PTY - 2 Magnificent Dividends To Generate Recurrent Income

2024-01-04 07:35:00 ET

Summary

• My portfolio continues to make income perpetually into my wallet.
• Dividend income portfolios are a great tool to make passive income.
• I'm earning up to 10% yields, enjoying monthly dividends.

Co-authored by Treading Softly

For centuries, people have tried to build a perpetual motion machine. This would be a machine that, once started, will never stop. The goal was to input an original amount of energy and let the machine go on forever.

This concept has been dreamed up for centuries and even Da Vinci himself mocked those who believed in the concept.

These machines are doomed to fail due to the nature of entropy. Energy will eventually be equalized via transfer through heat or friction, and motion will stop unless additional energy is added to the system.

When it comes to the market, many investors see dividend income portfolios as perceived perpetual motion machines. While this couldn't be further from the case, it is just due to a complete misunderstanding of how a dividend portfolio works. An investor will always start with an initial amount of capital and invest that into their portfolio, believing that the companies or the funds that they are investing in are going to be able to produce a predictable, steady income stream. Many investors will continue to add capital over time.

The big difference here is that a dividend portfolio is not a contained system. Each one of those companies generates a profit by interacting with the outside world, and then either uses that profit to grow the company or continue to pay strong dividends, or both. Many companies that don't pay dividends reinvest all of the money that they earn back into growing the company further. This means that the management teams of those companies believe that they have better uses of the money that they've earned than paying it to reward you for being a shareholder. I understand that many management teams may have great uses for money; however, many of my needs for money are more pressing than their believed goals. I've seen countless companies run into the ground by management teams believing that their ability to invest the money is better than paying it out to reward me. Therefore, when I created my income method, it was simple. I demanded to be paid for my ownership by every company that I invested in. Period. No exceptions.

Today, I want to look at two great opportunities that you could buy and enjoy recurring passive income. No additional work is needed, but simply to be a shareholder who bought shares and owns part of the company. The management team works diligently to earn the money that they pay you and continue to grow the company.

Let's dive in!

Pick #1: PTY – Yield 10.6%

PIMCO Corporate & Income Opportunity Fund ( PTY ) is my favorite fund from CEF (Closed-End Fund) manager PIMCO. It isn't the cheapest; PTY is currently trading at about an 18% premium to NAV. Some balk at the premium, and I love a discount as much as the next investor. Yet, PTY is PIMCO's best-performing fund, and history certainly justifies the premium.

Here is PTY's total return based on NAV:

A bond fund that outperformed the S&P 500 – that deserves a premium.

If you have paid attention to the financial news at all, you know that we have just seen one of the worst bond markets of all time. The Fed's hiking cycle put pressure on all debt investments. For funds like PTY, which is invested primarily in fixed-rate debt, there has been significant negative pressure on NAV.

PTY is an actively managed fund that leverages the expertise of its management. It invests in a variety of different investments, both US and non-US. Source

PTY also uses leverage, which is currently 23%, but we've seen it go over 40% in the past. PTY also uses interest rate swaps, both to hedge its interest expense and also to generate income from interest rate changes.

One of the main factors I use when deciding whether or not I am willing to pay a premium for a CEF is whether I am able and willing to duplicate the fund's portfolio and whether I can duplicate the results on my own. With PTY, I wouldn't even attempt. PTY has proven over the decades that it can outperform. In the past two years, debt investments have seen a lot of headwinds from rising interest rates. Now, the Fed has indicated it is finally willing to pivot, and that pivot could come as soon as March. The Fed was a headwind, and it is now preparing to become a tailwind.

I counted on PIMCO to navigate a difficult environment for debt investors, and now I certainly count on them to navigate an easier environment.

Pick #2: Realty Income – Yield 5.2%

Realty Income Corporation ( O ) is the lowest-yielding stock in our Model Portfolio. Though with a yield over 5%, it isn't exactly what most would consider "low" yield. The reason O can fit into a portfolio like the Model Portfolio, which has a target of an 8-10% current yield, is that our target yield is an average. With so many options available that have yields of 10%+, we can afford to have some super high-quality investments that are likely to provide consistent dividend growth.

When it comes to high-quality dividend growth, O is a stock that comes immediately to my mind. Here is O's dividend income since 1996, assuming no reinvestment : Source

O has raised its dividend five times this year alone. O has paid 640 monthly dividends (53.3 years) and has had 104 consecutive quarterly dividend raises (26 years). This is an impressive record that demonstrates O's dedication to shareholders. At Realty Income, a monthly dividend is engrained in the culture.

The amount of organic growth that O has proven it can provide through any economic environment is a significant benefit to an income portfolio. O's income growth is likely to continue, and the pace could accelerate as O is becoming the undisputed leader in the triple-net sector.

At one point, it was arguable that W. P. Carey ( WPC ) or NNN REIT ( NNN ) might be able to catch up to O. After the acquisition with SRC closes, O alone will make up approximately 50% of the Enterprise Value of the entire triple-net REIT sector. Source

With greater scale, a higher credit rating, and a cheaper cost of capital, O has built a moat that provides it a significant competitive advantage. O's scale allows it to pursue much larger transactions, including entire portfolio transactions, without losing the benefits of diversification.

Additionally, O has started leveraging its size and superior balance sheet to benefit from the expertise of others. For example, O recently reached a deal partnering with BREIT with a JV (joint venture) that owns the Bellagio. The investment is structured as part preferred/part common investment, ensuring priority payments for O. O also recently partnered with Digital Realty Trust ( DLR ) in a JV to build two data centers. While O doesn't have a lot of experience in data centers, DLR has been a leader in the sector for 20 years.

These are opportunities that smaller triple-nets can't seriously consider, but O can take advantage of them thanks to their size, scale, and low cost of capital. There used to be an argument about which triple-net REIT was the best; we believe that argument is settled, and O wins. The most compelling reason to buy any triple-net REIT that isn't O is if you believe that O might acquire them. They just bought SRC, so it will probably be a year or two before they buy another REIT.

While O is on the path of net-lease REIT domination, we get to enjoy a monthly dividend that continues to increase with frequent raises. With the Fed increasingly likely to pivot, we don't expect O will be yielding over 5% for long.

Conclusion

With PTY and O, we can remove the most common failure point in an investor's plan – their own decision-making. Being forced to choose when to sell shares to generate a profit or generate cash flow to be able to live day to day is the biggest issue that so many retirees run into. They often will time their sales based on emotions rather than facts. This will often cause them to underperform the market as a whole over the long run. This is because they reduce the size of their portfolio by trimming it to try and gain capital to be able to live their daily lives. They are reducing their portfolio size and ability to recover from losses, especially those losses that they've locked in. This opportunity cost just builds up over the years.

When it comes to retirement, I don't want you to have to play the game of rolling the dice and trying to decide when is the best time to sell your shares. Instead, I want you to be able to sit back, relax, and enjoy income as it flows in from your portfolio month after month. These two outstanding opportunities provide you the ability to own shares and do nothing else. They're truly passive income that you could just simply receive dividends month after month. Financial freedom is the ability to not have to worry about your finances and to have income that far exceeds your expenses. As long as your income exceeds your expenses, you will have access to be able to enjoy various opportunities that retirement has to offer you and use the time that you now have unlocked by no longer having to work, to explore and investigate those hobbies and interests.

That's the beauty of my Income Method. That's the beauty of income investing.

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