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Value investor and real estate investor. I invest in companies with reliable and growing income streams trading at fair prices. I invest in real estate, primarily single family homes with attractive rental yields. I strive to develop and share strategies which are "Index Beating"... More
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  • The "IndexBeating" Dividend Portfolio

    In the following article I will show you how to build a diverse portfolio of stocks as mentioned in my last post that have a combined yield of 5.2% as of market close on 9/19/13. All of the stocks have strong businesses, consistently grow revenues and cash flows, and reward shareholders with dividend payouts. Following posts will provide in depth analysis of each company mentioned here.

    Brookfield Infrastructure Partners (NYSE:BIP) 20% of portfolio

    Brookfield Infrastructure owns and operates a diversified global portfolio of real assets which generate steady, growing cash flows. Management has a great track record of making accretive acquisitions and returning cash to shareholders. The current yield is about 4.5% and the quarterly payout has grown by over 50% since 2010.

    The current payout ratio (calculated by dividing the quarterly distribution by the FFO per share) was 55% as of the second quarter of 2013. Management targets a 60-70% payout, which means there is room for further distribution increases. FFO stands for "Funds From Operations" and is a metric commonly used in real estate and other real asset businesses alongside EPS. About 90% of cash flow is generated from regulated businesses or long-term contracts.

    Brookfield's assets include toll roads in Brazil and Chile, railroads and a coal exporting terminal in Australia, natural gas pipelines in the US, ports in Europe, and electric transmission systems in Colombia. These might seem like a random hodgepodge of businesses, however they have a common theme of generating recurring revenues that grow over time. They also have high barriers to entry which makes competition much less of a concern.

    The largest holder of BIP is Brookfield Asset Management, which is also the manager of Brookfield Infrastructure.

    Brookfield Renewable Energy Partners (NYSE:BEP) 20%

    Brookfield Renewable is another member of the Brookfield family and operates renewable energy assets. Their assets include hydroelectric plants, wind farms, and pumped storage systems. Pumped storage is a way to store power by pumping water uphill into a reservoir at night when power is cheap, and then letting it flow downhill to spin turbines and generate power during the day when electric rates are higher.

    95% of revenues are contracted for the current year, with at least 80% contracted over each of the next five years. This gives investors comfort that there will be revenues to support the distribution, which is currently 5.4%, for the foreseeable future.

    The current entity was formed when Brookfield Asset Management combined its directly held renewable energy assets with the previously existing Brookfield Renewable Power. This vehicle became the primary entity through which Brookfield will acquire and develop renewable energy assets. The partnership displayed this when it acquired $600mm worth of hydroelectric plants from Alcoa last year. The new entity moved from Pink Sheets to NYSE earlier this year which should provide greater exposure to investors.

    Monmouth Real Estate Investment Corp (NYSE:MNR) 15%

    Monmouth is a relatively small REIT which yields 6.6% and owns warehouses throughout the US. The primary tenant is FedEx, which makes up about half of the tenant base. The other half is comprised of high quality tenants such as Coca-Cola, Anheuser-Busch and Kellogg Co. Although this would seem to imply concentration risk, FedEx is a strong and growing company which benefits from the long term trend towards e-commerce, so I am comfortable with the exposure.

    Monmouth consistently grows their portfolio, earlier this month they acquired warehouses in Green Bay, WI and Rochester, MN for a combined $11.8mm.

    Bar Harbor Bankshares (NYSEMKT:BHB) 15%

    Bar Harbor Bank is a small regional bank in Maine that operates a safe bank with a traditional business model of taking in deposits and lending it to businesses and consumers. The stocks yield 3.4% and the board has typically grown the quarterly dividend by about a penny every year.

    Earnings have shown consistent growth and the stock trades at 11.5x TTM earnings, roughly in line with larger peers such as PNC, WFC, and KEY. Given the small market cap ($140mm) and geography there is a chance the company could be acquired in the future which provides upside optionality.

    TAL International Group (NYSE:TAL) 10%

    TAL International Group is an owner and lessor of shipping containers. Given the cyclical nature of shipping, the stock was hit hard in the recession and the dividend was cut, but since then the stock and quarterly dividend have reached new all time highs, which shows the strength of management. The stock yields 5.8% and the board has been raising the dividend consistently since 2010.

    While it is the riskiest of the stocks discussed so far, it provides significantly higher growth potential and benefits from growth in global trade.

    Ares Capital Corp (NASDAQ:ARCC) 10%

    Ares is a business development company, or BDC, which is a type of company that provides financing to growing companies. They receive special tax treatment at the corporate level if they return 90% of income to shareholders.

    Ares is dependent on borrowing, so when credit markets froze it performed poorly. I believe holding a small piece of the dividend portfolio is riskier securities such as ARCC is prudent given the higher yield of 8.6%. Although the dividend was reduced in 2009, it was only cut by 17% and has since grown to over 90% of pre-recession levels.

    Corning (NYSE:GLW) 10%

    Corning is not typically thought of as a dividend stock, but after reinstating the dividend in 2007 it has doubled from five cents per quarter to ten cents, which translates to a yield of 2.7%.

    Potential earnings growth for Corning are massive. There are several products in the pipeline which could add significantly to earnings. The history of Corning shows their ability to innovate and adapt to new markets, as evidenced in recent years by their production of glass for smartphones and televisions.

    Corning should continue to grow earnings and dividends consistently, and with the stock trading at just over 11x TTM earnings, the stock price looks like it has potential to grow as well.

    Disclosure: I am long BIP, BEP, BHB, GLW, MNR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Sep 24 3:33 AM | Link | Comment!
  • The Bond Problem, The Income Solution

    Most investors agree that yields are going to rise in the future, the only question is when. Bonds are commonly viewed as safe investments, however they present more risk than most investors realize. In the following article I will show you how to construct a safe portfolio that yields 6.7% while holding 25% in cash.

    The challenge for many investors for the past few years has been finding attractive investments that generate income. This has been difficult because the Federal Reserve has been depressing interest rates to artificially low levels as they try to stimulate the economy.

    Bonds have been in a 30 year bull market as yields decline, which means prices increase. The yield on the 10 year Treasury has declined from nearly 16% in 1981 to a recent low of 1.63% in May of 2013. So, although yields are decreasing, investors have been able to generate an acceptable return through capital appreciation.

    Recently, yields have started to increase as fears that the Fed will begin to slow its bond purchasing program known as quantitative easing, or QE, now that the economy is beginning to stabilize. This is the start of what will happen in the coming years since yields cannot stay at these historically low rates forever.

    This creates a problem - how do you generate income without buying an asset that is likely to depreciate in value?

    I believe a low volatility income portfolio, in the current environment, should not hold bonds. It should hold high quality stocks with increasing payouts, income properties, and cash. The rationale for each is as follows;

    Dividend Stocks (50% of model income portfolio)

    Although equities present a higher degree of volatility relative to bonds, when selected carefully they produce far better returns in terms of current income as well as potential capital appreciation. Stocks selected for this portfolio should have a track record of earnings growth, with the potential for future sustainable growth. This means the company will be able to increase their dividend payout over time, and the yield off of your original cost basis grows continuously over time. A diverse portfolio of ten or so high quality stocks can be assembled with a combined yield of between 4% and 5%. A model portfolio will be published in next week's post.

    Investment Real Estate (25%)

    As an investor you can use low interest rates to your advantage by borrowing at low rates and investing in income properties. The current real estate market offers some great bargains in certain areas of the country with attractive cash on cash returns. I believe the following example is representative of opportunities readily available in certain markets.

    A house I recently purchased produces an annual unlevered rental yield of 11.5%. Adding a 5% mortgage with a 25% down payment increases the yield to 17.6%. These numbers include 10% of gross rent reserved for management & maintenance costs, as well as actual insurance and tax costs. Returns include closing costs of 4.5% for the unlevered model and 15% for the levered model, which are both conservatively high estimates.

    Investment real estate provides additional tax benefits. Real estate investments can provide tax benefits through depreciation (writing off the cost of the building over time, offsetting taxable income) and interest expense (writing off the cost of mortgage interest against taxable income). Please note that I am not a tax expert and you should contact a tax professional to learn more.

    Rent prices are likely to increase with inflation as time passes, making your income increase every year.

    Cash (25%)

    Cash currently produces effectively zero return, but provides two essential benefits to a portfolio. First, cash reduces the volatility of stocks, which often trade up and down with the overall market while underlying company fundamentals remain strong. Holding sufficient cash eliminates the need to sell stocks at a low point in the market. The second benefit is to provide liquidity to offset the illiquid nature of real estate. Investors are able to generate extraordinary returns by investing in illiquid assets (meaning they cannot be readily converted to cash at a desirable price). Holding cash provides the liquidity necessary to make investments in illiquid assets prudent in a conservative portfolio.

    Summary

    The overall current yield for the portfolio described above is 6.7% based on the following assumptions:

    • 50% in a portfolio of stocks yielding 4.5%
    • 25% in levered real estate returning 17.6%
    • 25% in cash earning 0.05%.

    These returns are pretax (both pre-expenses and pre-potential benefits) and do not account for appreciation of real estate and stock values, or increased income over time, which are likely to meaningfully increase total returns over the long run.

    The three main benefits of a bond portfolio are addressed in the allocation outlined above:

    Liquidity: 25% cash allocation provides immediate liquidity.

    Safety: Given the risk I see in bonds, this portfolio appears to have far less downside volatility relative to bonds.

    Income: As exhibited above, this portfolio produces significantly superior returns relative to bonds.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Sep 18 7:11 AM | Link | Comment!
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