2023-07-03 07:35:00 ET
Summary
- The hardest dollars to earn are the first ones.
- So many people make the mistake of not making their money work for them.
- We examine two excellent income opportunities for your portfolio today.
Co-authored with Treading Softly
A common joke within the world of aviation is to ask someone how do you make $1 million with an airline. The answer? Start with $2 million.
Operating an airline is an extremely capital-intensive business. You must have large expensive assets, pay highly qualified individuals large sums of money to fly those assets, and then have to pay highly skilled individuals to repair those assets – all while being at the mercy of fuel costs and other unforeseen expenses that can arise.
When it comes to the world of financial advisors, if you ask them which amount of money is the hardest to earn, many of them will tell you that the first $100,000 is the absolute hardest amount of money for an individual to save. Why is that? Well, once you've earned $100,000 and saved it, the next $100,000 becomes easier because the first $100,000 is helping propel you towards the second. All you have to do is double, not start from zero, and get all the way to $100,000.
Many novice investors or new retirees who are just taking over their portfolios find it extremely discouraging to try to earn money in the stock market. They've been told by various voices in the media or various financial advisors that they need to invest in stocks that don't pay them anything, and hope and pray that those stocks will appreciate with time. Those investors will cash out of the market when they feel that a recession or correction is coming to avoid potential losses while at the same time creating the losses they're trying to avoid.
This is where we can change over our mindset and radically revolutionize our retirement. By investing for income, and what I mean by that is by investing in investments that pay you to own them, you can get regular dividend checks right into your bank account as a thank you from the company for being a shareholder. Now your $50,000, $100,000, or $1 million can start paying you back and helping you create an even larger portfolio of income investments. Every dividend reinvested generates more dividends of its own. The snowball grows from there!
Today, I want to look at two outstanding opportunities to start your income investment journey.
Let's dive in!
Pick #1: Realty Income - Yield 5.1%
Realty Income Corporation ( O ) is a Real Estate Investment Trust (“REIT’) that invests in single-tenant properties using "triple-net" leases. These are leases that make the tenant responsible for most property-level expenses. O is also a Dividend Aristocrat that has trademarked the phrase "The Monthly Dividend Company", a tagline that O has more than lived up to with 636 consecutive monthly dividends. That is 53 years of monthly dividend payments, a record that extends well before O became a publicly traded company in 1994. Since becoming public, O has raised its dividend 121 times. That is raising the dividend an average of 4.17 times per year.
Many investors talk about the power of compounding in reference to accumulated price gains. O is a prime example that the power of compounding can be applied to income as well. Here is a look at the income growth from O without reinvesting.
Over 53 years, O has been through it all. Recessions, high inflation, low inflation, wars, regulatory changes, C-suite changes, black swans, blue swans... you get the point. Through it all, the dividend kept coming month after month.
What is O's secret? Consistency. O has built up a portfolio of over 12,000 properties using its underwriting process that prioritizes stable, long-term leases that are secured by high-quality real estate. Due to the quality of its real estate, O has been able to maintain above-average occupancy rates. Source
Long-term leases mean that there is very little variation in O's finances during recessions. For example, O only has 6.1% of its portfolio experiencing lease expirations in 2023 and 2024 combined. This puts O in a very good position to ride out a recession within the next year.
O has consistent occupancy, consistent income, and consistent high-quality management. Over the decades, this has translated into consistently rising dividends for shareholders. O is one of the highest-quality REITs in the market. It is one of only seven that holds a balance sheet with an A- or better credit rating and is one of the oldest REITs in existence. It is a great dividend growth option to hold through any economic environment.
Pick #2: ACRE - Yield 13.8%
Too many investors are reactive. When they see news, they act before they think, and the result is that they make poor decisions. When Ares Commercial Real Estate Corporation ( ACRE ) reported earnings, the share price fell 5% before the market opened. At its low point on that day, ACRE was down over 10% to $7.52.
When a company's share price collapses immediately after earnings, it can be a sign that something very bad happened. Or it could be a sign that the market is crazy and you should be buying the opportunity with both hands. To tell the difference, you need to read earnings and listen to the earnings call with a calm and clear head. On May 2nd, we published this to members:
"The entire commercial mortgage REIT sector is facing such strong negative sentiment that valuations have become completely unhinged with reality. No rational math can be done to conclude that under $8 is a fair value for ACRE.
These companies are not trading based on cash flows - which are easily covering their dividends. They are not trading by book values, which are down, but 70% higher than the trading price. Are investors in the market seriously pricing in 15%+ loss rates? Probably not. The market isn't reacting with a rational mind. It is selling off everything related to commercial real estate with a special focus on anything touching office space."
What has happened since that $7.52 bottom on May 2nd? ACRE has rallied over 30% and is trading over $10 for the first time since Silicon Valley Bank failed. Investors who reacted in panic and were selling below $8 were giving a gift to those of us who were buying. This is a shining example of why you have to avoid being reactive to news and the initial reaction of the share price. Don't assume that the market is "right" in its initial assessment. This is why we provide Earnings Roundups to members throughout the earnings season to analyze reports from our holdings.
A second common mistake that investors make is "recency bias". When considering whether a stock is "cheap" or "expensive", we tend to compare them to recent prices. An investor might look at ACRE and decide it is expensive and hold off on initiating a position, hoping that it will fall back to $8, where it was last month.
When evaluating a company, it is important to have a valuation that is independent of whatever the price might be. For commercial mortgage REITs, we have two tangible numbers on which we might base our valuations – distributable earnings and book value.
While there is variance quarter to quarter, ACRE's distributable earnings per share have been relatively stable, ranging from $1.36/year to $1.55/year. Source
Note that ACRE's trailing 12-month distributable earnings of $1.47 is 4% higher than in 2019, yet the share price is over 30% lower. ACRE is earning more money and paying a higher dividend, but is trading at a lower price. The valuation is lower. Additionally, leverage is lower with ACRE at 1.9x debt/equity today, compared to 2.9x in 2019. ACRE is earning more money with less leverage, paying a higher dividend, and has a lower share price. And people still believe the market is rational...
What is a fair valuation for a commercial mREIT? Since we expect most of our returns to come from dividends, and dividends will be 90-100% of distributable earnings, we would expect the price to range from 8-11x earnings. So at $1.47 in earnings, we would expect the "fair value" of ACRE to be in the range of $11.84 to $16.17.
Another valuation method is to rely on book value. ACRE's book value is $13.15/share. As income investors, we are not huge fans of relying on book value. After all, ACRE doesn't make money from selling loans; it collects interest and then is paid back at maturity. However, if you choose to use book value, ACRE is trading at a much larger discount than it has historically.
Keep in mind that book value includes $1.69 in CECL reserves. These are projected potential credit losses that might or might not actually occur.
ACRE is not as undervalued as it was a month ago, but when we look at the big picture, it is still trading at a low valuation relative to its own history. Combine that with the opportunity to get a +13% yield that is well-covered by cash flow, and you have a solid buy!
Conclusion
Today, we've looked at two excellent income investments. The first is the gold standard of income generation, providing monthly income and regular dividend increases for years, and we can expect that for decades to come. The second is a highly oversold investment opportunity to lock in great income now as the market comes to its senses.
I've long said that nothing makes money quite like money does. This would be something that I would print on HDO swag if I was to start selling it because it is exceptionally true! Those who have money and use it to generate more money know that it takes more effort to start from nothing and to go up than to start with something already there and propel yourself higher. It's the difference between jumping off the ground to see how high you can get and jumping on a trampoline and seeing how high you can get. Money provides that springboard!
Unfortunately, so many investors and retirees choose to let their money sit idly and do nothing for them now, believing that they can liquidate it later. It's the difference between owning a factory that prints dollar bills and owning a collection of baseball cards, hoping that somebody is going to want your Babe Ruth card in the future. They might or they might not. I wouldn't bank my retirement on it.
So instead of gambling on baseball cards, become a factory owner. Lay the groundwork for a portfolio that generates the income you need for your retirement. So you don't have to worry about what the market thinks your factory is worth because you know what it's producing. That way, you can go on a 4-day-3-night cruise, hike a mountain, or catch a ride to space without worrying about what your portfolio is doing.
I like to think that I am a simple man with simple tastes. I like to sit outside by a bonfire, drink my favorite beverage, and enjoy the sunset while listening to the laughter of my children without having to worry about where the next dollar is coming from. If you can't do that with your retirement portfolio, it might be time for a change. These are dirt-cheap investments!
That's the beauty of my Income Method. That's the beauty of income investing.
For further details see:
Bargain Alert! Up To 13% Yield Dirt Cheap