2023-10-22 11:30:00 ET
Summary
- Your goal shouldn't be beating the market. It should be meeting your financial needs.
- Time is the enemy of many financial goals, but it's the ally of income investors.
- We take a trip down history lane to see a choice that we've made and how it's played out.
Co-authored by Treading Softly
There's a classic saying that sometimes "it's better to be lucky than smart." This can feel exceptionally true when you're fighting against the grain.
When it came to the mortgage-backed securities market in 2008, Michael Burry, among others, recognized that the commonly accepted logic wasn't correct. They actively bet against this logic and were lambasted as foolish or plain wrong for years until the truth came out – they were right. The economy and market took it on the chin.
Another saying comes to mind: "Markets can stay irrational longer than you can stay solvent."
Burry and others were playing against the market and the clock, and won. Others before them identified the same problem, and were right, but took short positions too early and lost. With such strategies, being right isn't enough, you have to be right at the right time. A much more difficult endeavor.
As an income investor, time is my friend and not my enemy. Every dividend is an irrevocable return from my portfolio into my wallet, allowing me to hold shares, grow my portfolio, and enjoy everyday life.
At times, we don't have the best "timing", but I am not a gambler or trader. I am an investor for income, and I aim to hold for long periods. As a result, with my investment strategy, I don't have to be right at the right time. Being right eventually is enough to have a very successful investment.
Today, I want to look at a company that provides outstanding income today and helps illustrate why time is a strong ally for income investors.
Let's dive in!
A Trip Down Memory Lane
With many companies trading well below their post-COVID highs, it is refreshing to see a company that is trading at its highest prices since 2019. Antero Midstream Corporation ( AM ), yielding 7.2%, is trading at post-COVID highs. AM is structured as a C-corp, so unlike many peers, it reports on a 1099 at tax time. AM is a midstream focused heavily on natural gas – the transportation and export of it. Its parent company, Antero Resources ( AR ), is among the largest natural gas producers in North America, and it depends on AM to move that natural gas from point A to point B.
Since 2022, when the Fed started its hiking cycle which has been difficult for many stocks, AM has a total return of over 40% – it is having a strong year.
There are two times when people start inundating me with messages asking if they should sell a stock: when a stock is down a lot or when it is up a lot – "Should I sell?".
The answer to that question lies in "Why did you buy? Does the stock still fill an important role in your portfolio?"
It is interesting because Treading Softly wrote about AM back in May of 2019. He noted that AM substantially cut its dividend growth guidance:
"[AM] dropped expectations from 20% down to high single digits, cutting investors' hopes for growth literally in half."
Then, he concluded that it was a buying opportunity.
"With no equity raises needed and a self-funding business model, AM offers investors a chance at a highly-covered 9.8% yield whose coverage will only increase and rapidly so! The dividend will increase over time while being protected with high coverage. Other self-funding midstream companies and MLPs see a much higher share price and lower yield, and I expect AM to move towards similar valuations as the market recognizes the direction AM is headed and accepts the new policy."
Well, the market didn't agree at all. By the end of 2019, the share price had fallen 40% while the S&P went up 10%. Hate mail ensued. Then COVID hit, and that didn't help. AM was down over 80% from May 2019 to March 2020. AM's price fell to $2.10/share, even as it continued paying a dividend of $0.3075/quarter – a staggering yield of 58%! Yet AM kept paying much longer than the market expected. It wasn't until Q2 of 2021 that AM decided to cut its dividend.
Many sold, but Treading Softly didn't. He used a portion of his dividend income to buy more. Even as the market screamed in terror. Today, the total return from AM has exceeded the total return of the S&P 500 over the same period. The best part is that the dividends paid are much higher.
As we sit here today, investors who have bought over the past four years are sitting on gains, and those who bought during the COVID panic are sitting on huge gains. Those who threw in the towel and sold during the massive sell-off in 2019 into early 2020 realized large losses, and I hope they put that capital to good use. Selling at a large loss would have been a huge mistake in hindsight.
Sitting on a gain, I can understand the allure of selling today. Especially, since many other stocks are down in price. When you sell, you lock in a gain permanently – it's a very good feeling. You get warm fuzzies, you get to pat yourself on the back – you have a win. But what are you going to do? Take that capital and put it back at risk in another investment?
Which brings us back to, "Why did you buy AM?" One of the big reasons Treading Softly bought it was because he liked their business plan of converting to a midstream that is fully self-funded and does not rely on raising equity or debt. It is a business model that blue-chip peers like Enterprise Products Partners ( EPD ) have adopted to great success. It is this goal that eventually convinced me to join Treading Softly and buy as well. First, we bought the AM bonds , and when those were successfully redeemed, and AM had cut their common dividend - I jumped into the common shares .
2023 is a turning point for AM, as it will have significant FCF (Free Cash Flow) after dividends. Cash flow that it intends to use to reduce debt, bringing debt in line with its target of under 3.0x. Note that AM defines FCF as cash flow after all capital expenditures, including growth cap-ex. Source
AM has a great goal. Hands down, a midstream that is capable of self-funding is worth a premium. It significantly reduces some of the largest risks that midstream investors face – dilution and too much debt. A midstream company that has enough cash flow that it doesn't need to raise capital will have an easier time investing in opportunities when they are cheap because the times when assets are cheap strongly correlate to times when it is difficult to raise capital at an attractive price.
AM has made fantastic progress, from a negative FCF of over half a billion to a positive FCF after dividends. Now that AM has achieved this, it can reduce debt, increasing FCF more as interest expense is reduced. AM will be freeing up more cash that can be used to invest in more growth. In time, that will lead to more cash to raise the dividend back up. This dividend growth will be solidly supported by earnings and will be protected by a much stronger balance sheet and significant FCF. That is the kind of company I would love to own.
AM is just now starting to realize the fruits of its strategy that it has worked so hard to implement over the past four years. It hasn't been an easy path. There were trade wars, viruses, inflation, rising interest rates, two bear markets, and a dividend cut.
Selling now is like going through the effort to grow an apple tree, taking years to nurse it and care for it, protecting it from storms and weeds, growing it into a strong tree that starts bearing fruit, and then, instead of picking the apples as they ripen, you chop it down, get all the apples today and lose out on the bushels of apples you could pick in the future.
I didn't buy AM to "beat the market" over a certain period. It's nice that it has, but that was never my main goal. AM is doing what I expect it to do, and that is why I am still a buyer. It is producing positive FCF; it has achieved its goal of being fully self-funding, and it is positioned to grow FCF, filling my portfolio with bushels of dividends year in and year out. That is the Income Method.
AM will report Q3 earnings after market close on Wednesday, October 25th.
Conclusion
With AM, we can see that even imperfect timing or battling the market can provide outsized returns because time is our friend, not our foe.
When it comes to your retirement, I want you to have the easiest time managing your portfolio. I don't want you to have to spend hours or days every single month grueling over every holding in your portfolio, raking through all the news and trying to come up with the best strategy to beat the market this month. I want you to have a sustainable method that allows you to reap outstanding returns and income from the market without having to constantly go in and pull weeds.
A big difference between managing an orchard and managing a garden is that the orchard requires less immediate maintenance, although you have to wait years for it to show its absolute potential. Sometimes, investors would rather try and gamble or game the market, thinking that they can get great returns now. Over the long run, they actually see less fruit from their labor than an investor who's willing to hold, collect outstanding income, and let the market do what it may.
When you're retired or you're in retirement, you're not going to want to spend all your time fiddling with your portfolio – unless you enjoy that – what I would rather you do is find and enjoy hobbies that thrill you. While I will always be researching and writing even in retirement because that is what I love to do, I do not expect that all of my readers have that same passion. Doubtlessly, there are thousands of investors who are reading this today who would love nothing more than to spend less time with the market so they can spend more time doing what they love. Whether that be time with family, hitting up the golf course, or taking their Jeep on a trail, you can do that if you have financial freedom and financial security provided by having a portfolio that provides you with the income you need to live day by day.
That's the beauty of my Income Method. That's the beauty of income investing.
For further details see:
Earn 7.2% Yield From Natural Gas, And More Tomorrow: Antero Midstream