Trimming Realty Income To Add Wells Fargo

| About: Wells Fargo (WFC)

Summary

We love to let the winners run.

But most of us reach a point where selling is inevitable, irrespective of the reasons.

We are trimming our position in Realty Income to initiate a position in the best bank stock.

REITs are flying, flying high. Buzz, Buzz, Buzz. To the sky. (Try to sing that if you could).

Thanks to Janet Yellen's advice for caution. What was already a heavy position has become so overweight that our portfolio definitely needs some work. To be precise, Realty Income (NYSE:O) and Omega Healthcare (NYSE:OHI) now combine for 21% of our overall portfolio value, mainly due to reinvested dividends and capital appreciation. We aren't too concerned about Omega yet as the stock was unfairly beaten down earlier and the recent run up is only a little recovery. That brings us to Realty Income, the monthly dividend champ.

Make no mistake about it. Realty is still a great stock to hold with hot cash coming our way every month. But as indicated in this article, we are trimming Realty right here, right now. Realty will still remain a cornerstone of the portfolio, just that its position will drop off to #4 from #2.

One of the biggest questions to answer when selling winners is about the proceeds. Is there a good alternative to stay invested, assuming one wants to stay invested with the proceeds? Not having an answer to this question has stopped us from selling many times in the past. This time, luckily, we believe there is a good alternative. That brings us to Wells Fargo & Co (NYSE:WFC). When REITs fly, banks usually drop. And vice-versa. Evidently, Wells Fargo is nearly 17% off its 52 week high, thanks to the Federal Reserve and some analyst downgrades. What are we doing to take advantage of this situation?

We are selling some Realty income and using the proceeds to buy some shares in Wells Fargo. The section below explains our thought process in making this decision.

#1. Portfolio Reason: We've never had a bank stock. EVER. After the 2008/2009 banking disaster, this aversion only got stronger. However, as our portfolio started wobbling more prominently whenever the Federal Reserve was in the news, it was apparent that we needed some balancing. In addition to REITs that are sensitive to rate discussions, we also hold utilities and mainly income stocks that go up or down violently. Wells Fargo has always been seen more favorably than Bank of America (NYSE:BAC) and was the frontrunner to get into our portfolio all along.

#2. The Dividend Goes Far: Just like their slogan suggests "Together we'll go far", Wells Fargo's dividend goes farther. The current yield is 3.12% and this is not too far from Realty's own 3.80%. Yes, Wells Fargo isn't in the same league as Realty when it comes to dividend reliability but Wells Fargo is more likely to deliver higher dividend growth rate at least in the near future.

A dividend increase is very likely to be announced in April and if the company sticks with last year's 7% increase, the new annual dividend will b e $1.60 per share. That's a yield of 3.33% for buying at $48. Not a bad deal. In addition, as explained below, the dividend seems safe at least for the time being.

  • Trailing payout ratio is 36% based on trailing twelve months EPS of $4.15.
  • With 5 billion shares outstanding, Wells Fargo needs $1.90 billion (5 billion times $0.375) in quarterly free cash flow [FCF] to cover its dividends. Wells Fargo had more than four times that number as its average quarterly FCF over the last five years, at $8.1 billion.

In spite of the numbers above, we aren't as comfortable with this stock as we are with, say Coca-Cola (NYSE:KO), when it comes to dividend and dividend growth. However, given that the management has been keen to reward shareholders once things turned around (the dividend is now back above the 2008/2009 level), we are comfortable enough to have this stock in our portfolio.

3. Good Company: No, we are not just talking about Wells Fargo as a company here. But the fact that Warren Buffett has this stock as one of his four major holdings should comfort most investors. Yes, he may have had a more favorable deal and price but the fact is he is still holding this stock. In fact, he now has a higher stake accidentally due to Wells Fargo's repurchase program. That is, as the company retired more of its shares, Buffett's share of the pie increased.

4. Personal Experience: We use Wells Fargo as one of our trading/investing platforms. In more than 5 years, we've never once been dissatisfied with their service and in fact, we had to call the bank only once or twice. Even those instances were to make some changes with the account and nothing to complain about. Hence, it's no surprise for us that Wells Fargo repeatedly tops customer satisfaction rankings.

To paraphrase Peter Lynch, buying what you know and have experienced is a good way to start.

Conclusion: While we don't sell very often, we are now expanding our horizon. When you hold one stock that is more sensitive to macro conditions than the others in the portfolio, isn't it prudent to balance by finding one that usually goes in the other direction? By finding a stock with comparable yield, we aren't losing on near-term income either. By finding a quality bank that will likely be around for decades, we aren't losing on the long-term prospects either. Sounds like a win-win either way.

Disclosure: I am/we are long O, KO, OHI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Initiating a position in WFC today.