Over a 50-year span, immediate income investments will generate greater total income than the highly hailed S&P Dividend Aristocrats. Many investors place wealth in these reliable stocks to their long-term detriment - they see less gains in income.
A Simple Definition
Due to previous confusion, whenever I write concerning immediate income investing, I feel it is necessary to define what I'm speaking of when doing so. I define immediate income investing as: Investing with a taxable account seeking immediate high return via dividends.
Due to this focus, I am not concerned with total return or overly focused on capital appreciation. I am a long-term buy and hold investor who is willing to sell if necessary. I often explain you can milk your cows or slaughter them to unlock value - I'd rather milk them.
S&P 500 Dividend Aristocrats Vs. Immediate Income Darlings
For sake of open comparison, I decided to generate two evaluations for both categories.
S&P 500 Dividend Aristocrats are those stocks in the S&P 500 who have raised their dividends for 25 consecutive years. Within this grouping, I took three representative stocks and averaged their yields and 3-year average dividend growth. I also took one exchange-traded fund, ETF and used that as the other simple comparison in this group since many investors would rather simply invest in one simple reliable ETF.
Three S&P 500 Representative Stocks - AKA "Safe Dividends"
For the three representative stocks, I used: Coca-Cola (KO), Procter & Gamble (PG), and Emerson Electric (EMR). Together, these three stocks have an average yield of 3.14% and a 3-year average dividend growth rate of 4.11%.
The ETF Competitor - NOBL
For the ETF competitor, I used ProShares S&P 500 Dividend Aristocrats ETF (NOBL). NOBL has a yield of 2.04%, but a lively 3-year average growth rate of 11.71%. It should be noted this ETF has seen dividend growth and cuts in its history but averages strong growth numbers.
For immediate income stocks, I divided my top 10 current choices between "Safer" and "Riskier" options. Personally, I would buy any of these choices and hold the majority of them already, but some have a higher perceived risk that's why I decided to split them apart to allow investors to see how either group would perform.
"Riskier" Immediate Income Stocks
This group of stocks is made of 5 securities believed to be riskier - thus often avoided or relegated to small portions of a portfolio. These securities are:
Oxford Lane Capital (OXLC) is the second security included in this group, it is a closed-end investment management company that purchases collateralized loan obligations, CLO. It yields 15%. I've dug into it deeper here and explained what a CLO is.
Eagle Point Credit Company (ECC) yields 13.32% and is the sister company of OXLC, it invests in CLOs also. ECC is actually less risky than OXLC and thus yields less. Further reading is available here.
Uniti Group (UNIT) offers investors a 12.37% yield. Recently, it was yielding much higher after its largest revenue source Windstream (WIN) entered into a protracted legal dispute. UNIT has a soundly covered dividend and is an often written about stock, further reading can be found here.
Last but not least for the "riskier" stocks is Capital Product Partners (CPLP). Normally, this shipping stock offers around a 10% yield but currently sports an 11.26% yield. A well-articulated article can be read here regarding their dividend.
These 5 securities average a yield of 13.37% - for the purposes of this comparison, we will assume no dividend/distribution growth.
"Safer" Immediate Income Stocks
For this group, CPLP is also included again.
Alliance Resource Partners (ARLP) provides a 10.48% yield - which is growing and covered. They are also primarily a coal play, but management is wisely allocating its funds to reduce debt and grow its covered distribution.
Sachem Capital (SACH) is a hard money lender who specializes in short-term asset-based loans. Their dividend is set to grow since they are a REIT and has out-earned its required payout. SACH offers a 10.38% yield. Further reading available here.
KNOT Offshore Partners (KNOP) operates specialized tanker vessels under long-term contracts. KNOP's revenue is secured by these contracts and its dividend is covered and unexpected to grow. KNOP offers a yield of 9.27. Further reading is available here.
These 5 securities average a yield of 10.58% - for purposes of this comparison, we will assume no dividend/distribution growth even though some of these stocks are set to do so.
The Comparison Test
For this test, I gave my sample investors $10,000 and 50 years. I calculated the total income received. This is the amount of funds they received from their bundle of stocks and factored in the growth of the dividend also.
Source: Author's Calculations
The outcome is stark. The immediate income choices both "riskier" and "safer" strongly outperformed their competitors over a 50-year span. You can see how the dividend yield growth continues to catch up to the immediate income stocks, but it is extremely unlikely any bundle of stocks will continually grow their yield by 11% annually.
This test ignores total return and value growth since we cannot accurately project those 50 years in advance. Many investors focus on these metrics to evaluate their past performance. Dividends are subject to be cut or altered - even by aristocrats. As such, investors should always do their due diligence regarding any investment choice.
Let's talk about Dividend/Distribution Risk for a Second
Many readers may have a moment of pause when seeing that I have created not only one, but TWO bundles of stocks yielding in excess of 10% and comparing them as apples to apples with stewards of dividend payments and increases.
But let's examine the relative safety of the dividends/distributions of these securities.
KNOP has never cut its distribution and has historically had a coverage ratio of 1.5x - this is a solid and secure dividend connected to vessel leases that typically have 20-year contracts.
SACH is set to increase its dividend, why? Because as a REIT, it must pay out 90% of its taxable earnings - so far this year, it has paid out less than this. SACH is seeing phenomenal growth and has a well-covered dividend.
ARLP is growing their distribution, furthermore, its distribution has solid coverage.
CCR is actively paying down its debt and deleveraging - this is what it is doing with its excess cash. Before this, it is paying out its distribution which is covered 1.6x.
CPLP's distribution is covered also by similar long-term contracts that KNOP enjoys. CPLP is also actively paying down debt to deleverage and retaining earnings to fund future growth of their company.
UNIT is seeing solid growth and moving out of its tight liquidity situation. The market still looks pessimistically on UNIT allowing it to have a high yield which is covered by its AFFO - adjusted funds from operations, the main metric for distribution safety of a REIT.
ECC and OXLC both invest in CLOs and coverage can be determined by using net investment income or cash flow. ECC covers its dividend payments with cash flow and is actively seeking to cover it fully with net investment income. OXLC is now covering its dividend with net investment income.
OXLC has a colorful history with a single dividend cut, but this was due to a one-time issue that has been resolved.
AMZA is the only security - being an ETF - that is not actively covering its large dividend. The option choices of the fund managers have caused it to miss their coverage. Meanwhile, the bundle of underlying stocks is increasing their distributions - helping the managers achieve this. AMZA cut its dividend to make it more sustainable and converted to monthly payments. This should not be cut again, but if coverage continues to lack - they may be forced to do so.
So, are these high-yield options riskier when it comes to dividend/distribution coverage? Honestly, no. NOBL annual dividend rate dropped between 2016 and 2017. Furthermore, other conservative dividend bulwarks have struggled to maintain their dividends - perfect example is General Electric (NYSE:GE), who cut their dividend twice this decade after years of historic steady growth.
This comparison projecting forward has its limitations, but the securities chosen are just as reliable for long-term income as dividend growth investment choices - and out pay them in the long run.
Immediate income stocks and investing is often relegated to a niche portfolio or set aside as unnecessarily risky. But flocking to overly conservative stocks will cause investors to substantially miss out of possible income that they need now - or in the future. This process assumed no dividend reinvestment - with reinvestment the income.
Disclosure: I am/we are long UNIT, ECC, SACH, AMZA, KNOP, CPLP, OXLC.
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.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.