O - 2 Magnificent Yields Up To 9% You Don't Want To Miss

2023-12-06 07:35:00 ET

Summary

• As the year comes to an end, it's important to button up your income stream for as much growth as possible.
• Holiday shopping trends create two clear winners within the market.
• Removing the volatility of a fickle consumer from income stream is a great benefit to your retirement.

Co-authored by Treading Softly

As we move towards the end of the year, we start getting more and more advertisements about things you can't miss before the year ends. For many, there's holiday shopping and gift giving, family gatherings, and other end-of-year events that you must attend. When you take a moment to sit back and think about who truly benefits the most from this time of year, there are two groups of individuals or companies that seem to have the biggest marks of success. The first of those would be financial institutions or credit card companies; not only do they benefit from the higher spending activity through exchange fees, but they also benefit from any sort of interest or fees on a bank account that they can charge. The second group that benefits is not the stores themselves but the landlords of those stores. The stores typically are fickle to the whims of the consumer yet the landlord will always do everything they can to extract rent. So the stronger their client is, the better rent coverage and safety.

When it comes to the market, we have many different ways to invest in these two groups that provide a strong income. I want to look at two outstanding opportunities or methods to invest in these two different groups of companies today to enjoy strong income for decades to come.

Let's dive in!

Pick #1: BTO – Yield 9%

Humans have a nasty habit of assuming that current conditions will last forever. Nothing shocks people more than change, even though we all know that things change.

Interest rates are a prime example. In 2021, interest rates were going to be 0% forever. In fact, the most common question I was asked about interest rates was, "What happens if interest rates go negative?". Two years later, the most common question people ask is, "What happens if interest rates stay high or go higher?". It turns out that the question being asked today is the question that should have been asked in 2021.

For the past two years, we have seen interest rates climbing at the fastest pace in 40 years. The result has put pressure on financial investments, particularly those that rely on interest spreads.

Today, the yield curve is "inverted", which means that short-term borrowings have higher interest rates than long-term borrowings. When you are in the business of borrowing short-term and lending longer-term, that is not an ideal situation. While there are many complexities, at their core, banks are companies that use short-term money and profit from lending it out.

John Hancock Financial Opportunities Fund ( BTO ) is a CEF that invests primarily in banks. Banks declined with most stocks in 2022, but then in 2023 saw unique pressures as negative headlines were made in early 2023 with the failure of Silicon Valley Bank. The market panicked, with many investors imagining a GFC-style financial meltdown.

Yet, we haven't seen a large number of failing banks. In terms of size, Silicon Valley Bank was huge, but in terms of systemic risk, the number of bank failures in 2023 looks a lot more like 2000/2001 than 2008/2009. Source

That meltdown didn't occur, and in Q3 earnings, banks were generally healthier than they were in Q1. However, banks haven't really recovered in terms of share prices. In addition to negative sentiment, they continue to have negative pressures from rising Treasury rates and an inverted yield curve.

It is no secret that I expect a recession to happen. The question is whether the next recession is likely to look more like the dot-com bust or the Great Financial Crisis.

During the dot-com bust, we saw a similar dynamic with a high 10-year Treasury rate and an inverted yield curve. This was followed by a declining 10-year Treasury and a steepening yield curve as the Federal Reserve cut interest rates.

This combination proved to be extremely positive for banks, which saw a sharp recovery. This recovery was most notable because it occurred while the market indexes were collapsing.

During the dot-com collapse, banks were an island of green in a red market. This is why we diversify the HDO Model Portfolio to have holdings that benefit from different interest rate conditions.

It is difficult to predict exactly when they will change, and it is difficult to predict exactly how they will change, but we can be very certain that they will change. BTO is trading at a small premium to NAV, its assets are trading at low valuations, and there is a good probability that interest rate conditions for banks will change for the better. This makes it an ideal option to hold in your portfolio in case of a recession in 2024.

Pick #2: O – Yield 5.5%

As the market started predicting a 99%+ probability that the Fed will cut interest rates sometime next year, Realty Income Corporation ( O ) has seen its price bounce up from lows, along with many other REITs. Real estate is a sector that holds up to using relatively high amounts of leverage. 5.3x debt/EBITDA might be high in many sectors, but it is modest leverage for a REIT. However, it is enough to worry the market when interest rates go up. When interest rates go up, the market runs away from REITs as if they are going to explode.

O has been through high-interest rates before. O has paid 640 consecutive monthly dividends, which is 53.3 years of monthly dividends. Here are the interest rate environments that O has paid its monthly dividends through:

High rates, low rates, rising rates, falling rates, steep yield curves, inverted yield curves, recessions, depressions, and the good times too. O has been through this before; it has been through worse, and it has kept paying investors a dividend every single month.

When O goes on sale – just buy it. O is trading at the lowest valuation it has seen since the GFC.

O is trading at the same valuation it was in 1997! Did O have an A3/A- credit rating in 1997? No, but it has it today.

Was O's growth per/share lower than it was in 1997? No. If anything, O's growth rate is slightly higher thanks to large portfolio transactions in 2022 and another expected in 2024. Source

In the long run, O's growth rate is fairly stable, slightly over 5%.

Pick whatever measure you want, O is a decisively better REIT today than it was in 1997. It's bigger, has cheaper access to capital, a more diversified portfolio, and a stronger balance sheet. It certainly should be trading at a higher valuation than it has in the past, which, for most of the past decade, it has.

O continues to grow and has been busy consolidating the net lease REIT sector. It bought VER, and now it is buying Spirit Realty Capital ( SRC ). The economies of scale make O even more efficient, and investors will benefit immediately from the improved efficiency that O will bring to SRC's portfolio. Source

O's AFFO growth of 9.2% in 2022 was in large part due to the VER acquisition. Management projects that the SRC acquisition will result in an immediate 2.5% growth in AFFO/share, which will add to the natural growth within the portfolio and other acquisitions that O is making.

O is already the largest net lease REIT and has reached a scale where it can absorb any of its competitors with relative ease.

O has set itself apart as a clear leader in the sector. Indeed, perhaps the most compelling reason to buy any net-lease REIT other than O is because you believe it might be acquired by O.

O isn't likely to trade at a valuation this cheap for long. Buy, hold, and let the growing monthly dividends roll in.

Conclusion

With BTO and O, we gain meaningful exposure to not only financial institutions but also a vast majority of stores that consumers rely upon daily. When it comes to growing my income stream, I typically try to avoid the consumer-facing business. Instead, I like to choose to own the enabling platform of those businesses. For example, I don't own a grocery store. I own the company that owns the property that the grocery store is using. I don't typically own the car company that sells the cars, but I will own the company that delivers the fuel to the gas stations, which enables those cars to work. By taking this extra step back, I further insulate myself and my income stream from the fickle ways of a consumer.

When it comes to retirement, the last thing you want is for your retirement income stream to be reliant on the fickle mindsets of others. This is why I don't invest solely for growth, hoping that I can sell my shares at a premium because I can't control what other investors are going to find valuable. Instead, I invest for income, which many people view as a secondary means of returns, because I can control what yields I own and I can collect that income, knowing that the market historically trends positively over the long haul. For your retirement, I want its income stream to be one that is reliable, sustainable, and dependable. For that to be the case, removing as many fickle opportunities as possible, so that your income stream has less variation, is a benefit to you.

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

For further details see: