I am writing this on Labor Day, a U.S. holiday celebrating laborers of all types and the many achievements that would not have been possible without them. Workplaces close in honor of the innumerable workers who have quietly played their parts in building America.
Of course, the irony is that many laborers don't get to enjoy a day off on Labor Day. I think of the recycle bin collection truck driver who picked up my recyclables this morning. I think of the many restaurant and retail workers for whom today is just like any other workday. I think of the policemen, firemen, 911 responders, and hospital workers who can't take the day off, because emergencies are always happening.
This article — this manifesto — is for them.
We live in a remarkable age, one that is, at least in one way, very different than any age that preceded it. In almost every age of history, there was a working class and a wealthy class. The former — peasants, serfs, slaves, bondservants, laborers — had little to no opportunity to rise up out of their inherent station in life. Born a serf; die a serf. Born a slave; die a slave. Those fortunate enough to be born into the wealthy class — royalty, clergy, aristocrats, landowners, capitalists — had every advantage in life and would most likely remain in their privileged position for life.
The wealthy class owned almost all of the assets, and the labor class either worked for the wealthy or lived at subsistence level working the land.
Then, in the second half of the 19th century, stock markets came into existence. Assets gradually became more liquid as these exchanges grew and formalized. What was accessible only to the wealthy progressively became accessible to the non-wealthy. Even as early as 50 or 60 years ago, stock purchase commissions were prohibitively expensive for those with only small amounts to invest. But brokers competed for middle class households' dollars by lowering fees and commissions. Index funds were invented as a low-cost vehicle for average people to enjoy the wealth generation of American businesses. Fund fees continued to decline, as did commissions.
Today, multiple platforms offer commission-free trades, and dozens of ETFs offer exposure to the American corporate sector at a cost of a handful of basis points per year.
It has never been easier for the average laborer to be more than a mere laborer. It has never been easier for small-dollar investors to own assets — the primary source of wealth on the planet. In short, it's never been easier for a laborer to also be a capitalist.
I can sense some readers rolling their eyes or shaking their heads. Yes, I know the world is not a Horatio Alger story. Upward mobility is not as easy in today's world as we would all like it to be. And the assets of average folks tend to be homes, not businesses or stocks.
How to increase the real incomes of average households so that they have more disposable funds to invest is a discussion for another time. For now, my point is that we live in a fortuitous age. It has never been easier for those with some disposable income available to invest, even a small amount, to own a piece of a business or a slice of various businesses that generate wealth over time.
That's why I say that this manifesto is for the laborers. It's for the honest, hard-working, budget-conscious individuals who don't make six-figure salaries but who want to invest some money today for a better life tomorrow.
Of course, the office workers who make decent money and got Labor Day off today can and should participate in long-term wealth generation. But when I write, I do so with the average earners in mind. These folks, to me, are the real "cashflow capitalists." They are the laborers who want to be more than mere laborers.
So, this Labor Day week, I hope the following manifesto is of great benefit to those, like me, who are grateful for a world where laborers and capitalists can be one and the same.
Overarching Lifestyle Goals
Cashflow capitalists have two overarching goals, and they are very simple. They are:
Those in the "F.I.R.E." (financial independence, retire early) movement want to stop working before the typical retirement age. That is not necessarily a goal for cashflow capitalists.
To work is to add value to others. To stop working is to stop adding value to society or community or family. It's one thing to quit one's day job to become a full-time landlord, to volunteer, to care for dependent family members, to take up a more active role in one's church or religious community, to start a new business, or to pursue a passion that is meant to be shared with others. Work does not necessarily mean employment, but it does mean providing some good or service to others. Adding value to others' lives gives us meaning and purpose.
To replace work with more rounds of golf, more television shows, more video games, more woodworking, more reading, more vacations, etc., is to forego one of the primary sources of happiness and satisfaction in life.
No, cashflow capitalists don't want to jettison work, per se, but rather the bondage to a certain type of work — the kind that pays but does not fulfill.
The point of investing, then, is to obtain two things. The first, comfort, is additional income that, once substantial enough, can be used to pay bills, fund vacations, afford more luxuries, support charitable giving, or leave a legacy to family. The second, independence, is the ability to quit one's day job and pursue other passions if one wants to.
Overarching Financial Goals
I sketched out the overarching financial goals of the portfolio in a previous article ("The Best Offense Is A Good Defense"), but I'll reproduce them here. The five overarching goals for cashflow capitalists are to build:
- A growing income stream, at
- Low risk of income disruption, with
- Substantial diversification,
- A mix of low yield / high growth and high yield / low growth stocks, and
- A target 10-year yield-on-cost of 7+% for core holdings and 10+% for riskier holdings.
There are four risk categories into which dividend stocks can fall in the portfolio: Core, Secondary, Tertiary, and Cautious.
Core holdings are the most reliable, consistent companies that have been rewarding shareholders for a long time. They have the strongest balance sheets, widest moats, lowest payout ratios, and longest histories of dividend growth.
Secondary holdings are also fairly reliable dividend payers but have slightly weaker balance sheets, narrower moats, higher payout ratios, or less impressive histories of payout growth.
Tertiary holdings are either missing something or bear some obvious element of risk. Perhaps they have never been through a recession and, as such, have too short a dividend growth history to be reliable. Perhaps they are susceptible to the entry of a competitor that would substantially eat into revenue or cash flows.
"Cautious" holdings have multiple risks but still offer significant upside if the company is able to navigate those risks successfully. Alternatively, these may be stocks that have been so beaten down by the threat of risks that merely "scraping by" or producing flat growth would produce market-beating returns.
Temporal Categories Of Investments
There are five different temporal categories of investments. Some investments are, by nature, shorter term while others are meant to be very long term. We can think of these temporal categories like different trees. Some trees are fast growing and live very short productive lives, while others are slow growing and live very long productive lives.
Here are the five different kinds of "trees" and their corresponding investment types:
1. Ornamental Peach Tree: In the spring, Ornamental Peach trees burst with beautiful, delicate pink, purple, and white flowers that bristle in the breeze. These trees typically have very short productive lives, flowering only a few years and for short periods (three to fourmonths) each year.
The investment equivalent of Ornamental Peach trees is the kind with a short-term holding period, perhaps a few months to a few years, in which a large payout is expected but will not be repeated. An example would be trading in and out of a business development company stock as it swings up and down from oversold to overbought, enjoying the hefty payout along the way. I once did this profitably with Prospect Capital (PSEC) but have since moved away from this kind of investment.
2. Orange Tree: Orange trees can have productive lifespans of fifty years, producing juicy, sweet fruit year after year during that time. What's more, they are evergreens, yielding plump oranges year-round.
The investment equivalent of orange trees is the kind with a long holding period. The company could face competition or changing tastes someday, and it may not keep "producing" forever. But as far as the eye can see, it will continue putting out a moderate payout. Most stock investments fall into this category.
3. Olive Tree: Olive trees, amazingly, have typical productive lifespans of hundreds of years. Some produce much longer than that. There is an olive tree on the island of Crete that is estimated to be 3,000 years old and still produces olives today.
The investment equivalent of olive trees is the kind that has been around for a long time and has such a consistent, proven business model that it seems likely to keep "producing" indefinitely. All of my core holdings fall into this category.
4. Oak Tree: Oak trees are probably the kind of tree that pops into your head when you think of a generic tree. They start small but grow big, with thick trunks and robust crowns, fully maturing in 30-40 years. However, they produce no fruit or nuts that are economically useful. Their only economic use is as timber, but of course that requires them to be cut down.
The investment equivalent of an oak tree is your standard growth company. It produces no regular payout. Rather, one profits from these investments only when they reach "maturity" and are sold (tree is chopped down for wood). Since cashflow capitalists are more concerned with regular payouts from their investments, these kinds of investments are typically avoided.
5. Tree of Life: Indulge me here. In the Bible, the Tree of Life has an everlasting lifespan, and its fruit provides healing for all people.
When one works hard, saves, and invests, I believe one has the right to choose what to do with the after-tax returns from one's investments. But I also believe that those who have the ability to help others and still live a comfortable life ought to do so. The American industrialist Andrew Carnegie once said,
Wealth is not to feed our egos but to feed the hungry and to help people help themselves.
To "feed the hungry" or "help people help themselves," whatever form that takes, is the longest lived form of investment that anyone could make, in my opinion. It has the capacity to outlive oneself and to produce positive ripple effects that last forever. I strive to live by the proverb attributed to English theologian John Wesley: "Make all you can. Save all you can. Give all you can."
Here are the investment criteria for core and secondary holdings:
- A recession-resistant track record as proven by an uninterrupted dividend payout through the Great Recession. This criterion is listed first because it is of foremost importance. Dividend cuts obviously run counter to Points 1 and 2 of the overarching financial goals.
- A long-term history and trajectory of revenue growth. Would a single year of negative revenue growth negate a stock from consideration? No. But looked at over any five- or ten-year period, revenue growth should be positive. This is the sign of a company that is actually growing, not merely financially engineering EPS growth.
- A long-term trajectory of net income and free cash flow growth.
- Acceptable payout ratio. Whether the payout ratio is based on earnings (i.e., EPS), FFO (funds from operations), NII (net investment income) for BDCs, or DCF (distributable cash flow), the payout ratio should leave some room for error or economic weakness as well as investment. For REITs, a payout of less than 85% is acceptable, less than 80% is good, and less than 75% is ideal. For non-pass-through corporations, the target is less than 65%. Paying out less than 70% of FCF (free cash flow) is also ideal.
- Low debt relative to its industry. For instance, REITs tend to have much higher debt loads as part of their business models, and as such, a debt-to-EBITDA ratio of 5.8x or less is acceptable in that sector. For most other non-pass-through corporations, however, I aim for a 2.5x or less ratio.
- Cost of capital advantage. By this, I mean a weighted average cost of capital that is relatively low for its industry or compared to its peers.
- Annual dividend growth higher than the rate of inflation (at least 2%-3% per year).
- Relatively high earnings yield (EBIT/EV) and FCF yield. What does "relatively high" mean? For the FCF yield, I'd set the target around where the target 10-year yield-on-cost is set — around 7%, at least.
- A realistic target 10-year yield-on-cost of at least 7%, based on one's best estimate of forward average dividend growth.
There is no set list of criteria for tertiary and cautious holdings. Rather, to be considered "tertiary" or "cautious" would simply be to lack some of the above traits.
Moreover, to compensate for increased risk, I insist on at least a 10% 10-year target yield-on-cost for tertiary and cautious holdings. An example of a tertiary holding would be AbbVie Inc. (ABBV), and a cautious holding would be Tanger Factory Outlet Centers (SKT). I've written about both stocks recently in this article.
My Personal Core Holdings
Different investors will inevitably have different lists of their top or core holdings depending on their sphere of competence and interests. Here are my core holdings, some of which are already in my top 10 largest positions and others of which I'm waiting for the opportune time to build up:
- Brookfield Infrastructure Partners (BIP)
- Duke Energy Corporation (DUK)
- Enterprise Products Partners (EPD)
- Illinois Tool Works Inc. (ITW)
- Mid-America Apartment Communities (MAA)
- National Retail Properties (NNN)
- Realty Income Corporation (O)
- PepsiCo, Inc. (PEP)
- WEC Energy Group, Inc. (WEC)
- W.P. Carey Inc. (WPC)
This is an extremely defensive group, and as such, it has done extraordinarily well this year as defensives have outperformed the market. I'd consider each of these an "olive tree"-type investment that could potentially last much longer than my own lifetime while continuing to pay out a growing dividend.
As you can see below, each stock has grown its dividend at a varying rate:
Each either grew or held steady their dividend during the Great Recession, and each has at least a 7% 10-year yield-on-cost. Some are above 10%. BIPs, astonishingly, is ~20%.
Also, in the core holdings, we find represented both high-yield/low-growth and low-yield/high-growth stocks. Each has manageable debt, a cost of capital advantage, and good payout ratios. And aside from ITW, which is in the middle of implementing a new strategy, each has enjoyed strong revenue growth.
If these fall during the next recession or downturn, I plan to bring each up to size so that they represent my top 10 largest holdings.
This Labor Day week, I'd like to recognize both hard work and the fortunate ability to invest for a better life in the future. Surely to work is to add value to others, but to invest is to build value for future comfort and financial independence. Both are admirable.
I am immensely grateful to live in an age in which one can be both a worker and a capitalist. That is true of me, as I'm sure it's true of most of those reading this. To be a "cashflow capitalist" is to focus one's investments on the "orange tree" or "olive tree" varieties as described above. These produce regular, reliable payouts over long periods of time.
And, in my opinion, the cashflow capitalist who is able to also considers Tree of Life-type investments — charitable giving that helps others achieve at least a piece of the comfort and independence that one has had the good fortune of enjoying.
To quote the unspoken saying of George Bailey's father in the 1946 movie, It's a Wonderful Life:
All you can take with you is that which you've given away.
Disclosure: I am/we are long BIP, DUK, EPD, ITW, MAA, NNN, O, PEP, WEC, WPC. 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.