A 10-year Treasury bond pays just 1.4%. A three-year CD pays less than 1%. A 20-year AAA-rated municipal bond pays 1.20%. After taxes and inflation, you don’t even break even. And that’s not to mention the fact that bond prices can plummet if interest rates rise.
The only game in town is dividends. You can still generate high rates from well-chosen dividend stocks and other income-paying securities. It’s nerve-racking to have so many of your investment dollars in the stock market, but with bonds so low paying and treacherous, there is little choice if you need to generate income.
In this issue I highlight an ETF that strikes a more conservative cord than most dividend stocks. It employs a time-tested strategy that has proven to earn consistent high income while generating capital appreciation at the same time. It also pays dividend on a monthly basis and should thrive when the environment normalizes on the other side of the pandemic recovery.
For more great picks and information about navigating the current environment please join me for the 9th Annual Smarter Investing, Greater Profits Online Conference, August 17-19. We have an incredible lineup of experts ready to share their best picks.
Cabot Dividend Investor 721
A High Income for a Flat Market
Remember income? It used to be so easy. But good yields from traditional investments have gone the way of the eight-track tape.
A 10-year Treasury bond pays just 1.4%. A three-year CD pays less than 1%. A 20-year AAA-rated municipal bond pays 1.2%. After taxes and inflation, you don’t even break even. And that’s not to mention the fact that bond prices can plummet if interest rates rise.
The situation is particularly unfortunate because investors need income more than ever. Someone retiring today can reasonably expect to live another 20 or 30 years. It is vitally important to generate income from savings in order not to spend all the principal. But the old-fashioned way doesn’t work anymore.
The only game in town is dividends. You can still generate high rates from well-chosen dividend stocks and other income-paying securities. It’s nerve-racking to have so many of your investment dollars in the stock market, but with bonds so low paying and treacherous, there is little choice if you need to generate income.
At the same time, the market is high and uncertain. The easy gains of the past year are likely gone. Now investors are unsure what to expect as they look beyond the pandemic recovery to a more normal environment. We’re looking ahead to a market that will contend with slowing growth, tougher comparisons, no more stimulus and a less friendly Fed.
This advisory seeks to help you navigate these treacherous waters and generate a high income while growing your nest egg. In this issue I highlight an ETF that strikes a more conservative cord than most dividend stocks. It employs a time-tested strategy that has proven to earn consistent high income while generating capital appreciation at the same time.
Monthly Activity
June 9
Digital Realty Trust (DLR) – lower rating from “BUY” to “HOLD”
Qualcomm Inc. (QCOM) – raise rating from “HOLD” to “BUY”
Broadcom Inc. (AVGO) – raise rating from “HOLD” to “BUY”
Valero Energy (VLO) – raise rating from “HOLD” to “BUY”
July 14
Buy Blackrock Enhanced Capital and Income Fund (CII)
What to Do Now
It’s the best of times. But for how long?
On the one hand, things look great. Average earnings on the S&P 500 are expected to grow at a staggering rate of over 60% in the second quarter. And earnings usually exceed expectations. GDP is expected to grow at one of the highest quarterly rates ever this quarter.
But the market tends to anticipate. Sure, things are great now. But that’s what the huge market rally at the end of last year and the beginning of this year was about. Now, investors are looking ahead six months or so from now. And they can’t decide what to think.
Growth will probably remain solid well into next year. The Fed said they won’t raise rates for another two years. You don’t need 60% earnings growth to maintain a bull market. However, it will also be a situation where growth will be slowing, comparisons will be tougher, and the stimulus will end.
It’s not time to sell. But it may be wise to be more cautious.
It’s tough to predict the future or how the market will react. The pandemic and dramatic market recovery are proof of that. Under the circumstances, I like to stick with companies that can continue to thrive in a normalized economy that still sell at a reasonable valuation. Most of the stocks in this portfolio fit the bill.
A particularly good bet is technology. After all, the technological revolution will continue regardless of how the post-pandemic recovery market shapes up. As I mentioned in last month’s issue, I like our cheaply valued positions in Qualcomm (QCOM) and Broadcom (AVGO). I believe that 5G will be a bigger story in the post-pandemic environment and these companies will benefit.
I also particularly like the midstream energy companies Enterprise Product Partners (EPD) and ONEOK (OKE). These stocks are still cheaply valued with sky-high, safe dividends that are trending in the right direction. The situation for these companies should improve well into next year as the energy environment continues to normalize.
Featured SToCK
Blackrock Enhanced Capital and Income Fund (CII)
Yield 5.6%
This closed-end fund is designed to provide a high level of current income by employing a covered call writing (or selling) strategy on a diversified portfolio of large-capitalization stocks, as well as provide capital appreciation as a secondary objective.
It is similar to the income strategy used for the sister newsletter of this publication, Cabot Income Advisor. But this covered call ETF enables more passive investors to effortlessly benefit from the strategy. Covered calls are the best way to get a high level of income from securities that would not otherwise generate such a high payout. Let me explain.
A call option is essentially a right to buy a stock at a certain price at a specific date in the future. It is generally a bet that the price of the stock will go up. Buying a call is highly speculative because there is a good chance the stock price will not rise to the specified level by the designated, or expiration, date. If it doesn’t, the option expires worthless and investors lose 100% of their investment.
Statistics show that about 83% of options expire worthless. Consider the buyer of a call like a gambler in a casino. Every once in a while, he may win big, but the odds are stacked against him.
However, selling, or “writing,” a call when you own the underlying stock position (or a covered call) is a very conservative strategy. When you sell a covered call, you’re like the house instead of the gambler. It’s better to be the house. You’re on the smart side of the deal. Sure, the gambler may win sometimes, but you’ll win a lot more. All those massive hotels in Las Vegas are testament to that fact.
Here’s how it works in more detail.
Let’s say you own 1,000 shares of a $40 stock. You write (or sell) 10 calls (each call represents 100 shares) at a strike price of $44 expiring three months from now for $3 each, or $3,000 total. The stock price must rise above $44 for the option to be in the money; otherwise it expires worthless. But, either way, you collect the $3 premium.
If you write a call option under the above scenario one of three things will happen at the options expiration date.
• The stock trades flat anywhere below $44
In this case, the options you sold will expire worthless and you keep the stock and the $3,000 income, supplementing your income.
• The stock price falls
In this scenario you also keep the stock and the $3,000 premium. While you do own a stock that has gone down, you still outperform the buy-and-hold investor who just owns the stock by way of the $3,000 premium.
• The stock rises above $44
Your stock will be called and you effectively sell it at the $44 price even if the stock is a lot higher. You collect your $3,000 premium plus $4 of appreciation on the stock.
The strategy is the best way to generate an extra income, usually in addition to dividends, on the stock. Of course, writing covered calls does sacrifice appreciation potential in exchange for income. In a raging bull market there will be some opportunity cost. But in most other markets you will likely generate a higher income and total return.
Those are the mechanics of this income-enhancing strategy. But CII does it all for you.
CII has a portfolio of 58 stocks. Top positions include (as of January 29) Microsoft (MSFT, 6.46%), Alphabet (GOOG, 6.22%), Amazon (AMZN, 5.55%), and Apple (AAPL, 4.39%). Sector allocations are Information Technology 27.03%, Consumer Discretionary 15.91%, Communication 15.37%, and Finance 12.38%. Calls are currently sold on a little more than half of the portfolio.
The fund currently yields a very respectable 5.40% and dividends are paid out monthly. It’s a conservative way to earn a high and regular income without being exposed to the bond market and the risk of rising interest rates.
CII has an excellent track record. It has returned 225% over the last 10 years and 113 over the last five, with average annual returns for the periods of 12.5% and 16.3%, respectively. Even in a bull market, CII has returned on par with the S&P 500 over the last five years and slightly less over the last 10.
Portfolio at a Glance
| High Yield Tier | ||||||||||||
| Security (Symbol) | Date Added | Price Added | Div Freq. | Indicated Annual Dividend | Yield On Cost | Price on 7/13/21 | Total Return | Current Yield | Div Safety Rating | Div Growth Rating | CDI Opinion | Pos. Size |
| AGNC Investment Corp. (AGNC) | 04-14-21 | 17 | Monthly | 1.44 | 8.5% | 16 | -1% | 8.5% | BUY | 1 | ||
| Enterprise Product Partners (EPD) | 02-25-19 | 28 | Qtr. | 1.80 | 6.40% | 24 | 4% | 7.4% | 8.3 | 7 | BUY | 1 |
| ONEOK Inc. (OKE) | 05-12-21 | 53 | Qtr. | 3.74 | 7.10% | 56 | 8% | 6.5% | BUY | 1 | ||
| Realty Income (O) | 11-11-20 | 62 | Monthly | 2.81 | 4.5% | 68 | 13% | 4.1% | 9.3 | 9.8 | BUY | 1 |
| STAG Industrial (STAG) | 03-21-18 | 24 | Monthly | 1.45 | 6.0% | 39 | 96% | 3.7% | 5.2 | 5.9 | HOLD | 1/2 |
| Verizon Communications (VZ) | 02-12-20 | 58 | Qtr. | 2.51 | 4.3% | 56 | 3% | 4.4% | 8.6 | 9.2 | HOLD | 1 |
| Current High Yield Tier Totals: | 5.7% | 24.8% | 5.2% | |||||||||
| Dividend Growth Tier | ||||||||||||
| AbbVie (ABBV) | 01-28-19 | 78 | Qtr. | 5.20 | 6.7% | 118 | 72% | 4.5% | 10 | 8.6 | BUY | 2/3 |
| Broadcom Inc. (AVGO) | 01-14-21 | 455 | Qtr. | 14.40 | 3.2% | 484 | 9% | 3.0% | BUY | 1 | ||
| Brookfield Infrastucture Ptrs (BIP) | 03-26-19 | 41 | Qtr. | 2.04 | 5.0% | 56 | 67% | 3.6% | 6.5 | 8.6 | BUY | 2/3 |
| Chevron Corporation (CVX) | 02-10-21 | 90 | Qtr. | 5.16 | 5.7% | 104 | 16% | 5.0% | HOLD | 1 | ||
| Digital Realty Trust (DLR) | 09-09-20 | 147 | Qtr. | 4.64 | 3.2% | 155 | 10% | 2.9% | 6.8 | 10.0 | HOLD | 1 |
| Eli Lily and Company (LLY) | 08-12-20 | 152 | Qtr. | 3.40 | 2.2% | 235 | 58% | 1.5% | 10.4 | 8.3 | HOLD | 2/3 |
| KKR & Co. Inc. (KKR) | 03-09-21 | 48 | Qtr. | 0.58 | 1.2% | 59 | 29% | 1.0% | BUY | 1 | ||
| Qualcomm (QCOM) | 11-26-19 | 85 | Qtr. | 2.60 | 3.1% | 141 | 76% | 1.9% | 8.0 | 9.0 | BUY | 1/3 |
| U.S. Bancorp (USB) | 12-09-20 | 45 | Qtr. | 1.68 | 3.7% | 57 | 29% | 3.2% | BUY | 1 | ||
| Valero Energy Corp (VLO) | 06-26-19 | 84 | Qtr. | 3.92 | 4.7% | 70 | -6% | 5.4% | 6.4 | 8.6 | BUY | 1/2 |
| Current Dividend Growth Tier Totals: | 3.9% | 36.0% | 3.2% | |||||||||
| Safe Income Tier | ||||||||||||
| BS 2021 Corp Bond (BSCL) | 08-30-17 | 21 | Monthly | 0.42 | 2.0% | 21 | 8% | 1.5% | 9.0 | 4.0 | HOLD | 1/2 |
| Invesco Preferred (PGX) | 04-01-14 | 14 | Monthly | 0.74 | 5.3% | 15 | 59% | 4.9% | 6.3 | 1.1 | HOLD | 1/2 |
| NextEra Energy (NEE) | 11-29-18 | 44 | Qtr. | 1.54 | 3.5% | 75 | 80% | 2.1% | 9.4 | 8.0 | BUY | 1/2 |
| Xcel Energy (XEL) | 10-01-14 | 31 | Qtr. | 1.83 | 5.9% | 68 | 175% | 2.7% | 9.5 | 7.0 | BUY | 2/3 |
| Current Safe Income Tier Totals: | 4.2% | 80.5% | 2.8% | |||||||||
Portfolio Updates
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.
AGNC Investment Corp. (AGNC – yield 8.5%) – The past month certainly pierced the armor of this once relentlessly up-trending mortgage REIT. The yield curve story turned sour. AGNC makes money on the spread between short and long rates. That spread shrunk as the 10-year treasury rate fell. A steepening yield curve was a big part of the attraction of AGNC, but not the only one. The REIT also benefits from a booming economy. And the high dividend is safe. In addition, there is a good chance longer-term rates trend higher from here. BUY
Enterprise Product Partners (EPD – yield 7.4%) – The midstream energy partnership pulled back from the recent highs this past month, but no big deal. EPD continues to trend in the right direction, albeit slowly. Business should be booming in this economy. At the same time, EPD is still well below the pre-pandemic price with much higher earnings and growth. The stock seems like a laggard but it really isn’t. It has returned more than 30% so far this year. I expect it to continue to trend higher the rest of the year. That, combined with the huge and safe distribution, makes EPD a winner. BUY
ONEOK Inc. (OKE – yield 6.5%) – When considering this fellow midstream energy company think of EPD on steroids. It’s more volatile to the upside and downside. It’s too is still below the pre-pandemic high, but more so. But that’s a beautiful thing for now, because the midstream energy business is strong and the stocks are trending higher. OKE is already back to within pennies of the recent high. This natural gas and NGL infrastructure company should be a big winner the rest of the year while paying you handsomely along the way. BUY
Realty Income (O – yield 4.1%) – The legendary income REIT has been kind of dull but still good. It’s not a fast mover. And it tends to pull back and consolidate after each surge higher. But business is solid and getting stronger and the stock is still trending higher. And it’s still a bargain in this high-priced market. Despite that fact that the resilient REIT actually grew earnings in 2020, and those earnings are likely to grow much faster this year, O still sells well below the pre-pandemic high. I expect O to be a winner that bores you to tears going forward while paying you a solid yield. BUY
STAG Industrial (STAG – yield 3.7%) – This more cyclical industrial REIT is doing well. It has vastly outperformed the REIT index in both the long and short term. And YTD, it has almost doubled the S&P 500 return. I believe REITs in general are a good place to be in this uncertain market and low-interest-rate environment. But STAG also benefits from being in a cyclical segment amidst a booming economy in a space with a stellar longer-term supply/demand dynamic. HOLD
Verizon Communications (VZ – yield 4.4%) – Maybe next week’s earnings announcement will get this thing moving. VZ has become like an old-fashioned utility that consistently underperforms the market. Aside from the solid yield, there are two reasons to keep holding the stock. It’s great in a down market, which makes it a nice holding in an uncertain world. And, it could benefit from 5G at some point. We’ll soon see what the second-quarter story is. HOLD
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 4.5%) – ABBV is dirt cheap. It sells at a microscopic nine times forward earnings compared to 21 times for the overall market. It’s cheap because the market worries about replacing the Humira revenue when U.S. patents expire in 2023. But it has one of the best pipelines in the business and should be able to overcome the shortfall. Despite investor angst about Humira, ABBV has still significantly outperformed the market over the past two years. As well, health care is a great place to be. It’s both defensive and a growth business as the population ages. It’s also solid on a technical basis. And I didn’t even mention the dividend. BUY
Broadcom Inc. (AVGO – yield 3.0%) – Since being added to the portfolio, I’ve believed that it is only a matter of time until this technology behemoth takes off. And that time may be fast approaching. AVGO has been held back by consolidation in the tech sector. But that sector appears to be breaking out of its funk. AVGO has already moved to the highest level since April and within just 3% of the all-time high. BUY
Brookfield Infrastructure Partners (BIP – yield 3.6%) – This solid and defensive infrastructure partnership has performed on par with the S&P 500 over the past five-, two- and one-year periods, but with less volatility. That’s not bad in a bull market. This stock has outperformed the market in prior periods. The emphasis on infrastructure by the new administration and the growing popularity of the infrastructure subsector could return BIP to the days of outperformance going forward. BUY
Chevron Corp. (CVX – yield 5.0%) – The market has kind of soured on cyclical stocks and energy in recent weeks, although CVX has been much less negatively affected than the overall sector. But I’m skeptical that the recent economic pessimism will last. The economy is booming and oil prices hit the highest level since 2014. Business is great and should remain so for some time. Meanwhile, the stock is still below pre-pandemic levels. I don’t think CVX is done yet. HOLD
Digital Realty Trust (DLR – yield 2.9%) – This data center REIT was making new all-time highs when it got rudely interrupted by the selloff last month. But DLR has since been recovering. It’s moved higher over the past couple of weeks and already regained half of what it lost from the high. It looks on track to go right back and make a new high. However, the stock is near the top of its range and is no longer at an ideal buy point. It’s worth holding because it may break new ground, but let’s be cautious about the entry point. HOLD
Eli Lilly and Company (LLY – yield 1.5%) – Eli Lilly has a fantastic pipeline. I like the stock longer term regardless of what happens with any one drug. But the stock is trading at a higher level than it normally would be because of one drug. The odds of FDA approval for its Alzheimer’s drug dramatically increased when the FDA approved Biogen’s inferior drug, indicating a proactive desire to get some drugs for the illness out there. It could be a huge game-changer as there are no other drugs for the common disease. HOLD
KKR & Co. Inc. (KKR – yield 1.0%) – This alternative investment asset manager is trading extremely well. While the financial sector has trended lower over the last six weeks, KKR has continued to move higher. It’s not really affected by the flattening yield curve and the asset management business is booming. KKR is within bad-breath distance of the all-time high and should continue to roll. Go baby go. BUY
Qualcomm Inc. (QCOM – yield 1.9%) – Like the rest of the tech sector, this 5G chip maker hit the all-time high in February. But it’s been floundering ever since. Like AVGO, it may be breaking out again. It hit the highest price since late February. But it’s not a definitive move yet. QCOM may indeed find its mojo again after the earnings report at the end of this month. The last report was spectacular. Another good one could put it back on track. We’ll see. But sooner or later QCOM should get a move on as it benefits mightily from the 5G rollout. BUY
U.S. Bancorp (USB – yield 3.2%) – The bad news is that the rally in this best-in-class regional bank has petered. The good news is that the pullback should only be temporary. USB got knocked back by the recent yield curve trade. But it’s not out by any means. Profitability will surely benefit from higher loan volume in a booming economy. Business is much better than the recent stock action indicates. And long-term rates may trend higher going forward as well. The bank should have some very strong quarters ahead. BUY
Valero Energy Corp. (VLO – yield 5.4%) – This refiner is a high-leverage play on the cyclical recovery. Lately, the market has soured on that trade. VLO is down over 16% from the recent high in early June. But I don’t think the stock is done yet in this recovery. Business should be booming and the demand and price for gasoline and diesel is soaring in the strong recovery. And business should stay good for a while. VLO is a volatile stock that bounces around with the headlines. But it should trend higher. BUY
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.
Invesco BulletShares 2021 Corporate Bond ETF (BSCL – yield 1.5%) – This short-term bond fund is a safe port. While the market is promising for the rest of the year, there are still a lot of uncertainties out there. It’s nice to have something in the portfolio that you don’t have to worry about. That said, the bonds in this ETF mature at the end of this year. HOLD
Invesco Preferred ETF (PGX – yield 4.9%) – After falling during the pandemic, this preferred stock ETF has recovered and is back to a new all-time high. PGX is much less volatile than the stock market while providing a big yield. It also adds diversification as preferred stock performance is historically not correlated to the stock and bond markets. HOLD
NextEra Energy (NEE – yield 2.1%) – The move toward cyclical stocks over the last six months or so ahead of the anticipated full recovery has hurt this normally up-trending juggernaut. It’s still down 12% from the January high. But it is still one of the best regulated utilities in the country with the added benefit of growth from being the world’s largest producer of wind and solar. The high-growth clean energy business (which also gets more profitable every year) will have its day in the spotlight again, and probably in the near future. BUY
Xcel Energy (XEL – yield 2.7%) – This smaller and lesser-known alternative energy utility stock has been more of a ride than NEE. After crashing from neglect during the cyclical rally, XEL recovered almost everything it lost in March and April. But it has since fallen back and recently bounced off the recent bottom. It’s a similar story to NEE, but messier, and with a similar prognosis from here. The pandemic hysteria has temporarily forgotten about alternative energy. But it isn’t going away. BUY
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 estimated.
The next Cabot Dividend Investor issue will be published on August 11, 2021.
Cabot Wealth Network
Publishing independent investment advice since 1970.
President & CEO: Ed Coburn
Chief Investment Strategist: Timothy Lutts
Cabot Heritage Corporation, doing business as Cabot Wealth Network
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