Over the past century stocks outperformed bonds rather handsomely. One dollar invested in the S&P 500 in 1802 with reinvested dividends would have turned into $12.70 million by 2006; a similar investment in fixed income would have only grown to $18,235. Most investors have far shorter investing periods than two centuries however.
Source: Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies
While US stocks have always produced positive total returns over any 30 year periods, this has come with tremendous volatility in total returns. Bonds on the other hand could also experience volatility in total returns, since they are particularly sensitive to changes in interest rates. The one thing which is helpful is that the coupons are fixed, which at least provides some stability of nominal income.
As mentioned earlier, bonds are sensitive to changes in interest rates. Bonds have been in a bull market for almost three decades now, fueled by a decrease in yields in the 30 year Treasrury Bond from 15% in the 1980's to 4.50% now. Most investments in bonds can hardly keep up with inflation. Only the TIPS ( Treasury Inflation Protection Securities) offer some inflation protection, as their principal and interest payments adjust to annual changes in the Consumer Price Index. Other than TIPS, fixed income securities typically do not do very well during inflation.
Furthermore most Corporate Bonds also have added risk, since there is always the possibility of default. Many prominent companies which were once regarded as solid blue chips have fallen on hard times and have had to go bankrupt, wiping out both shareholders and leading to huge losses of principal by bondholders. Municipalities, which lure investors with their tax exempt securities, are also prone to defaults. As a result I tend to concentrate my fixed income efforts only to US Treasury Bonds or FDIC insured Certificates of Deposit.
In a previous article I mentioned that a dividend portfolio in retirement must have at least a 25% allocation to fixed income. Despite the fact that I believe dividend growth stocks are a much better investment than fixed income, I still believe that bonds could offer some comfort for diversification purposes. While a bond portion of a portfolio would certainly lose purchasing power due to inflation, it would provide a portfolio with a cushion during market turmoil and during deflationary periods. If we were to experience higher inflation in the future, the dividend stock allocation should do its magic by lifting incomes and stock prices. If we have a repeat of the Great Depression or the Lost two decades for Japan, investors with a bond allocation should sleep better at night.
The way to actually invest in Treasuries is either by directly buying bonds or by investing through a bond fund or ETF. One way to purchase bonds is either directly by participating in Treasury Auctions or by buying bonds through your broker. While some brokers charge a small fee for bond transactions, others do not charge anything. If you decide to purchase your fixed income directly and hold to maturity, then you might consider laddering your bonds. Bond laddering means purchasing bonds with varying maturities, so that one is not overly exposed to interest rate fluctuations. Bond ladders could also be set up in a way that you can have bonds maturing at predetermined intervals of time. This allows investors to allocate bond proceeds to new bonds with the same maturities but different interest rates as the bonds which matured.
The advantage of holding onto individual bond issues is that investors could decide whether to hold to maturity or sell before that. Even if interest rates went to 10% and bonds with 4% yields were trading at steep discounts to par, investors holding to maturity will get their principal back. In addition to that investors would keep receiving the coupon payments every six months. Proceeds could also be reinvested back at the higher interest rates.
Investing in bonds should be done only as a long term investment. There has been a lot of speculation about interest rates rising since at least late 2008, claiming that bond investors would surely lose money over the long term. If one had $1000 in cash and invested in a ten year Treasury bond, they would lock in a 3.80% yield for 10 years. If one were to wait for three or four years however until rates on ten year bonds rose to 6%, then they would receive much lower returns.
The other method to buy bonds is by purchasing a bond mutual fund or a bond ETF. Some of the most active bond ETFs include:
iShares Barclays 20+ Year Treasury Bond (TLT )
Vanguard Long-Term Bond ETF (BLV)
iShares Barclays 7-10 Year Treasury (IEF )
iShares Barclays 1-3 Year Treasury Bond (SHY)
iShares Barclays TIPS Bond (TIP)
The issue with bond funds is that investors are charged annual management fees for them, which lower returns. Some bond mutual funds also tend to sell bonds, which triggers capital gains liabilities.
At the end of the day, dividend growth investing is a superior investing strategy. Adding another low correlated asset class such as fixed income however can smooth volatility in income in times of recessions and deflations. The goal is reducing risk as much as possible and providing a floor to the amount of sustainable income in retirement. Investors need to eat even during recessions. Thus, an allocation to fixed income should provide investors with a peace of mind and reduce long-term risk, without sacrificing long term growth for the rest of the portfolio.
Full Disclosure: Long US Government Bonds
- Dividend Reinvestment is important
- Dividends Stocks versus Fixed Income
- The case for dividend investing in retirement
- Living off dividends in retirement [more]
Universal Health Realty Income Trust (UHT) operates as a real estate investment trust (REIT) in the United States. The company invests in health care and human service related facilities, including acute care hospitals, behavioral healthcare facilities, rehabilitation hospitals, sub-acute facilities, surgery centers, childcare centers, and medical office buildings. The company is a dividend achiever and has raised distributions for 22 consecutive years.
Over the past decade this dividend stock has delivered a total return of 16.70% per annum to its shareholders.
As a Real Estate Investment trust, the company has to distribute almost all of its net income to shareholders. An important metric for evaluating REITs is Funds from operations (FFO). Over the past decade FFO has increased by 1.10% on average. Future growth in funds from operations could come from acquisitions or increase in rents. Universal Health Realty Income Trust earns bonus rents from the subsidiaries of UHS, which are based on the excess over base amounts revenue that these facilities generate. There were no acquisitions in 2009, although the company did make a few acquisitions in 2010 and 2008.
Fifty-one percent of UHT’s revenues are derived from leases to Universal Health Services. UHT’s advisor is a subsidiary of UHS, and all officers of Universal Health Realty are employees of UHS, which could create conflicts of interest. In addition to that over $32 million dollars in long-term debt are expected to mature in 2010. The company expects to refinance almost $12 million dollars of its maturing loans, which carry market interest rates. Another portion of the debt maturing in 2010 for $7 million could be extended for an additional three years to 2013. A construction loan for almost $13.5 million at a very low rate could be extended for up to one additional year. The company also has $48.8 million of outstanding borrowings under the terms of its revolving credit agreement which matures in January 2012.
Over the past decade distributions have increased by 2.90% per annum, which was higher than the growth in FFO. A 3% annual growth in distributions translates into dividends doubling every 24 years. In 2009 the company raised quarterly distributions by 1.70%. Dividends of $2.38 per share were declared and paid during 2009, of which $1.94 per share was ordinary income and $.44 per share was a return of capital distribution.
As a Real Estate Investment trust HCP, Inc. must make distributions to its stockholders aggregating annually at least 90% of its REIT taxable income, excluding net capital gains. The FFO payout ratio is at 85%, which was the first decrease in this indicator since 2004. Overall the FFO payout has increased from 72% in 2000 to 85%, which was due to distributions growing faster than funds from operations. A lower FFO payout is preferable, as it minimizes the effect of short term fluctuations in rental incomes on the distribution rate.
Overall I find UHT Inc an attractive company for investment, with a business model that generates stable income streams in the healthcare field. I like the low Price/FFO ratio of 13, which is in the low range when compared to the past five years. This REIT yields 6.80% and has an adequately covered dividend.
I would not expect much growth in funds from operations and distributions above the rate of inflation however. I own two Real Estate Investment trusts dealing with retail properties on a triple net lease terms, so adding a healthcare related REIT would add to diversification in my portfolio.
Full Disclosure: Long UHT
- Realty Income (O) Dividend Stock Analysis - National Retail Properties (NNN) Dividend Stock Analysis - Six Dividend Stocks for current income- 8 Dividend Achievers Strike Back - Health Care Property Investors, Inc. (HCP) Dividend Stock Analysis [more]
The dividend yield on the S&P 500 has been declining throughout 2009, amidst one of the worst years for dividends since 1955. Back in late 2008 and early 2009, yields on major market indices exceeded 3%. Currently the dividend yield on the S&P 500 is 1.70%. However, if we remove the negative yield effect of non-dividend payers in the index, the dividend yield increases to 2.30%.
In order to be flexible in this market and not limit myself only to higher yielding stocks with disappointing dividend growth prospects, I am considering lowering my entry yield criteria to 2.50%, down from the 3% which was in effect since the end of 2008. As long as the selected companies for purchase have long histories of consistent dividend raises in addition to having good prospects for future dividend growth, my yield on cost would keep on increasing over time.
The screening criteria applied toward the S&P Dividend Aristocrat index was:
1) Current yield of at least 2.50%
2) Dividend payout ratio no higher than 60%
3) Price/Earnings Ratio of not more than 20
4) 25 years or more of consecutive dividend increases [more]
Many dividend investors ignore stocks which have low current yields. It is interesting to note however that many low yielding stocks frequently are able to raise dividend payments faster while growing the business, which translates into higher stock prices over time. The rising stock price offsets the effect of the increasing dividend payments, leaving the current yield low. The yield on cost for original investors however could get to a very respectable level after a series of consistent dividend increases.
Several of this week’s dividend increases show companies which are not yielding much today, but have the power to grow distributions over time to an above average yield on cost:
Bank of the Ozarks, Inc. (OZRK) operates as the bank holding company for Bank of the Ozarks that provides a range of retail and commercial banking services. The board of the directors of the bank announced a 7.10% increase in its quarterly dividend to 15 cents/share. The company is a member of the dividend achievers index, after raising distributions for 12 consecutive years. The stock yields 1.60%. An investment at the end of 1999, when the stock yielded 2%, would have generated a yield on cost of 12.31%.
The TJX Companies, Inc. (TJX) operates as an off-price retailer of apparel and home fashions in the United States and internationally. The company raised its quarterly dividend by 25% to 15 cents/share. This was the 14th consecutive annual dividend increase for this dividend achiever. The stock currently yields 1.30%. An investment at the end of 1999, when the stock yielded 0.70%, would have generated a yield on cost of 5.90%.
Tanger Factory Outlet Centers, Inc. (SKT) engages in acquiring, developing, owning, operating, and managing factory outlet shopping centers. The company increased its quarterly distributions by 1.30% to 38.75 cents/share. This was the seventeenth consecutive year of annual dividend increases for this dividend achiever. The stock yields 3.60%. An investment at the end of 1999 , when the stock yielded 11.60% , would have generated a yield on cost of 15%.
Monro Muffler Brake, Inc. (MNRO) provides automotive undercar repair and tire services in the United States. The company’s board of directors authorized a 28.60% dividend increase to 9 cents/share. This will be the fifth consecutive year of annual dividend increases for the company. The stock yields 1%. An investment at the end of 1999, when the stock did not pay a dividend, would have generated a yield on cost of 10.80%.
IDEX Corporation (IEX) engages in the manufacture and sale of an array of pumps, flow meters, other fluidics systems and components, and engineered products worldwide. The company raised its quarterly dividend by 25% to 15 cents/share. This is the first dividend increase since 2007. The stock yields 1.80%. An investment at the end of 1999, when the stock yielded 1.80%, would have generated a yield on cost of 4.40%.
Entergy Corporation (ETR) engages in electric power production and retail electric distribution operations. The company raised its quarterly dividends by 10.70% to 83 cents/share. This was the first dividend increase since 2007. The stock yields 4%. An investment at the end of 1999, when the stock yielded 4.70%, would have generated a yield on cost of 12.90%.
Full Disclosure: None
- Why do I like Dividend Achievers
- Yield on Cost Matters
- Seven Dividend Stocks in the News
- Bank Shareholders: Forget About Dividend Increases [more]
Back in 2009 I was invited to participate in a stock picking competition, where I had to submit my top four stocks for 2010. The companies which I thought included high yielding companies from four sectors of the economy, which also were characterized with consistent cash flows and stable but rising dividend payments. The sectors covered include real estate, utilities, energy transportation and tobacco.
The companies which I selected for 2010 include:
Consolidated Edison (ED) provides electric, gas, and steam utility services in the United States. This dividend aristocrat has raised annual distributions for 36 years in a row. The last dividend increase was in January 2010. The company is a natural monopoly in its geographic area, and thus is able to generate strong and steady revenue streams. The stock spots a yield of 5.3%, which a good compensation if you seek current income for the next 5 - 10 years. The stock is unchanged year to date. Check my analysis of Consolidated Edison.
Kinder Morgan (KMP) owns and manages energy transportation and storage assets in North America. This dividend achiever has raised annual distributions for the past 13 years. The last dividend increase occurred in 2009 however. Master Limited Partnerships like Kinder Morgan (KMP) typically receive a fixed fee for moving a product over a certain distance through their pipelines. In addition to that there is little competition between pipeline companies for business, as they are almost monopoly like businesses. Thus, their revenues tend to be rather stable. Kinder Morgan is eyeing expansion, which would be accretive to distributable cash flows per unit for the near future. The stock currently yields 6.50% and is up 9.40% year to date. Check my analysis of Kinder Morgan.
Philip Morris International (PM) engages in the manufacture and sale of cigarettes and other tobacco products in markets outside of the United States. The company has raised distributions each year since it was spun-off from Altria Group (MO) in 2008. While it does face declining demand in Western Europe, which accounted for a little less than 50% of its operating income, the company could benefit from growth in emerging markets such as China or India as well as from strategic acquisitions. Add in to that the strong shareholder focused culture of Altria Group, which has always tried to deliver strong and consistent dividend growth and buybacks, and you have a recipe for success. Tobacco usage is not going to stop just like that no matter how much taxes are being levied on the products. The stock currently yields 4.4%, and is up 9.40% year to date. Check my analysis of Philip Morris International.
Realty Income (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. This dividend achiever has raised distributions for sixteen consecutive years. The last dividend increase occurred in March 2010. Some investors are concerned that Realty Income has a high dividend payout ratio, which stops them from purchasing its shares. The truth is that real-estate investment trusts have to distribute all of their earnings to shareholders in order to avoid being taxed by the IRS. Thus, a more useful gauge for Realty Income’s dividend coverage is its Funds from Operations, which includes earnings per share and certain non cash items such as depreciation expense for example.Realty Income (O) currently yields 5.60%, and is up 19.90% year to date. Check my analysis of Realty Income.
The four stocks that I selected have delivered a total return of 9.60% year to date, which so far is better than the returns from the rest of the investors participating in the competition:
Dividend Growth Investor: 9.58%
My Traders Journal: 5.78%
Where does all my money go: 5.45%
The Financial blogger: 2.87%
Zach Stocks: 2.55%
Four Pillars: -1.01%
Intelligent Speculator: -1.27%
Million Dollar Journey: -11.83%
While the four stocks are ideal for investors seeking current income, in order to reduce risk one has to hold a diversified portfolio of income stocks. At a minimum a diversified dividend portfolio should hold at least 30 securities representative from the ten sectors in the S&P 1500. In addition to that a well diversified income portfolio should also have at least a 25% allocation to fixed income.
Full Disclosure: Long ED, KMP, PM and O
- Six Dividend Stocks for current income
- Four Percent Rule for Dividend Investing in Retirement
- Dividend Investors are getting paid for waiting
- 2010’s Top Dividend Plays [more]