both T and F.   I also own UL and this stock provides some international diversification and call option opportunities.

Take a look at the call I sold today.






I want to emphasize the over 14% return is only possible if the call buyer actually executes their option and buys your shares at $55.00.    Calls expire 90% of the time.  Therefore, as an income investor, you must be prepared to keep your UL shares even if they tank during the time you cannot sell them because of the option contract.   You will still receive your dividends from UL but you could be underwater on your basis. 

Income investors need to concentrate on the additional yield they receive from selling calls with a strike price high enough that it is most likely the call will expire useless.  Even when the call expires useless, you keep the call income and the dividend income.   In the UL example, your total income over a year would be the dividends plus the income from this call premium.   Let's use UL's  last four dividend payments plus the call premium and you get $3.306 per share for an annual yield of 6.62% on my basis.

If I lose UL, there is always another 3.39% yielding stock to buy.

M* MoneyMadam

Long T, F, UL with calls

Sunday, November 18, 2018

BIg Yield Portfolio - Can you get more than 5% from Dividend Stocks

A 39 year old successful man doing work for me asked me what I thought he could get in cash flow if he had a million dollars.  My standard view recently is to first remind him that any advice is worth what you pay for it and then to deliver the uninspiring number $50,000.

For someone dreaming to be a millionaire, the realization that safe income from a million dollars is about 5% can be disappointing. You could get a job earning $25 an hour and make that income. I could hear him calculating how many millions of dollars will he need to replace his current income?

  • Dividend Stocks should be one source of income
  • Dividend Stocks can increase dividends
  • Dividend Stocks with revenue growth may be able to increase stock price
  • Always remember Dividend Stocks can decrease in value and decrease or eliminate the dividend

You have worked and saved and now you are retired.  You have a sum of money to invest in the basket called Dividend Stocks.  You don't want to earn $25 an hour, you want to live off of what ever your multiple sources of income can create one of them being your Dividend Stock portfolio.

Can you get more than 5% from a stock portfolio with "Dividend Machine" quality fundamentals? I say yes and here are the stocks I would buy.

In the table below you see a $200,000 portfolio invested in nine stocks.  The stocks are not equally weighted .  The weighted basis uses closing price on Wednesday 11/21/2018.



11/21/2018
Price
Shares
Basis
Div/Shr
Div. Income
Div Yield
LVS
$51.96
481.139338
$25,000.00
$3.00
$1,443.42
5.77%
MAIN
$37.86
660.3275225
$25,000.00
$2.34
$1,545.17
6.18%
MFC
$16.19
1080.914145
$17,500.00
$0.76
$824.08
4.71%
WDC
$46.90
373.1343284
$17,500.00
$2.00
$746.27
4.26%
T
$29.77
839.7715821
$25,000.00
$2.00
$1,679.54
6.72%
NHI
$75.26
332.1817699
$25,000.00
$4.00
$1,328.73
5.31%
CM
$85.74
204.105435
$17,500.00
$4.17
$852.00
4.87%
WY
$26.68
843.3283358
$22,500.00
$1.36
$1,146.93
5.10%
MIC
$39.28
636.4562118
$25,000.00
$4.00
$2,545.82
10.18%



$200,000.00

$12,111.95
6.06%



In order to invest your precious savings, you need to be sure your investment has a good chance of continuing the high income, some chance of increasing the income, little chance of going belly up, and resilient during down times.   In the table below, you will see important fundamentals that I use to pick my Dividend Machines.



11/21/2018
EPS
DIV
DIV INC
D/E Ratio
P/E Ratio
Rev Growth
LVS
$4.80
$3.00
15.38%
1.75
10.6
3.6
MAIN
$3.18
$2.34
8.33%
0.63
10.5
11.04
MFC
$0.92
$0.76
46.15%
0.33
22
11.02
WDC
$2.20
$2.00
0.00%
0.98
24.8
15.62
T
$5.12
$2.00
6.38%
1
5.9
3.88
NHI
$3.67
$4.00
17.65%
0.89
20.4
8.38
CM
$8.60
$4.17
9.31%
0.13
10
3.81
WY
$1.47
$1.36
31.82%
0.71
16
2.14
MIC
$5.55
$4.00
-11.50%
1.12
7.2
5.05


This is an interesting group of stocks. I mostly like the combined yield of greater than 6%.

Measure of Balance Sheet Safety - Debt to Equity Ratio


Next, I like the debt to equity ratios.  None of these stocks seems to be in financial distress.  LVS has the highest D/E ratio at 1.75.   This is higher than 1 but it is within industry standard.  Note WYNN D/E 4.95 as of September 2018 and MGM 2.165 (source Ycharts.)

T has regularly paid down debt and increased equity so their D/E is right around 1.  Competitor VZ carries a debt load of 2.072 (source Ycharts.)

For anyone who looks at this portfolio and thinks these stocks are risky consider their balance sheets.  I like to use D/E ratio but you can delve deeper into the balance sheets of these stocks and be satisfied that this group of stocks is quite safe.

Potential to Continue Dividend Payments - Revenue Growth & EPS greater than Dividend Paid out


Revenue growth starts the funnel to earnings and then dividends.   Finding nine stocks with revenue growth was not easy.   For instance IBM did not make the cut because their revenues growth is not positive.    These stocks all have revenue growth which makes me think there is the potential to continue paying dividends.   We might even find some stock price growth.

We have one stock on the list that is a REIT,  National Health Institutes which looks as if EPS are only equal to dividends paid out.    By law, NHI as a real estate investment trust has to pay out the majority of its earnings.  Many people prefer to use free cash flow for a stock like this.

There are two schools of thought on dividend payout ratio.  The ratio is calculated as how much of earnings are paid out in dividends.  The best of this group is Telephone, symbol T.   Their payout ratio is .39%.

One school of thought on dividend payout ratios is to find a stock that loves to reward its shareholders with income in the form of dividends.   When the company makes money they share it with us.  However, says the other school of thought, when the payout ratio is high, the margin for error is low and could mean a dividend reduction or suspension could happen.

Dividend increases.


One of my mottoes is to retire with income that grows.  I used to tell my clients to go back 20 years and list some of the same expenses you had back then that you have now and you will find they usually double about every 20 years.  That means if you retire today, even as a millionaire, your financial plan has to provide for income increases over time.   Let's look at these stocks from an income growth viewpoint. 

Macquarie, symbol,  MIC cut the dividend in half in February of 2018 and the stock had a concomittment reduction in price.   That is when I bought it and I will add because I like the fundamentals post cut.   It still sports a yield of more than 10% and has returned to having earnings greater than dividend paid out.  Western Digital (WDC) a previously overpriced stock is getting earnings back above the dividend suggesting they may be able to deliver dividend increases. Those two experiences are balanced by MFC with annual dividend growth over the past 3 years of 10 plus %.

If, and that if always a big if, these stocks can continue to deliver strong fundamentals, they should be able to deliver income.

Diversification is always important.  I used my Dividend Machine fundamental screens to select this group of stocks.  I did not try to find stocks in industries where my assets are under deployed.  I use only my Dividend Machine criteria to select these stocks.  See the table below to learn about the industries.


INDUSTRY
11/21/2018
Price
Shares
Resorts & Casinos
LVS
$51.96
481.139338
Asset Management
MAIN
$37.86
660.3275225
Insurance - Life
MFC
$16.19
1080.914145
Data Storage
WDC
$46.90
373.1343284
Telecom Services
T
$29.77
839.7715821
REIT - Healthcare Facilities
NHI
$75.26
332.1817699
Banks - Global
CM
$85.74
204.105435
Lumber & Wood Production
WY
$26.68
843.3283358
Airports & Air Services
MIC
$39.28
636.4562118



This group of stocks ended up heavy in the financial services area.  That is where the value is and with a sniff of interest rates increases, they should be poised for a growth spurt.  Remember insurers function very much like financial stocks.  When interest rates go up, they can get more income from their investments and payout less on their deposits and payouts.

We shall see what happens with this portfolio.  Our millionaire will now have about $60,000 annual income with a chance to grow that income.   I don't know about you, but for most of us an extra $10,000 per year can make a difference.   As always I will track this portfolio and report on it.

M* MoneyMadam


Disclosure:  Long T, NHI, CM, WY, MIC, LVS  expect to add WDC and strongly considering moving some existing positions into, MAIN or MFC.