THQ - 2 Magnificent Passive Income Stocks Up To 12% Yield

2023-10-04 07:35:00 ET

Summary

• Healthcare - we all need it, we all pay for it.
• You can receive outstanding income from this beaten-down sector.
• Stop just paying your medical bills; have those medical bills pay you.

Co-authored by Treading Softly

Healthcare professionals got hit hard in 2020. I have many friends who work in that sector as nurses and doctors. They saw more death, experienced more trauma, and endured struggles against the unknown than most of us did. I'm always appreciative of their efforts while recognizing each professional had a limited scope of insight based on their location.

The recovery of many sectors has left healthcare investments often in the dust.

There is a lot of negative sentiment towards healthcare companies. Several factors are driving this, including:

• The loss of government stimulus from the COVID era, as well as the "easy money" from COVID vaccines.
• Labor costs have gone up significantly, especially in the chronically understaffed healthcare industry.
• Costs of healthcare commodities have gone up.
• Healthcare revenues are not a free market. Companies in the sector are often restricted by the government and contracts with insurance companies. As a result, expenses go up immediately, but revenues take time to catch up.
• Regulatory uncertainty and lawsuits have impacted many businesses in healthcare.

Yet, the issues today are not so different from those that healthcare companies have faced in the past. Healthcare has always been a contentious area for political debate and has frequently been the target of significant regulations. That isn't going to change today, and I imagine in 20 years, we will still be arguing about whether healthcare companies are "gouging" us or whether the government is too intrusive or not intrusive enough in the sector.

Two years ago, Wall Street couldn't rush into healthcare fast enough. Today, it is running away. Yet, at the end of the day, whether Wall Street likes them or not, healthcare companies will continue to produce a lot of cash flow.

The reason healthcare is such a contentious political issue is that everyone wants it, and everyone wants the best. In the long run, it is always good to be in a business providing something that everyone wants to use. This is why healthcare has been a great investment opportunity in the long run.

One of the oldest CEFs (Closed-End Funds) I own is Tekla Healthcare Investors ( HQH ), a fund that focuses on healthcare and has easily outperformed the S&P 500 since its inception.

One feature that HQH has that some investors don't like is a variable dividend policy. HQH pays out 2% of its Net Asset Value each quarter. As a result, the income from HQH will vary from year to year.

A Pretty Pair: THW/THQ – Up To 12% Yield

For investors who want more predictability, Tekla has some other funds to choose from. At HDO, we hold two of them, Tekla World Healthcare Fund ( THW ) yield 12.1%, and Tekla Healthcare Opportunities Fund ( THQ ), yield 8.0%. Both offer fixed dividends, and both have similar portfolios.

The largest difference is that THW invests about 23% of its portfolio in non-US companies. Source

While THQ is invested 100% in U.S. companies, they share 7 of their top 10 holdings, and both funds have the same investment team.

One other major difference between the two funds is their dividend policy. CEFs are required to pay out the majority of their taxable income, which includes taxable capital gains. However, that is a minimum. CEFs are free to set a dividend policy that is more aggressive or more conservative.

THW chooses to pursue an aggressive policy, paying out a high yield, while THQ has chosen a more conservative policy, retaining value to support NAV.

What does this mean for investors? Here is THW vs. THQ on a NAV basis over five years:

Note that THQ's NAV has been essentially flat over the past five years. It surged with the COVID hype and has now returned to prior levels. THW's NAV has declined over 20% over the same period. Yet, for investors, that doesn't tell the whole story. When we consider the dividends received, the comparison looks like this:

THQ has outperformed, but not by much. Yes, THW has been "overpaying", but investors who prioritize cash flow have received it without giving up too much total return.

Of course, this is based on NAV, not the share price. When we look at total return results by share price, THW has outperformed THQ.

This is a lesson worth digesting. CEFs are closed-end funds, with emphasis on closed . CEFs are funds that invest in a portfolio; when that portfolio has gains or losses, it is reflected in NAV. When that fund pays a dividend, it comes out of NAV. For investors, it doesn't make a huge difference in their total return whether the fund pays out a higher dividend or allows gains to grow NAV. In fact, it doesn't even matter if the fund pays an oversized dividend. At the end of the day, the shareholder's return will be very close to the total returns of the underlying portfolio – whether they get them as a dividend or they get it through NAV growth. The gains/losses are whatever they are, and changing the dividend isn't going to change that.

We can expect this general trend to continue with THW and THQ in terms of their NAV and total returns on NAV. As long as THW is more aggressive, its NAV will decline more or grow less than THQ's NAV, and their shareholders will be compensated with more cash upfront. So far, the market has rewarded THW for its aggressive dividend policy by trading the shares at a premium to NAV, while THQ's shares typically trade at a discount to NAV.

The only time THQ has traded at a steeper discount was March 2020. THW currently trades very close to NAV; it is a bargain compared to the 12%+ premium it has frequently traded at in recent years.

Both CEFs are at attractive price to position yourself to benefit when healthcare comes back into favor. Which one should you buy? That is up to you. With THW, you will get a very large dividend right now. It is a great option for those looking for immediate income and prioritize that over maintaining higher prices. THQ is a better option for those who prefer a more conservative strategy of holding a fund that easily covers its distributions with gains.

Conclusion

When it comes to investing in the healthcare sector as a whole, we like all three funds mentioned here: HQH, THQ, and THW. THQ and THW provide a more reliable stream of steady income for investors and retirees who don't want to gamble trying to pick individual companies that will succeed. Instead, as a professional income investor, I can leverage the skills of the portfolio managers who operate these funds to unlock income from this sector for me.

Part of being an investor is understanding your field of expertise, which is why we have a whole team of experts instead of just me running everything! I can use funds like THQ and THW to utilize the expertise of others to achieve more success.

This way, your biggest worry is if you want ketchup or mustard or both on your hamburger tonight at your family cookout. Stop having to worry about how you'll pay your bills. Start living in financial security. Stop having to time the market and sell shares to unlock income. With up to 12% yields, start getting paid to simply sit back and hold your positions.

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

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