The huge market rally earlier this week gives us a taste of what lies ahead on the other side of this pandemic. The lockdowns will end and the economy will boom. Many stocks that have not participated in the market recovery will come alive.
While the market indexes have recovered, many stocks and sectors have not. Technology may be booming but energy, travel and hospitality, finance and other industries are still wallowing in bear market oblivion. It is these stocks that came alive this week and they should benefit when the virus fades and the recovery gains full traction.
It’s time to invest for the other side of the pandemic. In this issue, I highlight one of the very best income stocks in the history of the market. While the company has remained profitable, it has experienced a disproportionate selloff. The stock is still cheap but starting to move ahead of the next phase of this recovery.
Cabot Dividend Investor 1120
The Promised Land Awaits
It has been an amazing week in the market. Events have transpired to leave the market approaching all-time historic highs. And it may be just the beginning.
In the past weeks and months there were two major risks holding the market back, the election and the pandemic. Those uncertainties appear to getting resolved in the market’s favor.
First, there’s the election. While we still don’t know the official results, and may not for some time, the market already got what it wanted – divided government. It appears, at this point, that Republicans will keep control of the Senate and Democrats will prevail in the House. That means any kind of draconian legislation, like an overhaul of the healthcare system or a ban on fracking, is off the table.
The market doesn’t care about politics. It only cares about money. In the market’s eyes, the risk posed by the election has been averted. There won’t be any game-changing policies or legislation. Nobody will be able to screw things up too badly. The market loves it and has been rallying since Election Day.
Then there’s the pandemic. There was huge news yesterday.
Pharmaceutical giant Pfizer (PFE) along with German biotech company BioNTech (BNTX) announced stunning late-stage study results for a Covid-19 vaccine. The vaccine indicated better than 90% effectiveness. Final FDA approval could be just weeks away. And large scale distribution could begin before the end of the year. The market exploded higher on the news, with the Dow up as much as 5% on the day at one point.
The news indicates that we will move past this pandemic sooner rather than later. This is crucial. While the economy is recovering strongly and ahead of expectations, it still has one arm tied behind its back with the Covid restrictions.
There is a Promised Land on the other side of this pandemic. The long overdue recession and bear market is out the way. The economy should boom with the shackles taken off. It will be an early-stage bull market with a roaring economy, low interest rates and a friendly Fed.
We aren’t there yet. And there will likely be pitfalls along the way. But the writing is on the wall. There is huge opportunity on the other side of the pandemic. While the market indexes have already recovered, the returns have been skewed by an overweighting in technology companies, which are thriving in the pandemic.
Many industries and sectors are still wallowing in bear market oblivion. Travel and hospitality stocks have been decimated. The energy sector is still down 50% YTD and the financial sector has been creamed as well. Many of these downtrodden stocks rallied big time yesterday with just a taste of what lies ahead.
It’s time to invest for the other side of the pandemic. Of course, profiting from beaten down stocks isn’t as easy as it seems. Many companies will never recover from the devastation. Others will continue to struggle financially long after the pandemic ends. But certain well chosen investments are poised to benefit mightily in the months ahead.
In this issue, I highlight one of the very best income stocks in the history of the market. While the company has remained profitable, it has experienced a disproportionate selloff. This income juggernaut should be among the first to recover ahead of the next phase of this recovery.
What to Do Now
Some long dormant positions and well as the underperforming stocks are reawakening. The most notable change so far is in the health care stocks, AbbVie (ABBV) and Eli Lilly (LLY). ABBV has soared 22% since late October and LLY is 13% higher in the same time frame. Those are impressive moves for stocks that have been floundering for months.
Health care is a highly desirable sector as earnings are defensive but also growing with the enormous tailwind of the aging population. The stocks had been held back by uncertainty regarding the election. With that over, momentum has returned. And the stocks appear poised to make up for lost time in the weeks and months ahead. Because of valuation and momentum, LLY and ABBV are the most attractive stocks to buy right now.
The two energy stocks, Enterprise Product Partners (EPD) and Valero Energy (VLO), may be on the cusp of reversing the hideous performance so far this year. Energy is a sector that will likely benefit most on the other side of the pandemic as it has been the hardest hit.
We got a taste of what might be ahead yesterday. VLO soared 32% in one day on news of the vaccine. EPD has moved about 9% higher so far this month. But these stocks are still rated “HOLD” for now. I’m still cautious and will not raise them to a “BUY” rating until I am more assured of lasting momentum.
The best performing stocks, Innovative Industrial Properties (IIPR) and Qualcomm (QCOM), are continuing to soar ever higher. Qualcomm just reported blowout earnings and raised future guidance as 5G phones bring in even more royalty profits than expected. IIPR is up 115% since being added to the portfolio less than a year ago.
I’m not taking profits because I’m a greedy man and these stocks show no signs of letting up. Why should the growth stock guys have all the fun?
Realty Income (O)
Realty Income is one of the highest-quality and best-run REITS on the market. Cash flow from a conservative portfolio of 6500 properties has enabled the company to amass a phenomenal track record of paying monthly dividends; to such an extent that Realty Income actually has the audacity to refer to itself as “The Monthly Dividend Company.”
The large REIT has operated for over 51 years and currently has 6500 properties rented to 600 different tenants in 49 states, Puerto Rico and the United Kingdom. Since its 1994 IPO, Realty Income has amassed a record as one of the most successful income investments on the market.
Here are a few things to like about it.
- 15% average annual total return since 1994
- 604 consecutive monthly dividends
- 92 consecutive quarters of dividend hikes
- 5% annual dividend growth since 1994
- Sky high credit ratings
An investor would be hard pressed to find a more reliable dividend payer and grower than this exceptional REIT. Realty has paid 604 consecutive dividends throughout its 51-year operating history dating back to 1969. And the monthly payout has been raised 92 times during that period. This is a rare monthly dividend payer with some serious stamina and staying power.
How do they do it?
The company buys established properties with a proven record of profitability and rents them to high quality tenants. The business model is to generally use a “sale-leaseback” arrangement whereby Realty Income purchases the property from the tenant and then the company remains there and pays rent under long term leases of 10 to 20 years.
Most of these leases are also “net leases”, meaning the lessees pay all the costs associated with the property including maintenance, insurance and taxes. This arrangement frees Realty Income from unpredictable expenses and the REIT just receives regular rent payments with built-in increases over time.
For long term investors, there is probably no bad time to buy the stock. But there are good times. And this is one of them.
This pandemic has not been kind to the REIT sector. In fact, next to Energy and Finance, Real Estate has been the worst performing sector of the S&P 500 so far this year. But returns in the sector have been lopsided.
REITs in this portfolio like Innovative Industrial Properties (IIPR), Alexandria Realty Trust (ARE) and Crown Castle International (CCI) have performed well through the pandemic. But these are REITs with special niches that insulated them from this recession. Other REITs are really taking it on the chin.
Office properties have been hit hard. Hospitality properties (like hotels, resorts, theme parks and restaurants) have been hit the worst as people stopped going anywhere. Retail is another problematic area during this recession. That’s where Realty Income comes in, because 85% of the portfolio is in retail properties.
The retail REIT subsector is down over 40% YTD. Particularly hard hit have been regional mall operators and shopping center REITs. O is still down 25% from the 52-week high in February. The stock is also selling below most of its 5-year average valuations.
But the operational performance is way more solid than that selloff indicates. In the first nine months of this year, revenues are actually 20% higher and earnings per share are actually up 3.7% over the same period last year. Even in a severe recession, earnings are still growing.
Most of the properties have been doing fine. The only problem is in the service-based properties like movie theaters and fitness centers. Half of the movie theater properties are still closed and fitness centers are still struggling to a much lesser extent. In October, Realty collected 93% of the contracted rents in the overall portfolio, which was enough to put earnings in the positive column.
But things will likely return to normal by the middle of next year. And the market usually looks ahead about six months. At the same time, investors will still crave income. And Realty Income, one of the all-time best income stocks, currently yields 4.6% at a time when the 10-year Treasury is paying just 0.94%.
After a year that has dragged much of the REIT sector down, ahead of what is likely to be a powerful recovery, O represents a fantastic buying opportunity for a stock that is rarely cheap.
Realty Income (O)
Security type: REIT
Category: Retail properties
52-week range: $38.00 - $84.92
Profile: Realty Income operates a highly diversified portfolio of retail properties throughout the country and is considered one of the all-stars in the industry.
- The stock has an amazing track record of total return and dividend growth.
- O has been disproportionately punished for its retail exposure ahead of what is likely to be a REIT recovery.
- One of the most highly desired income stocks on the market should come back into vogue.
- We aren’t out of the woods with the pandemic yet and REITs could continue to underperform the market for a while.
- Some of Realty’s more vulnerable properties may never recover from this recession.
Portfolio at a Glance
High Yield Tier
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.
B&G Foods (BGS – yield 7.0%) – It’s been a crazy week for this packaged food company. Great earnings were reported for the third quarter last week. The company grew earnings per share over last year’s quarter by 37%, not bad for a company that had seen average earnings growth of 3% over the past five year. It also soundly beat expectations. But the stock fell over 5% in the euphoric Pfizer (PFE) vaccine market yesterday. It’s because short term investors consider BDS a pandemic trade that will come back to earth as it goes away.
But sooner or later the pandemic was sure to fade. The stock was purchased in this portfolio with that understanding. An increased level of business and growth is sure to last beyond the pandemic, making the stock a good value with a safe and high dividend. The one day reaction doesn’t tell the story, and the stock should outperform in the future. BUY
Brookfield Infrastructure Partners (BIP – yield 3.9%) – The infrastructure giant reported earnings yesterday that proved why it is such a great stock. Funds from operations per unit grew 8.2% over last year’s quarter. The stock soared over 7% on the day. The pandemic has apparently phased performance very little. The earnings were also helped by 40% growth in the data sector (which includes cell towers). It’s also worth noting that the company has been able to buy assets on the cheap during the recession, which should boost growth in future quarters. BIP has sprung to a new all time high and is still in a strong uptrend. BUY
Enterprise Product Partners (EPD – yield 9.9%) –The vaccine rally even lit a fire under EPD’s backside. The stock soared over 7% yesterday to just below 18 per share. Operationally this midstream company has been quite resilient, posting earnings growth in the third quarter. But it didn’t really matter while the market was shunning the entire energy sector. The stock and the sector are levered to a robust recovery that propels those stocks that haven’t moved higher already. The vaccine news just made that more likely with a more optimistic time frame. You get a huge yield that is safe while you wait for a strong 2021 recovery. HOLD
STAG Industrial (STAG – 4.6%) – This industrial REIT is tough to define. It has a great niche with its high demand industrial properties and E-commerce exposure. It’s more cyclical than most of its peers. But it was actually down yesterday in the market party. Earnings were solid and the company will continue to grow with a good yield and a monthly dividend. But the stock trades on its own schedule and should be a solid performing income stock over time. HOLD
Verizon Communications (VZ – 4.2%) – This stock has also been tough to figure of late. It is a good pandemic stock as people locked up at home rely on cellular service more than ever. It isn’t very cyclical and has a beta of just 0.39. But it was up almost 3% on the vaccine rally yesterday, a big move for this stock. And it’s not far from the 52-week high. My guess is that the stock rally is about 5G. On the other side of this pandemic, the 5G story will likely take center stage and VZ will benefit. The normally stodgy income stock should get a growth catalyst from the new technology as it will create more demand for cellular service and Verizon has built out the most comprehensive infrastructure for it. We may see the 5G part of the story come to fruition in future quarters. BUY
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.
Rating change “HOLD” to “BUY”
In addition, the drug companies had a record day after the election on the likelihood of divided government, making significant reform in the industry unlikely. This stock and many others in the sector had been held back on election risk. They could make up for lost time in the weeks and months ahead. ABBV is still cheap at less than 8 times forward earnings. And now, it has momentum back. BUY
Altria (MO – 9.0%) – Even this cigarette maker had a good day yesterday, up 2.41%. Earnings this quarter were good and bad. Altria announced another $2.6 billion write off in its investment in E-cigarette maker JUUL. The late 2018 investment of $12.8 billion has been written down to $1.6 billion. But the disastrous acquisition was already baked into the stock price. Earnings, aside from that, were superb. Revenues were up 4.9% and cigarette volumes increased on a yearly basis. The dividend is safe. Operational performance is strong and better than expected. The safe dividend makes MO at least a strong income stock, but it could turn out to be more in the quarters ahead. BUY
Crown Castle International (CCI – yield 3.3%) – The REIT issued guidance for 2021 at 10% earnings growth and raised the dividend by 11%. Earnings are solid and future growth seems assured with demand for cellular technology buoyed by the 5G rollout. The company is growing earnings in a severe recession and the dividend hike is encouraging. While the stock performance of late has been uninspired, the company is well positioned for the volatile market and beyond. It should also benefit in the post-pandemic market as investors focus on 5G as a major story in the market. HOLD
Digital Realty Trust (DLR – yield 3.1%) – This data center REIT is another stock that moves to its own drummer. Yesterday that was a bad thing as DLR fell 5.77% when the market had a big up day. The market rewarded stocks that have not benefited in this recovery and punished others that have. DLR had been up 25% YTD compared to just 11% for the market. But data centers and technology will continue to grow strongly after the pandemic. This is no pandemic flash in the pan. DLR has average an 18% total return over the last five years. It should also benefit from 5G going forward. BUY
Eli Lilly and Company (LLY - yield 2.1%) – Lilly got a huge bump on the day after the election as the health care sector reveled in the likelihood of dividend government, making any draconian changes to the industry all but impossible. LLY shot 14.5% higher, the most of its peers. It may have gotten an additional boost from positive FDA news about a competitors Alzheimer’s drug because Lilly has a promising Alzheimer’s disease blood test in trials. Recent news aside, this is a great company with a fantastic pipeline that should continue to perform well going forward. BUY
Innovative Industrial Properties (IIPR – yield 3.1%) – This marijuana farm REIT had a huge run up but then sort of went sideways for a while. Now is back. IIPR has soared 24% since the end of October to new all time highs. It’s worth noting that IIPR, currently 145, shot as high as 165 yesterday before pulling back by the end of the day. Innovative had a big week after it beat earnings expectation and nearly tripled revenues from the year ago quarter. The stock shot 26% higher in the next two days. The position has returned over 115% in less than a year since being added to the portfolio on 12/18/2019. Given the torrid growth in revenue and earnings along with the intact uptrend, I am still holding onto the remaining 2/3 position. HOLD
Qualcomm Inc. (QCOM – yield 2.1%) – This chip maker blew away expectations with earnings last week. Revenues grew 35.1% and earnings were 26% higher than last years quarter. Revenues were $6.5 billion versus an expected $5.9 billion, and earnings far exceeded the expected $1.17 per share with an actual $1.45 per share. In addition, the company significantly raised guidance for next quarter. The rollout of the 5G phones is having an even bigger impact than expected. And last quarter only partially included the new Apple (AAPL) phones. The stock shot up 12.5% on the day of the announcement. HOLD
Valero Energy Corp. (VLO yield 7.8%) – FINALY! This most beaten down dog of the 2020 recovery has come to life. The refiner stock was always levered to the next phase of the recovery. The story got a huge shot of adrenalin with the vaccine announcement yesterday. VLO soared 31.2% in just one day, from 38.17 to 50.08 per share. The pandemic was bound to end sooner or later. There can be no robust recovery without a big boost in demand for gasoline and diesel. It was a waiting game. The wait may be over. We’ll see. But the stock showed a glimpse of what it is prepared to do on the other side of this pandemic. HOLD
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.
Alexandria Real Estate Equities (ARE – yield 2.7%) – This life science and research lab niche REIT is rallying along with the rest of the market today. It’s a conservative dividend stock in a market that hasn’t been particularly kind to such stocks. But it has reliable earnings and a great niche. Interest rates are near historic lows and the market is turbulent. There will continue to be an appetite among investors for a stock like this. It won’t set the world on fire but ARE should come as advertised going forward. It should provide you with a decent total return without risking your shirt. HOLD
Invesco BulletShares 2021 Corporate Bond ETF (BSCL – yield 2.4%) – This short term bond ETF is a beautiful thing in markets like this. It’s nice to have something in the portfolio that you don’t have to worry about. It still has a yield that’s better than you’ll get in most traditional safe haven investments. BSCL is a safe port in a stormy market and owning it provides much needed comfort as risk and uncertainty abound. BUY
Invesco Preferred ETF (PGX – yield 5.1%) –This preferred stock ETF is rock solid in all but the most tumultuous market selloffs. PGX has been consistently trending back toward the high and the uncertain market will probably edge it over the top. It is less volatile than the market in general and provides a high yield and excellent diversification from both the stock and bond markets. HOLD
NextEra Energy (NEE – yield 1.8%) – This combination regulated utility and alternative energy juggernaut is a superstar. The market recover has not been kind to the utility sector. But NEE is up over 25% YTD. In fact, this utility stock has provided an average annual return of 20% over the last ten year and 26% over the last five. You can own a conservative utility and still generate the outsized returns from a promising alternative energy company. NEE is the best of both worlds and investors will continue to heap piles of love on this stock. Go baby go. HOLD
Xcel Energy (XEL – yield 2.4%) – The alternative energy utility reported earning last week that beat estimates. What virus? What recession? The utility grew earnings 12.87% over last year’s quarter. It also issued guidance for solid earnings for this year and next. The stock has rallied since the announcement and is now within bad breath distance of a new all-time high. The stock is pricey but continues to be in high demand as investors love the higher growth from alternative energy. HOLD
The next Cabot Dividend Investor issue will be published on December 9, 2020.
Cabot Wealth Network
CEO & Chief Investment Strategist: Timothy Lutts
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