Living Off Dividends With My 3 Favorite Monthly Payers

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Includes: LNGG, LTC, OCSL
by: Efficient Alpha

Summary

Investors may need to increase their allocation to stocks as historically low bond yields fail to satisfy their income promise.

Monthly dividend payers offer an opportunity to fill the gap left by quarterly dividend payers but should be diversified across sectors.

LTC Properties, Linn Energy and Fifth Street Finance all offer sustainable dividends with upside potential in share appreciation.

Income investors have been in a tough spot lately with bond yields dropping to ridiculously low levels on global monetary programs. Nearly half (45%) of all government bonds globally are yielding less than 1% and even the yield on corporate bonds has fallen to just 2.9% for U.S. companies. An investment that yields an annual return of 1% after inflation over the next ten years is no investment at all.

Fortunately, companies flush with cash have jumped in to fill the void with higher dividend payments. Most of these cash returns are made on a quarterly basis, making it difficult to budget monthly expenses. Adding stocks that pay monthly dividends can be a great way to supplement the quarterly dividends you receive from your income portfolio. The three stocks below provide a monthly cash return from three different industries and could be strong additions to your retirement or income portfolio.

Three Stocks, Three Industries

Diversification is key in any investing strategy but even more so with stocks paying high yields. Companies paying out a large proportion of cash flows tend to be focused mainly in the energy, real estate and financials sectors where special tax considerations drive higher payouts.

Higher payout ratios means a dependence on debt and equity market to provide financing for growth projects that can increase the cash payout. If interest rates jump or if the company's cash flows are called into question, the shares can sell off pretty quickly. When this happens, it helps to be diversified across several companies and sectors and to be able to keep calm against any short-term weakness. The search for yield will help support investor interest in these names and large price drops are often an opportunity to add to your position.

LTC Properties (NYSE: LTC) is a $1.4 billion REIT that invests in senior housing and long-term care facilities. LTC Properties holds most of its assets in real property (84.9%) but also invests 15.1% of assets in loans to diversify risk. The company owns 101 skilled nursing properties (54.9% of its total portfolio by value) and 106 assisted living properties (37.4%). LTC is also geographically-diversified with properties or loans in 35 states though slightly more exposed to Texas and Michigan with 21% and 11% of total investments concentrated in the two states.

While the senior housing theme has been hot for the better part of the last decade, there is still strong upside for REITs in the industry. More than 10,000 people reach the age of 65 in the United States every day and this trend will continue until well into the next decade. Seniors' share of the total population is expected to increase to 19% by the year 2030 and the group will place enormous demands on our healthcare system.

LTC Properties has very stable cash flows with just 13% of its portfolio up for lease expiration through 2017. Its leases are generally for 10 to 15 years and on triple-net terms meaning the tenant pays all costs and taxes. The company has just 18% of its capital structure in debt, which I think could actually be increased to boost returns.

Shares yield 5.3% with dividend growth of 6.6% annually over the last three years. Including the cash payout, the shares have provided an annualized return of 20.7% over the last three years.

Fifth Street Finance (NASDAQ: FSC) is a business development company (NYSE:BDC) that invests between $5 million to $75 million in small- and mid-sized companies. The company holds investments in 125 companies with a 10.8% weighted average yield on its debt investments while borrowing money at a fixed rate of 4.87% on five-year notes. The majority (82%) of the company's portfolio is senior secured debt and 72% of debt investments are floating rate.

I am bullish on the BDC group over the next year as economic improvement leads to higher loan demand. The NFIB Small Business Optimism Index increased to 95.7 in July, just below its seven-year high in May, and showed small businesses continue to see better times ahead. The Federal Reserve Board Senior Loan Officer Survey in July showed that 25% of banks reported strengthening demand for commercial and industrial loans by small businesses, but only 8.3% of banks were willing to ease credit standards for small firms. If traditional banks are not willing to meet loan demand, BDCs will step in and will produce higher cash flows over the next couple of years.

Fifth Street announced another expansion of its credit platform last week with the close of $305 million in a senior loan fund targeting middle-market secured loans. The funding follows $210 million in February and is all written on floating rates so an increase in rates will drive interest revenue higher.

Shares yield 10.1% though the distribution has decreased by 8% annually over the last three years. Including the cash payout, the shares have provided an annualized return of 13.1% over the last three years.

Linn Energy (NASDAQ: LINE) is an oil and gas explorer that specializes in acquiring older producing assets and increasing production. The company just started paying a monthly distribution in July but has a strong record of quarterly payments back to 2006. Linn Energy owns approximately 6.4 trillion cubic feet (Tcfe) of proved reserves with a reserve-life of 16 years and spread across the strongest energy plays in 12 states.

Shares were hit last year when investors questioned the sustainability of distribution growth and cash flows. Since December, the company has completed its acquisition of Berry Petroleum and acquired the mineral rights for 6,250 acres in the Permian Basin of West Texas for $525 million. Through acquisitions and strong operational performance, the company has increased production by a compound annual rate of 85% since its IPO in 2006 and proved reserves have increased at a 58% annual rate.

The company's natural gas production is fully hedged through 2017 and more than half (60%) of oil production is hedged through 2016. That means stable cash flow for at least the next few years and upside on new acquisitions. The energy boom in the United States is just beginning to play out and master limited partnerships (NYSEARCA:MLPS) like Linn Energy are primed to pay out healthy distributions for years to come.

Shares yield 9.3% with distribution growth of 1.7% annually over the last three years. Including the cash payout, the shares have provided an annualized return of 2.0% over the last three years. The lower distribution growth and return over the near-term is largely on the recent problems the company has had rationalizing its cash distribution. I think these problems are largely over and the company should be a solid performer in the future. Over the longer 5-year period, the distribution has increased by 2.9% annually and the shares have returned 17.3% on an annualized basis.

Since most cash flow is paid out as a distribution or dividend, the company must continuously tap the debt or equity market to raise money for growth projects. This kind of business model increases the risk that the cost of funds will increase significantly during a financial crisis, sending the shares lower and making you rethink your investment. You absolutely must diversify over several companies and several sectors so you are not caught with large losses on any one investment and can ride out any short-term weakness without selling out of panic.

Beyond the three companies above, consider adding at least one other company within each sector to balance out the company-specific risks in your portfolio. I will highlight three more strong dividend payers later this week from energy, real estate and financials. Until then, do a little more research over the three above to make sure they fit your investing needs.

Disclosure: The author is long LINE.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.