Buffett Buys Fear, 2 Big Dividends For A Retirement Dream

Jul. 29, 2022 8:10 AM ETEPD, ETO193 Comments

Summary

  • The price for certainty in the markets is too high; successful investors know this well.
  • I am buying big dividends hand over fist in this fearful market.
  • Sleep well at night with these two picks with up to 8.6% yields.
  • Looking for a portfolio of ideas like this one? Members of High Dividend Opportunities get exclusive access to our model portfolio. Learn More »

Warren Buffett And BofA CEO Brian Moynihan Speak At Georgetown University

Drew Angerer

Co-produced with "Hidden Opportunities"

How will the July inflation report look? What will be the Fed's next steps to control inflation? Will the employment report look good? So many questions, but no one knows the answers. During bull markets, the investor community takes these reports as they come, but there is always heightened anxiety around the numbers during bear markets. Fear looms and pushes investors to make the worst decisions.

Did you think all the signs would be crystal clear for you to hop on the rocket ship to the moon?

"The future is never clear. You pay a very high price in the stock market for a cheery consensus. Uncertainty is the friend of the buyer of long-term values." - Warren Buffett

What are your long-term values? Are your actions during this bear market getting you closer or further away from those values? My long-term objectives are to slowly build passive income through dividends and scale it to a level that will help me retire. Naturally, the larger the dividend from reliable companies, the closer I get to achieving my retirement goals. Hence, I am using this market fear to buy big dividends. Two picks with yields of up to 8.6% to get you started.

Pick #1: ETO, Yield 8.6%

Eaton Vance Tax-Advantaged Global Dividend Opportunities Fund (ETO) is a closed-end fund ("CEF") designed to derive a sustainable income from global equities. ETO comprises over 127 holdings, and we see some of the biggest global companies form the most significant share with ~22% of its Net Asset Value. (Source: Fact Sheet)

Fact Sheet

Fact Sheet

Eaton Vance is one of the oldest investment companies in the U.S. and has over 20 years of experience with income solutions through CEFs and currently manages ~$25 billion in CEF assets. ETO, in particular, is designed to generate current income for investors from qualified dividends and long-term capital gains.

What is the significance of "tax-advantaged" in the CEF's name?

By investing primarily in dividend-paying common and preferred stocks, ETO seeks to distribute dividend income that qualifies for favorable federal income tax treatment. Buy and sell decisions are made by balancing investment considerations and tax considerations, and taking into account the taxes payable by shareholders. (Source: Eaton Vance)

In the past four years, most of ETO's distributions have been through Long Term Capital Gains, and Qualified Dividends (22%). LT gains and Qualified Dividend Income ("QDI") are eligible for favorable tax treatment for U.S. investors. Altogether, ETO is a solid fund to hold in a taxable account to realize distributions with favorable taxation.

During this bear market with slim capital gains, ETO estimates that distributions for this fiscal year will include some Return of Capital. ROC provides a deferred tax treatment where you are not taxed on the distribution as you receive it but will be taxed as long-term gains when you decide to close your position.

A common misconception about return of capital distributions is that they are somehow less legitimate, or less valuable, than other fund distributions. In this thinking, dividends and capital gains distributions are based on fund returns, and therefore earned, while return of capital distributions are not based on fund returns, and therefore unearned.

A key distinction that may elude those who take this view is the difference between return of principal (economic concept) and return of capital (tax concept). While they sound like the same thing, they are not." - Eaton Vance, Return of Capital Distributions Demystified

It is pretty straightforward to gauge the health of a CEF. If the change in a fund's NAV per share over a period shows a NAV increase, the fund earned more than it distributed. If NAV has gone down, the fund distributed more than it earned. The chart below tells me that the fund has shown long-term durability while maintaining a steady distribution.

Chart
Data by YCharts

Note: ETO's distributions have varied over time. While the fund made a 26% distribution reduction during the early days of the pandemic, they have returned to pre-COVID levels as of July 2021.

Today, ETO distributes $0.1792/share every month, an impressive 8.6% annualized yield. Since that increase, the stock has sold off under the bear market pressures. Such a shame that the market doesn't like increasing dividends. I do, so I am happy to load up.

Pick #2: EPD, Yield 7.2%

Speaking of increasing dividends, we have another one for you. Enterprise Products Partners L.P. (EPD) is a leading U.S. midstream company that operates over 50,000 miles of pipelines; over 260 million barrels of storage capacity for NGLs, crude oil, petrochemicals, and refined products; and 14 billion cubic feet of natural gas storage capacity. With its business primarily oriented towards commodities that form feedstock for manufacturing and industrial products, EPD has a bright future.

Author's calculations

Author's calculations

Note: EPD is a Master Limited Partnership that issues a schedule K-1 for tax purposes.

Last year, Americans in mid-Atlantic states and across the southeast faced gas shortages following the cyberattack on the Colonial Pipeline. This made the Biden administration realize the importance of reliable supply and the role of pipelines in ensuring that. At a White House press briefing, Energy Secretary Jennifer Granholm said that pipes are the best way to go for an efficient and safe supply of commodities. It is scientifically and politically accepted that transporting energy commodities by pipeline is significantly more affordable than rail. Access to these pipelines proves critical for overall energy independence and affordability, mainly when oil prices spike.

EPD management demonstrated spectacular shareholder stewardship with 24 consecutive years of distribution growth. The company recently announced a 5.6% YoY increase, and the current payout is an attractive 7.2% yield. The return to shareholders doesn't end there. The partnership announced the repurchase of $35 million of its common units during Q2. EPD still has ~75% of its authorized $2.0 billion buyback program, indicating that the number of outstanding shares will shrink a lot more in the upcoming quarters. With over 32% of common units owned by insiders, it is safe to say that management has the best interests of shareholders at heart and will continue shareholder-friendly decision-making.

EPD maintains an investment-grade balance sheet with a 3.4x leverage ratio at the end of Q2. With an average interest rate of 4.3% and 95% fixed rate debt, the company is at a comfortable spot for a rising rate environment.

In EPD, we see a company with assets vital for the safe transportation of commodities to support growing economies. Look past the uncertainties in the market and grab this 7.2% yield for dependable income.

EPD reports earnings on the morning of August 3rd.

Istock

istock

Conclusion

Wall Street loves consistency and certainty about the future prospects of any business and will usually over-reward (overvalue) for that certainty. But successful investors have consistently taken advantage of uncertainty-driven undervaluation in the markets. We face one such situation now, and you would be better off as a buyer than a seller.

Let us look at what billionaire investor Mohnish Pabrai (a humble disciple of Warren Buffett) had to say about his mindset during the great financial crisis.

.....the fourth quarter of 2008, especially in the last, I would say, four or five weeks of the year, I probably did more investments than in my career…." - Mohnish Pabrai

Successful investors buy hand over fist when the market shakes in fear. They don't wait for buy signals or positive news from economic reports because they know that the price of that certainty is too much. Investors like Buffett and Pabrai have no problem reaching out and grabbing a stock dropping like a dagger, and then keep buying while it plummets into the abyss. However, most investors have limited capital and cannot make such brave moves.

The biggest reason I like the income method is that it involves investing in businesses that prioritize returns to shareholders. That way, I get paid to wait for these economic uncertainties to clear themselves. I am buying dividends hand over fist during this bear market, and you can join me. Two picks with up to 8.6% yields will get you started.

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This article was written by

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