Cabot Dividend Investor Issue: September 14, 2022

In a Rough Market, Look to Dividends

I’m not going to sugar coat it. The market doesn’t look good here.

The latest inflation data for August came in at a worse-than-expected 8.3%. While it’s down from the last two months, inflation is proving stickier than hoped. That means that the Fed will likely remain hawkish longer than hoped. Investors can no longer see a light at the end of the tunnel where inflation is under control and the Fed is done hiking rates.

Even if the market manages to avoid new lows, it is increasingly difficult to see how stocks will be able to generate any lasting upside traction in the face of inflation, rising interest rates, and recession. The end of the road for these pesky problems is no longer in sight.

Where’s the best place to put your money in such a predicament?

The obvious answer is cash. There’s a good chance stocks go lower. Bonds are getting creamed with interest rates rising. Why not wait safely on the sidelines until the situation improves?

While it makes sense to raise some cash in order to limit risk and have some dry powder to take advantage of low prices ahead of the next bull market, it doesn’t make sense for too much of your investable money. Money markets pay very little. And market timing seldom works.

It sounds like a good idea to wait in cash until things improve. But when is that precisely, and how will you know? In most cases investors miss the boat and don’t get back into the market until much of the easy upside is gone, negating the advantage of investing on the cheap. Plus, cash has been the worst-performing asset class in just about every measurable period over the last forty years.

The better answer is dividends.

Since 1930 dividends have accounted for 40% of total market returns. And dividend stocks have done so with much less volatility than the overall market. But that’s just the overall average. During sideways and down markets, dividends account for most of the total market return. In problematic decades, dividends have almost completely offset market price declines.

It’s true that dividend stocks can still fall in a down market. But the market may not fall further, and the long-term trend for the market is higher. History clearly shows that bear markets are the best time to get in cheap ahead of the next bull market. Meanwhile, dividends provide an income and less volatility while you wait.

In this issue, I highlight a company in one of the most defensive and recession-resistant industries on the market that currently pays a massive 8% yield. The stock is already cheap and likely near the trough of its own bear market with far more upside than downside over time to complement the high dividend.

What to Do Now

With the near-term prognosis not good, it isn’t time to start buying beaten-down cyclical stocks on the cheap. There is a good chance that the selling gets worse. It’s better to stay defensive for now.

There will be a day to scoop up great values ahead of the next bull market. But not yet. That’s why there are currently only 14 stocks in the portfolio and 9 of them are defensive. The rest are technology stocks which can quickly make up for lost time when the market turns and Visa (V), which should maintain solid earnings because of the removal of covid restrictions internationally.

Dividends are ideal for markets like this. They provide income and lower volatility in turbulent markets and make it easier to stay invested ahead of the next bull market. As I mentioned above, dividends account for most of market returns during flat and down markets. But dividend stocks also excel during times of inflation.

During the three decades where inflation averaged 5% or higher (1940s, 70s, and 80s), dividends contributed 56% of market returns. In the higher-inflation decades of the ’40s and ’70s, dividends contributed 67% and 73% of market returns respectively.

Three of the current BUY-rated stocks are midstream energy companies Enterprise Product Partners (EPD), ONEOK (OKE), and The Williams Companies (WMB). These are the highest-yield stocks in the portfolio that also offer cheap valuations, high and safe payouts, and favorable industry dynamics. These companies should also be able to thrive in recession and inflation.

Highlighted below is another high-dividend-paying stock that offers the same attributes as the midstream energy companies in a different industry.

Monthly Recap

August 10th
Purchased Williams Companies Inc. (WMB) - $33.02

September 14th
Buy Medical Properties Trust, Inc. (MPW)

Featured Action: Buy Medical Properties Trust, Inc. (MPW)

Yield: 8.0%
Medical Properties Trust is a healthcare Real Estate Investment Trust (REIT) that invests in hospitals and clinical spaces and leases them back to healthcare providers. It rents 447 properties in 10 countries and is the largest company to focus exclusively on hospital facilities with more than $1.6 billion in annual revenues.

The 447 properties are leased to 54 different operators primarily by a sale-leaseback arrangement. Medical Properties Trust buys properties from hospital operators and leases the property back to them. The arrangement provides operators with cash to fund facility improvements, make technological upgrades, and various other investments in operations. Medical Properties gets a steady and predictable cash flow whereby operators are responsible for costs and upgrades.

The portfolio is well-diversified with no one property representing more than 3% of the total. Properties are primarily located in the U.S. (61%) with the rest in the U.K. (18%), Spain (6%) and several other European countries. Medical Properties also invests in non-real estate assets in the form of the operators themselves to a small degree (roughly7% or assets) in the form of high-interest loans and equity stakes, which have been profitable. But 75.5% of revenue is derived from leases to general hospitals.

Results for the company and the stock have been very good over the longer term. MPW has significantly outperformed its healthcare real estate peers over the past three, five, and ten-year periods. The health care property REIT has grown its assets by a compound annual growth rate (CAGR) of 29% over the last ten years. Over the same period, Medical Properties Trust has increased cash from operations by 810%. The REIT has also grown its asset base by 122% just since 2018.

A big part of the success is the property selection process. The underwriting process identifies certain characteristics that make each facility attractive to any experienced and competent operator including physical qualities, market demographics, competition, and financials of the local area. It’s good at finding facilities that are the natural result of true community need where the proper conditions are in place for lasting profitability.

Recent StumblesThe things that make the stock particularly attractive now, namely a cheap valuation and a high yield, are the result of recent bad performance. The stock price is down more than 30% YTD and fell 15.3% in August alone. The reasons behind the stock plunge are rising interest rates and flat guidance and concern for one of its tenants reflected in the recent quarterly earnings report.

Rising interest rates pressure REITs in two ways. First, it makes competing fixed-rate investments more competitive for income investors. Second, it raises the cost of funding for acquisitions and expansions. The former is the more legitimate problem. REITs pay out most of their earnings in the form of dividends and need to borrow money or issue stock to raise money for expansion. Higher rates make expanding more expensive and limit growth.

The higher rates are limiting near-term growth for Medical Properties. The REIT targets $1 billion to $3 billion per year for acquisitions and this year will be near the low end. That limits earnings and dividend growth. But the stock sells at just eight times funds from operations (FFO) compared to about 17 times for its peers and its five-year average. Just making up most of that difference can move the stock price significantly higher.

The concerns about the tenant are overblown. Because of the superior property selection, new tenants can be easily found if it comes to that. Medical Properties has only ever replaced 11 operators in 20 facilities from a total of 530 hospitals and those tenants were easily replaced. Investors also underestimated the value of its investments in the operators, which are very profitable and are another source of cash flow. The company also grew FFO by 7% in the quarter but left guidance for the rest of the year unchanged.

The Dividend
MPW currently pays $0.29 per quarter, which translates to $1.16 per share annually for a current yield of 8%. That’s a big yield for a company this solid. The dividend has also been raised for eight consecutive years and MPW has one of the lowest payout ratios of its peers. It’s also worth noting that during the pandemic six of its healthcare REIT peers cut the dividend by an average of 31% while MPW raised its payout by 12% over the same period.

The dividend is also solid even amid inflation and recession. Hospitals and health clinics are highly recession-resistant properties for obvious reasons. The performance through the pandemic exemplifies that strength. Medical Properties also has inflation adjustments built into its leases and properties themselves should also hold value as hard assets during periods of inflation.

Looking Ahead
The market will have difficulty mustering sustainable upside traction amid inflation, a hawkish Fed, and recession. Two issues ago I targeted a security at a very low price to scoop up in case the market selling gets much worse. But MPW is near the trough of its own bear market and sells at a fire-sale price already. The dirt-cheap valuation combined with the high and safe dividend should make MPW a great holding through future tumult and a solid longer-term play as well.

The 8% combined with just a little appreciation can provide a double-digit return in a troubled market. In a year where the market index is down nearly 17% already and things could get worse, it’s time to look to positions that can be a single or a double. And MPW fits the bill while providing a high income.

Medical Properties Trust, Inc. (NYSE: MPW)
Security type: Real Estate Investment Trust (REIT)
Industry: Healthcare Properties
Price: $14.50
52-week range: $14.06 - $24.13
Yield: 8.0%
Profile: MPT is the largest healthcare REIT to focus exclusively on hospital facilities.

Positives

• Well-selected properties have a long history of success.
• Hospitals are a very recession-resistant business and properties hold value in inflation.
• MPW sells at a dirt-cheap valuation with a high and safe dividend.

Risks

• Higher interest rates limit expansion opportunities and earnings growth.
• The company has a high amount of debt.

Medical Properties Trust, Inc. (MPW)
Next ex-div date: September 14, 2022

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 7.2%) – This midstream energy partnership has been bouncing around for a long time and is still at the same price level it was back in April. But EPD has still returned nearly 30% YTD. That’s terrific outperformance considering the S&P 500 is down 15% this year. Looking forward, EPD seems to have everything going for it. It sells at a still-cheap valuation, pays a stratospheric and safe distribution, and it operates with rising profits in an industry with favorable dynamics. It’s one of the few stocks that can endure recession and inflation. (This security generates a K1 form at tax time). BUY

Enterprise Product Partners (EPD)
Next ex-div date: October 28, 2022, est.

ONEOK Inc. (OKE – yield 6.3%) – The same attributes of EPD apply to OKE. But this gas and natural gas liquids (NGLs) midstream energy company in the form of a regular corporation has underperformed EPD, returning only 14% YTD. That’s still strong outperformance of the market, but returns are lower this year because it had such a good year in 2021, returning nearly 70%. Natural gas and NGLs are the best place to be as those fossil fuels are fast growing, in high demand, and the most recession-resistant. BUY

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

Realty Income (O – yield 4.4%) – This legendary monthly income REIT has pulled back a lot after a 20% surge from the June low. O is down about 10% since the middle of August when the market turned. But this stock typically bounces around a lot on a slow longer-term trend higher. It’s also a good safe dividend stock for this uncertain market. Earnings rose 10.2% and the company is navigating inflation and recession like a champ. The occupancy rate for its consumer staple tenants is the highest in 10 years and the company increased guidance. HOLD

Realty Income (O)
Next ex-div date: September 30, 2022, est.

The Williams Companies, Inc. (WMB – yield 5.0%) – Although this newest addition to the portfolio has dipped a little bit lately in the turbulent market, the uptrend since the June low is still intact. WMB tends to trend higher in the absence of indiscriminate selling in the overall market. Operations are strong. The recently reported quarter featured a whopping 48% earnings per share spike over last year’s quarter. Williams also increased 2022 earnings guidance. It also has the same positive attributes as EPD and OKE in cheap valuation, a high dividend, and strong industry fundamentals. BUY

Williams Companies, Inc. (WMB)
Next ex-div date: December 8, 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 4.1%) – The biopharmaceutical company stock has been a lousy performer since April, falling nearly 20% from the high. That said, returns are still positive YTD (+8.45%) and this stock has held up well in the bad market downdrafts. It’s also typical of the stock to pull back after a big surge. But that’s all short-term noise. This is one of the best big pharma companies out there with one of the best pipelines and a population aging at warp speed. It should pay to simply hold the stock and collect the dividend through rough patches en route to better things in the future. HOLD

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

Broadcom Inc. (AVGO – yield 3.3%) – The chipmaker and infrastructure software provider once again delivered on earnings with 40% earnings growth and a 25% revenue increase versus last year’s quarter. It also raised guidance for the rest of the year. But the stock is down over 20% YTD because it has been dragged down by the technology sector. It currently sells at a forward price/earnings ratio below that of the overall market and below its five-year average. Good things are bound to come to this stock eventually. It may flounder for longer, but once it moves it can make up for lost time. In the meantime, you get a solid dividend yield while you wait. BUY

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

Brookfield Infrastructure Partners (BIP – yield 3.3%) – The infrastructure partnership is one of the best places to be in this market. The reliable earnings generated by crucial infrastructure assets make BIP very defensive and recession-resistant. It also has inflation adjustments built into its contracts.

The partnership also announced a joint venture with Intel to fund a $30 billion semiconductor fabrication plant in Arizona. It’s certainly a timely investment after the passage of the CHIPS Act and should get some generous government subsidies. Brookfield has been phenomenal at finding great investments over the years that are accretive and boost the stock price. BIP spiked higher on the news. It’s been on a torrid uptrend since mid-July and may be moving to a new high. (This security generates a K1 form at tax time). HOLD

Brookfield Infrastructure Partners (BIP)
Next ex-div date: November 30, 2022, est.

Eli Lilly and Company (LLY – yield 1.3%) – This best-in-class pharma giant has slowed down a bit. The stock price is only up about 15% YTD after averaging returns over 43% per year over the last three years. But so what. That’s still great outperformance this year and the stock is a defensive holding that is highly preferable as the economy bounds into recession. Also, Lilly has a strong pipeline and pending approvals of important drugs for Alzheimer’s and weight loss that could give it a big boost before the end of the year. HOLD

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

Intel Corporation (INTC – yield 4.8%) – The chipmaker just made a massive investment in chip production. It partnered with BIP for a $30 billion investment in a semiconductor fabrication plant where Intel will maintain majority control by providing 51% of the capital. It’s a big and bold move. But the stock is still under pressure as growing recession worry weighs on projected PC sales over the next year. The one consolation, its semiconductor peers are down a lot more over the past few weeks. We’ll see how this news shakes out in the weeks ahead. HOLD

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

Qualcomm Inc. (QCOM – yield 2.3%) – After a strong summer rally, QCOM has hit the skids again. It got hit as technology sold off again amid fears of higher rates and continuing inflation. Then it took another hit as semiconductor stocks sold off on recession worries. Even though QCOM is performing well individually on an operational basis, it just can’t overcome a market that is souring on the sector. The selling is overdone as earnings continue to be strong and the stock already sells at a cheap valuation. It can move higher fast and make up for lost time when the going gets good again. BUY

Qualcomm Inc. (QCOM)
Next ex-div date: November 30, 2022, est.

Visa Inc. (V – yield 0.7%) – As a cyclical financial company, V has been knocked back again in the latest round of selling amid recession worries. But it has consistently tended to have strong support around the 200 per share level, where it is now, and to be among the first such stocks to rally back when the selling abates. Earnings should be more resilient than in past similar points in the cycle because of covid. Earnings are still benefitting more from increased global business due to the ending of covid restrictions than they’re being hurt from a slowing global economy. It should hold up relatively well in increased market tumult and be among the first stocks to recover when the market turns. HOLD

Visa Inc. (V)
Next ex-div date: November 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 1.8%) – This alternative energy utility is still running hot and trending higher from the market bottom in the middle of June. It sold off briefly during the worst of the recent market downturn but has come right back and is near the August high and not far from the all-time high as the rest of the market struggles. NEE is in the sweet spot of this uncertain market. It provides safety as a utility and offers growth as a clean energy provider amid high conventional energy prices. HOLD

NextEra Inc. (NEE)
Next ex-div date: November 29, 2022, est.

Xcel Energy (XEL – yield 2.6%) – This safe utility stock has returned 16% YTD, outperforming the overall market by 30%. Like NEE, the alternative energy utility has the right stuff for this market. It offers defensive earnings as well as growth from clean energy. The passage of the CHIPs bill gave it new life, and XEL closed mere pennies for the all-time high on Monday. Plus, it’s in two timely sectors, utilities, and clean energy, and should be well positioned for the longer term as well. 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 October 12, 2022.