Cabot Dividend Investor Issue: July 13, 2022

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Exploit More Bad News

It’s a bear market. The S&P 500 fell into bear territory on June 13, down 20% from the high on a closing basis. And there is a good chance that stocks make new lows in the weeks and months ahead.

The high and persistent inflation hasn’t even peaked yet. And the behind-the-curve Fed will have to continue to raise interest rates aggressively from here to tame it. It is becoming increasingly less likely that inflation can be tamed without a recession. In fact, a growing chorus of economists are now calling for a recession sometime within the next year.

Of course, a recession is still not confirmed. It’s possible that we manage to avoid it and stocks have partially factored in an event that never happens. But even if that positive scenario unfolds, it will take months to realize. In the meantime, it will be difficult for stocks to generate lasting upside traction while the strong possibility of recession looms.

In a good scenario, the market continues to bounce around in the next few months, maybe slightly to the upside. But bad news is a bigger risk to a market that’s going nowhere. And it is very possible that more evidence of an imminent recession develops. While anything is possible in the near term, it seems that the greater odds favor more downside from here.

But there is good news. Bear markets create fantastic opportunities for longer-term investors. Markets trend higher over time. Bull markets tend to last much longer than bear markets and go far higher than bear markets fall. It’s been a bull market more than 80% of the time over the last 80 years. History shows that bear markets create ideal entry points ahead of the next bull market.

While mostly defensively postured, this portfolio also has stocks with leverage in a market recovery with the technology positions in Qualcomm (QCOM), Broadcom (AVGO), and Intel (INTC) as well as other more cyclical stocks in Innovative Industrial Properties (IIPR) and Visa (V). These positions should provide strong upside in a market recovery and be worth the wait and trouble in the event the market has further downside.

But let’s not just weather the storm. Let’s take full advantage of the very possible further downside from here in the market. In this issue, I highlight one of the very best stocks on the market with a targeted low, low price that may be reached in the panic selling of a market bottom. Specifically, we target a highly desirable stock at a dirt-cheap price with a good ‘til cancel (GTC) for that stock at the designated price.

What to Do Now

Recessions are typically a great time to buy stocks for longer-term investors. The market usually falls a lot ahead of the actual recession and then starts to recover before the recession is over, as the market anticipates. But a “looming recession” isn’t the best time to buy.

The market usually falls in anticipation of recession and in the early stages, and there is a good chance we are in the pre-recession phase now. For that reason, many of the more cyclical positions in the portfolio have been sold, including the four that were sold in June. The sales raise cash for a more advantageous time and make it easier to weather a possible storm ahead.

However, an exception is being made with the technology stock positions for a few reasons. First, markets can be confounding, and there is no guarantee that we are headed for recession or that the bottom isn’t already in. We don’t want to put all our eggs in the further-downside-scenario basket.

Also, technology is a good place to take that risk. The stocks have fallen a lot already and may precede the market toward recovery like they have led it down. But it also makes fundamental sense.

Consider, that in a fickle market, inflation, the Fed and recession are all the rage right now. But it could be a much different story in six months, and different than that in a year. Sectors go in and out of favor. Economic cycles change. Markets go up and down. What won’t change is the fact that we are in a technological revolution where technology will advance more rapidly than before.

Whatever happens with the economy, you won’t stop using the Internet or streaming movies. Automated cars and artificial intelligence are coming, along with a host of new technologies in a digital age regardless of what the Fed does or who is President. The best tech companies will continue to thrive like few others. And investors will come back.

Even if these stock fall further, they sell at historically cheap prices in a rare out-of-favor period ahead of a magnificent future. Even if it’s an ugly road higher, the investment should prove well worth your while over time.

Monthly Activity

June 15
Global Ship Lease (GSL) – Rating change “BUY” to “HOLD”Innovative Industrial Partners (IIPR) – Rating change “BUY” to “HOLD”

June 22
Global Ship Lease (GSL) – SOLD (17.35, total return -23.88%)Discover Financial Services (DFS) – SOLD (94.02, total return -23.98%)Chevron Corp. (CVX) – SOLD (147.87, ½ position total return 71.51%)Valero Energy (VLO) – SOLD (113.13, ½ position total return 56.26%)

Featured Action

Target Home Depot (HD) at 200 per share

Home Depot is the world’s largest home improvement retailer with over 2,300 stores in the U.S., Canada and Mexico and over $152 billion in annual revenue.

The stores offer products for every type of home project imaginable as well as installation services and tool and equipment rentals. The company primarily serves homeowners and renovators/remodelers, general contractors, maintenance professionals, handymen, property managers, building service contractors and specialty tradesmen, such as electricians, plumbers, and painters.

Home Depot offers a different kind of retail experience, and it is one of the best-insulated retailers from online competition, as people tend to want to go to the stores and look at things in person. While it’s been like Gettysburg out there for many traditional retailers, Home Depot has grown earnings at an average annual rate of 19% over the last five years. That’s impressive for a retailer this size.

But size is a key ingredient for the success of this behemoth. As the largest home improvement retailer in the world, they have a tremendous cost advantage as they buy in such volumes. It enables very high margins that drive profitability. And the store is good at what they do. They know their customers and how to keep them coming back for more.

Stock performance reflects a superior business model. HD provided a return (with dividends reinvested) of 106% over the last five years and 600% over the last ten years. It has significantly outperformed the market over both periods. A $10,000 investment ten years ago would be worth about $70,000 today. And those returns are after the stock has fallen 30% YTD.

How do things look for the stock going forward?

Future growth
The company has 2,300 stores in all 50 states, as well as Canada and Mexico, with opportunities for expansion. Home Depot also has a best-in-class market share of the pro market (professionals rather than do-it-yourselfers). This is the fastest growing customer segment with people who shop more frequently and spend a lot more money.

Pros have grown to be about 45% of sales with a large runway for further expansion as Home Depot still has just a 13% market share. The company also has a rapidly growing online presence and has fantastic distribution and merchandising networks.

There are also some powerful longer-term headwinds playing in Home Depot’s favor. For one, the average age of a home in the U.S. is over 45 years, that’s the oldest it’s ever been. Naturally, older homes require more upgrades and improvements. Also, there is a significant shortage of lower-priced homes in this country. That space will have to be built out in future years to accommodate demand.

The Dividend
The current yield is only 2.7%, but the dividend grows like crazy. The ten-year average dividend growth rate is over 20% annually and the payout has grown nearly sixfold over that period. Meanwhile, it has just a 44% payout ratio with plenty of room to grow in the future. Earnings per share growth is estimated to be an annual 14.6% over the next five years and the payout should continue to grow by double digits every year.

The strong and predictable growth is not lost on the shareholders. The company has invested $67 billion, or more than 20% of market cap, over the last five years on dividends and share buybacks. That pace of shareholder reinvestments will continue in the future. It uses its excess cash to reward shareholders and that’s a nice tailwind for the stock.

Timing
For a long-term investor, there is probably no bad time to buy this stock. But it’s still best to buy it cheap on the rare occasions that’s possible. Consumer stocks have been the worst-performing sector in a terrible year for the market. Inflation, supply chain problems and falling consumer confidence are taking a toll on the sector and HD has fallen 30% YTD. It’s also a big problem that a growing number of economists expect a recession in the next year. That will take a toll on consumer spending and pressure profits at even the very best retailers.

We are also targeting a purchase price at 200 per share, much cheaper than the current market price of 286. It’s possible the stock never reaches that price. That’s OK. It’s a way take advantage of further market downside. If it doesn’t happen, so be it.

More downside and a panicky bottom are possible. It’s surprising how cheap stocks can get at the peak of panicked bear market selling. It may not be the ideal point in the economic cycle to buy HD, but if you can pick up this longer-term juggernaut at a rock-bottom, bear-market price, it could turn out to be one of the best investments of a lifetime for a longer-term oriented investor.

Home Depot (HD)
Security type: Common stock
Industry: Retail
Price: 286
52-week range: 264.51 - 420.61
Yield: 2.7%
Profile: Home Depot is the world’s largest home improvement retailer.

Positives

• The store has a great niche and is insulated from online competition.
• Management returns a huge amount of cash to shareholders.
• There are powerful tailwinds for the store as a result of an aging housing market and strong demand for new houses.

Risks

• In the event of a recession the housing market will weaken, and consumers will likely pare back purchases.
• There is more limited opportunity to expand in the U.S. than in the past.

Portfolio at a Glance

High Yield Tier

The investments in our High Yield Tier have been chosen for their high current payouts. These investments will often be riskier or have less capital appreciation potential than those in our other two tiers, but they’re appropriate for investors who want to generate maximum income from their portfolios right now.

Enterprise Product Partners (EPD – yield 7.6%) – After trending ever higher all year long, EPD got hit along with the rest of the energy sector in June when fears of recession took hold. It did pull back to the levels of this past spring but has bottomed and has been holding steady. We’ll see if the recession worries continue to pressure the sector. But EPD should be solid as revenues rely on volumes rather than commodity prices and the distribution is rock solid. It also has inflation adjustments built into its contracts. (This security generates a K1 form at tax time). BUY

Enterprise Product Partners (EPD)
Next ex-div date: July 28, 2022

ONEOK Inc. (OKE – yield 6.7%) – This midstream company also sold off with the energy sector in June. It sold off more than EPD because it tends to be more volatile and was also up a lot last year. OKE has bottomed for now. It does trade with the overall energy sector in the near term. But it has defensive earnings that aren’t levered to commodity prices, sells at a compelling valuation and pay a sky-high dividend that is safe. A defensive energy company with a high payout could be the ideal stock in the months ahead. BUY

ONEOK Inc. (OKE)
Next ex-div date: July 28, 2022, est.

Realty Income (O – yield 4.3%) – The REIT sector has posted solid relative returns amidst the recent market tumult. It’s also worth noting that O is one of the rare stocks that is trading higher now than when the June selling began. It’s a well-known defensive income producer, and that type of stock is in demand in troubled markets like this. Although it deals in retail properties, most tenants are staples like supermarkets and drug stores. I expect more market-beating returns if the turbulence persists in the months ahead. HOLD

Realty Income (O)
Next ex-div date: July 31, 2022, est.

Dividend Growth Tier

To be chosen for the Dividend Growth tier, investments must have a strong history of dividend increases and indicate both good potential for and high prioritization of continued dividend growth.

AbbVie (ABBV – yield 3.7%) – Investors rediscover the defensive attributes of healthcare stocks in times like this. That’s why healthcare in the best-performing sector over the past month and the second-best-performing sector over the last three months. Health care will continue to thrive regardless of the state of the economy. Despite the strong performance, ABBV continues to sell at dirt-cheap valuations as it overcomes the looming loss of the Humira patent in the U.S. It’s a good stock to hold anytime, but the relative performance is especially good in markets like this. HOLD

AbbVie Inc. (ABBV)
Next ex-div date: July 14, 2022

Broadcom Inc. (AVGO – yield 3.4%) – The selling is overdone and AVGO has strong technical support around where it currently trades. It been a technology bloodbath this year and AVGO has not been immune. But the company should continue to post solid earnings growth in the months and years ahead as it benefits from technological advancement in the cloud and as a result of 5G infrastructure. Investors should rediscover this stock as some point. Earnings growth and valuation dictate that this stock should trade a lot higher in the future. HOLD

Broadcom Inc. (AVGO)
Next ex-div date: September 21, 2022, est.

Brookfield Infrastructure Partners (BIP – yield 3.8%) – This defensive infrastructure partnership took a hit along with everything else in June. But it has been solid in the absence of market panic. BIP should be ideally suited for this market over the rest of the year. Its earnings are highly recession resistant, and Brookfield has inflation adjustments built into its contracts. Earnings are growing at a higher-than-normal clip because of the recent midstream energy acquisition and the stock is a very reliable dividend payer. (This security generates a K1 form at tax time). HOLD

Brookfield Infrastructure Partners (BIP)
Next ex-div date: August 27, 2022 est.

Eli Lilly and Company (LLY – yield 1.2%) – While the world goes to Hell in a handbag, LLY is making new highs. The company has the best growth profile in big pharma as it continues to rack up successes with its strong product lineup and promising pipeline. It has been further buoyed recently by promising results for its type 2 diabetes drug that also has strong trial results for obesity. It also has a potential blockbuster Alzheimer’s drug that should be approved later this year. It’s been the best of big pharma, an industry whose strong relative performance should continue as investors look to defensive earnings. LLY is a great place to be right now. HOLD

Eli Lilly and Company (LLY)
Next ex-div date: August 12, 2022

Innovative Industrial Properties, Inc. (IIPR – yield 6.3%) –Innovative is a high-growth REIT in a new industry. This year’s market has been brutal to such stocks. IIPR fell again in the recent tumult even though it had been beaten to a pulp already. But fundamentals justify a much higher price. The company is projected to grow earnings 37% this year and it sells at a price/earnings ratio below that of the overall market. It also pays a large and rapidly growing dividend. Things might get worse before they get better. But the returns over the longer term should make is well worth the pain. HOLD

Innovative Industrial Properties, Inc. (IIPR)
Next ex-div date: September 30, 2022, est.

Intel Corporation (INTC – yield 3.8%) – The trouble with buying undervalued companies is that they can stay undervalued for a while and even sell down more in markets like these. But INTC does pay a 3.8% yield in the meantime. Looking ahead, tech is oversold and should bounce back at some point. Plus, Intel’s earnings should grow at a solid clip in the years ahead. It’s a great company at a dirt-cheap price that should deliver strong results over the longer term. But it could take a while. BUY

Intel Corporation (INTC)
Next ex-div date: August 5, 2022, est.

Qualcomm Inc. (QCOM – yield 2.3%) – Qualcomm is in a strong earnings growth cycle that should last a while. It is also so well positioned for the future. But the rollover in the technology sector took everything with it. Analysts were slobbering all over this company a few months ago when it was blowing away earnings expectations and raising guidance. Sure, smartphone sales will decrease in a recession. But that is already more than priced in. The stock sells well below what the fundamentals justify. And such things win the day eventually. HOLD

Qualcomm Inc. (QCOM)
Next ex-div date: September 2, 2022, est.

Visa Inc. (V – yield 0.7%) – V got knocked back amidst all this recession talk and the downgrading of global growth projections. But is always seems to bottom in the just under 200 per share range and quickly recovers well before market selling eases. Visa continues to get a huge benefit from the removal of covid restrictions globally despite slowing global growth. Earnings blew away expectations with YOY revenue growth of 25% and 30% earnings growth. This stock should be one of the first to reverse course and move higher when the market recovers. HOLD

Visa Inc. (V)
Next ex-div date: August 12, 2022, est.

Safe Income Tier

The Safe Income tier of our portfolio holds long-term positions in high-quality stocks and other investments that generate steady income with minimal volatility and low risk. These positions are appropriate for all investors, but are meant to be held for the long term, primarily for income—don’t buy these thinking you’ll double your money in a year.

NextEra Energy (NEE – yield 2.0%) – NEE struggled for a while despite the solid performance of the utility sector after the earnings report revealed that delays from solar panels in Asia will slow solar projects. But the stock bottomed and has been solid in the recent market environment, having recovered all the June losses and then some. NEE is now at a higher price than before the market fell into bear territory. This is a great utility and a phenomenal way for conservative investors to play the growth in clean energy. HOLD

NextEra Inc. (NEE)
Next ex-div date: August 28, 2022, est.

Xcel Energy (XEL – yield 2.8%) – Although XEL sold off in June during the market tumult, it has since recovered nicely and has had a solid year. It’s in two great sectors to own right now, utilities and alternative energy. It has come off the highs but has been holding around the 70 per share range. In the absence of panic, XEL is gravitating back to where it belongs. HOLD

Xcel Energy Inc. (XEL)
Next ex-div date: September 14, 2022, est.

Dividend Calendar

Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Dividend Investor for an explanation of how dates are estimated.

The next Cabot Dividend Investor issue will be published on August 10, 2022.