2023-07-21 07:35:00 ET
Summary
- Warren Buffett has held his favorite positions for decades.
- Is “forever” a possibility? No matter how large, unrealized gains are unusable numbers if never realized.
- We adopt the income method of investing forever with two excellent picks.
Co-authored with “Hidden Opportunities”
Amidst the plethora of financial advice, the call to be long-term investors echoes persistently. Experts speak about the merits of the buy-and-hold approach, encouraging us to seize the power of lasting investments, but this is easier said than done. This method is undoubtedly tremendously rewarding, but if you never sell your position, how do you make “usable” money?
Coca-Cola ( KO ) is Berkshire's ( BRK.A ) oldest equity position. The Buffett-driven conglomerate first started buying the beverage king in 1988 and has held on to its position for ~35 years. Moreover, the Oracle of Omaha has said on record that he will never sell any of his shares. What's the point of investing if you never realize the returns and use the money? Sure, you can pass on your position to your children, but someone has to “realize” the gains to put the proceeds to use.
Mr. Buffett has not only owned KO for 35 years, he has been paid handsomely for it. He collects a staggering 57% annual yield on a stock, doubling his initial investment every 1.5 years with cold hard cash dividends. During his ownership of KO stock, Mr. Buffett has collected $10.15 billion in dividend income against a total cost of $1.3 billion, which BRK.A has redeployed in numerous investments over the years, making the proceeds constantly available for meaningful use as desired.
Like Mr. Buffett, I love to hold my investments forever and like to make money in my sleep. I'm also a follower of the income method for my goals. My requirements and portfolio size are much different than those of the Oracle of Omaha. Hence my investment choices differ from what he buys today. Here are two 8%-plus yielding picks that I'm buying with the intent to hold forever. Let's dive in!
Pick #1: ARCC – Yield 9.8%
In the 1980s, Congress created business development companies (BDCs) to fuel job growth and assist emerging U.S. businesses in raising funds. This newly formed sector was instrumental in helping the economy recover from the recession. Since then, BDCs have been intimately involved in mentoring and developing the companies in their portfolios, as it's in their best interest to ensure their borrowers succeed.
While BDCs may appear similar to banks, there are some critical differences. These entities are regulated to invest at least 70% of their assets in private or public U.S. companies with market values of $250 million or lower. Unlike banks, they only lend to institutions by providing permanent capital through equity, debt, and hybrid-instrument financing. BDCs are more involved with their borrowers than traditional banks by providing advisory and management support and being involved in strategic decision-making should challenges arise.
Ares Capital Corporation ( ARCC ) is the largest public BDC by market cap. The company offers a range of financial products, including senior secured loans, subordinated debt, mezzanine debt, and equity investments.
ARCC is highly diversified to protect itself from the credit risks posed by a few borrowers. The BDC has 466 portfolio companies across 32 industries, with an average position size of ~0.2% of its portfolio. The BDC maintains a risk-averse lending strategy with a weighted-average portfolio LTV of ~43%, indicating that the borrowers have a substantial stake in the overall business with a stronger incentive to stay current with their debt obligations.
During the 18-month bear market, ARCC has achieved market-beating total returns, demonstrating its alignment with our income method – reliable dividends through thick and thin.
During Q1, ARCC reported a $0.60 Net Investment Income (‘NII’), which provides a 125% coverage to the $0.48 quarterly dividend. Notably, 88% of ARCC’s first-quarter loan originations had interest rate floors, indicating that management is prudently preparing for a shift in the rate cycle. As such, we may not see special dividends in the upcoming quarters. Nevertheless, ARCC maintains an FY 2022 spillover that is ~2.5x greater than the regular quarterly dividend, providing adequate payment stability and the potential for rewarding shareholders with special dividends when the economy recovers.
ARCC is a blue-chip BDC and a must-have in an income portfolio. This battle-tested BDC currently sports a mouth-watering 9.8% yield at an attractive valuation. The waters may be troubled, but I feel comfortable with ARCC knowing that a cautious team of experts steers the ship.
Pick #2: RLJ Preferred Shares - Yield 8.1%
RLJ Lodging Trust ( RLJ ) is a hotel investment company that owns premium-branded properties in 23 states and Washington, D.C. The company’s portfolio comprises 96 hotels with ~21,200 rooms with a high concentration in the sunbelt states. Source
RLJ Investor Presentation
RLJ is the 8th largest REIT in the U.S., and its hotels are operated under well-recognized global brands, including Marriott, Hilton, Hyatt, and Wyndham.
RLJ continues to demonstrate shareholder alignment through its post-pandemic profitability improvement. During Q1 2023, RLJ repurchased $40 million of its common stock and refinanced $825 million of its debt. 93% of the company’s debt carries fixed interest rates with no maturities until 2024. RLJ ended the quarter with $1.1 billion in available liquidity ($474 million in cash and $600 million unused from the corporate revolver), positioning the company well with near-term cash flow needs to ride out this rate cycle.
Owing to its strong performance, RLJ raised its common dividend by 60% in March; its $0.08/share common dividend annualizes to a modest ~2.4% yield. As investors in RLJ’s cumulative preferreds, these dividend raises indicate healthy and sustainable business execution.
RLJ Lodging Trust, Series A Cumulative Convertible Preferred Shares ( RLJ.PA ) represent fixed, perpetual income at its finest. The issuer cannot redeem the preferred but can force conversion to common stock only if RLJ trades at or above $89.09 for 20 out of 30 trading days. So for RLJ-A to cease being a cash machine, RLJ has to see at least a 767% upside; not impossible, but quite improbable (in my opinion).
If that happens, shareholders will receive 0.2806 shares of RLJ common stock (giving shareholders at least $25 in conversion value). Until then, we can sit back and collect our $1.95 annual dividend, which calculates to a healthy 8.1% yield.
Author's Calculations
RLJ has maintained steady preferred dividends through the pandemic years that severely strained the hospitality industry. During Q1, RLJ reported $76.6 million in EBITDA and $42 million in net cash from operating activities. These figures provide comfortable coverage for the $24 million interest expense, $6.2 million preferred dividend, and $8.1 million common dividend payment for the quarter.
RLJ is experiencing solid organic and inorganic growth as the industry inches closer to pre-pandemic performance metrics. The preferred present safer perpetual income prospects for investors with an 8.1% current yield.
Conclusion
There are numerous benefits of the buy-and-hold-forever approach with quality dividend payers. The most important one is that you get regular paychecks and don’t have to think about selling to release the capital. Warren Buffett may not openly call himself a dividend investor; still, all of his longest-held holdings are notably dividend payers, making it worth his time to hold them and not worry about price movements.
While Mr. Buffett has his own rules and criteria for investing, I have mine that are designed to suit my requirements better. We hold +45 securities in our “model portfolio” that targets an overall yield of +9%.
We would love to buy all of our picks to hold forever, but the reality is that we don’t have decision-making authority over any of our companies. As such, active management is essential to ensure the investment continues to meet our objectives. Barring any unforeseen circumstance, the two picks discussed in this article present up to 9.8% yields and will be an excellent fit for your income needs for the foreseeable future.
For further details see:
Buffett Says Make Money In Your Sleep, +8% Yields For A Retirement Dream