It's Time To Build Core Holdings In These Blue-Chip Dividend Stocks

Summary

• The S&P 500 has declined about 15% year-to-date at its intraday worst.
• With no "light at the end of the tunnel" visible yet for either inflation or interest rates, it is difficult to call a bottom in stock prices.
• It is during drawdowns like the present one that investors ought to build core holdings from blue-chip stocks that rarely go on discount.
• I highlight four high-quality dividend stocks that could make great core holdings in a dividend-oriented portfolio.
• Looking for a helping hand in the market? Members of High Yield Landlord get exclusive ideas and guidance to navigate any climate. Learn More »

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Economic weakness, high inflation, and rapidly rising interest rates.

These seem to be the ingredients for a stock market selloff and perhaps also a recession, at least this time around.

Stocks have struggled to gain any momentum this year amid high valuations, high input cost increases, and the reversal of pandemic-era fiscal and monetary stimulus from 2020 and 2021. In the last few days, despite some reprieve late in the day on Monday, May 2nd, the S&P 500 (SPY) shed ~15% of value from its all-time high, while the Nasdaq index (QQQ) is down 22% and the real estate index (VNQ) down nearly 14%.

Data by YCharts

Despite the late day rebound on Monday, I can't shake the feeling that the market is caught up in a selloff reminiscent of the one that occurred in late 2018, when the Fed was raising rates and sending a clear signal that their balance sheet reduction would continue "on autopilot."

From October to Christmas Eve that year, the S&P 500 dropped by ~20%.

Data by YCharts

Now, I am not trying to say that the market will sell off 20% again this time. That is impossible to say, especially with the magnitude of economic turmoil at present right now.

And, if you'll recall, reaching the 20% down mark spurred the government to action in stopping the bloodshed. Treasury Secretary Steve Mnuchin and the other members of what became called the "Plunge Protection Team" (cue the "A-Team" theme song) made clear their intent to "do something," and the Fed backed off its hawkishness shortly thereafter.

On the one hand, the stock market has become more important to both the US economy and to federal politics, which would seem to imply that greater asset price declines should lead to a quicker Fed pivot. But on the other hand, the Fed and federal politicians know that the #1 issue facing Americans today (and the #1 factor in politicians' reelection bid!) is inflation, and the Fed cannot back down from its hawkishness until inflation is at least beginning to cool down. That would seem to imply the Fed pivot isn't coming anytime soon.

In lieu of any "light at the end of the tunnel" visible yet on either the inflation front or the interest rate front, it's hard to believe we've seen the near-term lows in stock prices.

Regardless which direction stocks head from here, it strikes me as a good idea to use the current selloff as an opportunity to acquire those high-quality stocks that usually trade at too rich a valuation to consider.

It is always tempting during downturns to buy whatever is cheapest or highest yielding, but that will often cause an investor to end up with a portfolio weighted towards lower quality or riskier holdings. Times like now, it takes discipline to buy the blue-chip stocks that don't have the highest yields but do look undervalued relative to their own historically average valuations.

It's times like now that core holdings should be built.

What Makes A Core Holding?

Let's talk briefly about this concept of core holdings. I would define "core holding" as a stock position in one's portfolio that has a significantly above-average weighting. So, what exactly makes a stock worthy of becoming a core holding?

Some would say holdings should be weighted by quality (in terms of balance sheet strength and/or profit margins). Others say weighting should be by conviction. Still others by growth rates. Yet others by market cap or size relative to the stock's respective industry.

I don't believe there is a right or wrong answer, only one that is right or wrong based on one's personal investing goals and disposition toward risk.

Personally, I use a combination of factors when weighting stocks. Here are the five criteria I use for determining core holdings:

• My personal level of understanding in the company/business model
• Management's competence and shareholder-alignment
• Cost of capital advantage
• Quality of balance sheet
• Projected growth rate

Five of my top ten holdings are net lease REITs that each specialize in a different property type. Most financial advisors would probably say that my portfolio is too heavily weighted toward REITs in general and especially net lease REITs, but this is a business model I understand well.

Moreover, each of my top holdings have top-quality management, a cost of capital advantage over peers, a strong balance sheet, and a solid growth rate.

That said, there are other blue-chip dividend stocks that make solid contenders as core holdings. Here are brief pitches for four that I believe investors ought to consider.

1. Brookfield Renewable Partners (BEP)

• Dividend Yield: 3.66%

I own the partnership version of this company that generates a K-1 form for tax purposes, but the corporate version (BEPC) that generates a standard 1099-Div form is currently only marginally higher in price.

BEP is one of the largest owner-operators of renewable energy assets such as hydropower dams, solar arrays, and wind farms in the world.

BEP March Investor Brochure

Here are some the highlights that make BEP worthy of consideration as a core holding:

• As part of the Brookfield Asset Management (BAM) family, BEP has access to ample funding, resources, and expertise.
• BEP is capable of developing renewables projects in-house, as opposed to peers NextEra Energy Partners (NEP) and Clearway Energy, Inc. (CWEN) who have third-party sponsors that do development.
• BEP's 62-gigawatt development pipeline is massive - nearly three times the size of its current portfolio's operating capacity of 21 GW.
• BEP has the strongest balance sheet of any North American owner-operator of renewables assets with a BBB+ credit rating and a 13-year average term to maturity.
• 50% of revenues derive from hydropower, which boasts stability and dispatchability as opposed to solar and wind's intermittency.
• BEP's global presence across four continents allows the company to take advantage of the best opportunities in the world, wherever they may be.
• Global decarbonization efforts by governments and corporations are sure to continue expanding BEP's development pipeline bigger and bigger for years to come.
• Unlike most publicly traded peers, most of BEP's long-term contracts have CPI-based fee escalations built in.

2. Crown Castle International (CCI)

• Dividend Yield: 3.25%

CCI is a real estate investment trust that specializes in telecommunications towers exclusively in the United States, despite the word "International" in the company title.

CCI Investor Presentation

Between over 40,000 towers, over 80,000 small cells (with tens of thousands more to be added in the coming years), and around 80,000 route miles of fiber lines, CCI is the premier telecommunications infrastructure provider in the US.

Mobile carriers like AT&T (T), Verizon (VZ), and T-Mobile (TMUS) are spending larger and larger sums of money to invest in their network capacity and 5G rollouts in order to remain competitive. And CCI is in control of the mission-critical infrastructure they need in order to operate their core business.

Here are some reasons why CCI may deserve to be a core holding in a dividend stock portfolio:

• The US is arguably the best market in the world for telecommunications infrastructure, as industry estimates expect over 30% of global mobile network investment through 2025 to be centered in the US, which makes up 4% of the world's population.
• The huge number of small cells, which CCI has been building up for years, will prove an advantage in urban areas as more and more devices connect to 5G.
• CCI has consistently beaten its own target of delivering 7-8% annual growth in AFFO per share and dividends.
• The rise of mobile gaming, video streaming, and cellular video communications will only increase infrastructure needs going forward.
• CCI's contracts have a weighted average life of around 5 years and embedded annual rent escalations of 3% (for towers).
• Debt is quite reasonable at 4.8x adjusted EBITDA as of Q1 2022.
• CCI is generating a 10% return on invested capital, and that return will only increase over time as more carriers are added to its towers and small cells.

3. Main Street Capital (MAIN)

• Dividend Yield: 6.58%

To quote myself (one of my favorite people to quote) from "These 2 Reliable Compounders Make Great Core Holdings":

MAIN is arguably the highest quality, bluest blue-chip business development company ("BDC") on the market. The company's business model is to provide mostly debt and some equity capital to private, lower-middle-market companies that are otherwise bank-dependent for the purpose of acquisitions, recapitalizations, or leveraged buyouts.

The name of the game for BDCs is "premium to NAV." These companies issue equity when their stock price trades at a premium to net asset value, and they (should) hold off when it trades at a discount to NAV. Part of MAIN's quality as a BDC is the fact that it consistently trades at a premium to NAV.

MAIN Investor Fact Sheet

This creates a positive cycle in which MAIN can issue equity accretively, thereby growing distributable net investment income ("DNII") per share as well as its monthly dividend. Meanwhile, MAIN retains some cash (12% of DNII in 2021) to further grow its loan book, which in turn grows NAV per share and pushes the stock price up.

The management team, led by CEO Dwayne Hyzak, is internal (employed by MAIN rather than a third-party asset manager), and it is also heavily shareholder aligned as insiders own roughly 5% of shares outstanding.

As far as BDCs go, it doesn't get any safer than MAIN.

4. Mid-America Apartment Communities (MAA)

• Dividend Yield: 2.29%

MAA is a multifamily REIT with the overwhelming majority of its apartment communities located in fast-growing markets in the Sunbelt. These markets were the destination of a great number of those who moved cities during the pandemic.

MAA March Presentation

So, demand is going up in MAA's markets, and fast. And yet, the supply side is having tremendous trouble keeping up with demand in these markets, due largely to supply chain constraints and severe cost overruns.

MAA March Presentation

Hence, we find, as I showed with charts in a recent article on MAA, that rents are rising extraordinarily fast in MAA's core Sunbelt markets. For the full year of 2022, MAA has guided for rent growth of 10-12% and net operating income growth of 12.5% to 14.5%.

Another competitive advantage enjoyed by MAA is the ability to develop properties in-house, as MAA can construct new communities from the ground up for yields of around 5.7%, compared to cap rates for existing properties around 3.5% to 4%.

Lastly, note that MAA has one of the strongest balance sheets in the multifamily REIT space, with BBB+ credit ratings and positive outlooks from all three major ratings agencies, implying that upgrades into the coveted "A" tier could be in the cards in the near future.

MAA March Presentation

This would further lower MAA's cost of debt, which would be helpful in its ability to acquire attractive properties in its markets at low cap rates of 4% or under.

In short, it looks like MAA is going to enjoy above-average rent growth for many years to come, which should translate into above-average dividend growth.

Bottom Line

Though it is impossible to say whether these four stocks will sell off further this year, they each look like a good value today. They are sitting 12.7% to 17.2% below their recent highs.

Data by YCharts

The above analysis was admittedly brief - a shorthand pitch for each one. In an article of this length, that is the best a humble Internet scribe like me can do. I encourage readers to do their own due diligence.

It is my view, though, that each of the four companies highlighted above make great core holdings for a dividend stock portfolio. And they are each name that I will be building in size for as long as the market is offering discounts on them.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BEP, CCI, MAIN, MAA either through stock ownership, options, or other derivatives. 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.

Comments

[RMUinFL]

@Austin Rogers ,
I agree that these are good picks for dependable income (and could be core holdings for anyone using this as an investing criteria). The market was certainly in love with MAA last year....it gained about 85%! All of the apartment REITs look pretty pricey right now. It looks like AVB might be the best value at this time.

[Lean in the direction you want to go]

When you refer to a core holding, what percentage of your portfolio might a core position be?

[Austin Rogers]

@Lean in the direction you want to go It depends on the number of total positions in one's portfolio, which is why I merely say it is a "significantly above-average" weighting.

[Marrk]

Thanks for the note.

Long CCI. Long & Overweight MAIN.

[Austin Rogers]

@Marrk Happy to be of service!

[Peteybird1]

@Marrk Been adding to MAIN, not overweight yet.

[doug pfister]

I'm always curious what people consider to be their core holdings & why.

[Austin Rogers]

@doug pfister As am I, and yet it rarely gets talked or written about.

[DougBodde]

I prefer buying your top ideas, especially if they have descended from where you recommended them. (I mean that as high compliment.)

[Austin Rogers]

@DougBodde It is almost a rule that if I publicly proclaim a stock a buy, it will then drop by some amount or another. So buying stocks that have descended from where I recommended them is probably all too frequent an opportunity :)

[Dividend_Dawg]

Love MAIN under $40. Just added yesterday. Thanks for the article.