Wednesday, October 2, 2013

Two dividend payers I recently purchased for my taxable accounts

For the first five years of this site, I have mostly discussed companies I found attractively valued for investment, as well as my dividend investing strategy. However, I rarely discussed the companies I have been purchasing in my accounts. This is because I believed that it was much better to discuss the tools of the trade and my investment philosophy and ideas, rather than focus too much in on recent investments. I never even published my investment portfolio in detail, until recently. Readers could only guess what I owned by going through articles, and checking my full disclosures. However, through interactions with readers over the years, I have realized that some enjoy reading about specific investment ideas that I have added money to.

Over the past ten days, I made two purchases in my regular taxable stock accounts. I purchased Realty Income (O) and British Petroleum (BP).

When I last analyzed Realty Income (O), I mentioned that I would only purchase it at a specific yield. Well, back on September 21 I tweeted about my purchase of the stock as I found the yield to be attractive. The company has managed to raise dividends multiple times per year since going public in 1994, and continued raising even during the dark days of the Great Recession in 2008 and 2009. After an acquisition closed in early 2013, Realty Income raised distributions by over 19%. I like that this triple net REIT continues growing through targeted acquisitions of competitors and properties and that it is not afraid to look outside the box in order to find attractive uses of its capital at attractive cap rates of return. You are also paying for the expertise of the management team, which has done a superb job of ensuring quality tenants, diversification and keeping the properties occupied.

One of the risks behind REITs is that rising interest rates would cause investors to sell their stocks off, and purchase bonds instead. As an investor, I realize this could potentially increase the cost of capital for Realty Income, which obtains money to grow through stock or debt issuance. As long as new properties are acquired at rates of return above cost of capital however, future acquisitions should continue adding to the pool of funds available for shareholder distributions. In addition, while interest rates would increase, they would likely do so very slowly and would likely reach about the same levels that we had prior to the 2008 – 2009 crisis first. In addition, I would much rather have my money in a business like Realty Income that provides the potential to generate a high dividend yield today and the opportunity for dividend growth versus a long US Treasury Bond at a similar yield. This is because an increasing dividend payment over time would keep the purchasing power of my income and protect it from inflation. Fixed income instruments do not do this for you. Currently, Realty Income yields 5.40% and has a ten year dividend growth rate of 4.20%/year. It trades at 16.70 times FFO ( assuming FFO of $2.40/share).

The other company I purchased was British Petroleum (BP) on September 30. In addition, I also sold a January 2015 put with a strike of $42. If the stock trades below $42 at expiration date, I would have to buy it at $42/share. However, my effective cost would be slightly less than $37/share. If the stock trades above $42/share, I would end up with the equivalent of slightly more than $5/share. The option premium received financed a portion of my purchase of BP.

Before I discuss the purchase, I wanted to discuss my history with the company. I initially purchased shares back in 2008, and considered them one of the safest dividends for current income. However, the events in 2010 led to a dividend cut, after which I sold out my position completely and reinvested the proceeds into Royal Dutch Shell (RDS.B). I sell automatically after a dividend cut, as a means to protect myself from getting married to a company that is collapsing. I do not want to be in a position of someone who has received dividends from a company for 40 years, and is emotionally attached to the stock, and therefore ignores warning signs that the business is in trouble. This could lead to losses in investment capital, which could result in going back to work. There have been investors who hold on for too long to a lost cause, and then end up not only losing their income source but also their capital. I also do not want to end up justifying to myself that a business will bounce back, while I am experiencing the pain from losses and hoping, rather than assessing the situation with a cool head.

Since the company has started raising dividends after the cut however, I am willing to give it another try. I think that the Gulf of Mexico spill is a major reason why the stock is still so cheap at 9 times forward 2013 earnings and 7.90 times forward 2014 earnings. However, I think that the fear of bankruptcy for BP is larger than the total cash outlays it would end up expending over time for the oil spill. Therefore, I sense an opportunity to purchase an asset at reasonable valuations that no one likes. The stock also yields 5.10% with a $2.16 in annual dividend. The total amount dividends paid annually was $3.36/share prior to the oil Spill in the Gulf of Mexico. I believe that this could easily be achieved by the end of this decade, especially if oil prices keep steady.

British Petroleum owns 19.75% of Russian Company Rosneft, which is the largest energy company in the world by reserves, and has a market capitalization of over 80 billion. BP also received a sizable cash consideration in the process, and will be using $8 billion from that to repurchase shares over the next 12 – 18 months. This would offset the reduction in earnings following the sale of its stake of BP –TNT to Rosneft for the cash and stock consideration.

In addition, BP has managed to replenish its reserves continuously over the past two decades. This is an important metric for oil companies, because it shows that they can replace the oil and gas extracted from developed fields through exploring for or acquiring fields that hold an equivalent amount or more of these precious carbons it sells worldwide.

Just like all other integrated energy companies, BP could suffer if oil and gas prices fall and stay low. However, I think that in the long-term, energy demand is only going higher from here. For example oil has so many uses outside of energy, that even if the whole world was running on solar and wind, there would still be a massive need for oil and gas. Even if the whole world used renewable energy to power the economy, realistically this is at least a couple decades away from it becoming mainstream. In the meantime, you can use the sizable dividend from BP as a sort of “rebate” to lower your cost basis in the stock.

Overall, I don't think I can go too wrong on a company like BP, which is cheap but has room to grow over time, offers a good dividend and buys back its cheap stock.

I would hate to turn this site into a stock picking service, but if there is interest, I would keep posting recent investments. As was the cash with my Roth IRA investments, I am going to post those in a couple weeks. I do post the tickers on Twitter, the day I make the transactions in that portfolio.

Please remember that I am making investments in my own accounts with my own money, based on information, estimates and biases (or experience) I have. These are not investment recommendations for you, but merely examples of the end result behind my investment philosophy and strategy in action. Do your own research before putting your money to work.

Full Disclosure: Long O, BP, RDS.B

Relevant Articles:

Ten Dividend Paying Stocks I purchased in September.
Realty Income (O) – The Monthly Dividend Company
Is BP’s dividend safe?
Royal Dutch Shell – An Undiscovered Dividend Gem
Three Dividend Stocks to Capitalize on BP’s weakness

9 comments:

  1. Hi DGI,

    I’ve been following your blog for quite a while and I really appreciate all the hard work you put into your stock analyses. I think yours is one of the best blogs out there and I take all of your recommendations to heart. That being said, I like that you’re expanding in to options strategies, but I’m curious why you would sell a LEAP when you could get a better return with less market exposure by selling shorter term puts at lower strike prices for better entry points? For example, you could sell the November 1st $40.00 put for $55.00. With 30 days until expiration, you’re risking $4,000 to make $55.00, which comes out to an annualized yield of 16.72% ($55 / 30 days x 365 / $4000 x 100). If exercised, you get into the stock at $40.00 instead of $42.00 which represents a $200 savings to your LEAPS strategy. Moreover, with the LEAPS strategy, you’re exposed to the market for 472 days and your annualized yield is only 9.57%. ($520 / 472 days x 365 / $4200 x 100). By repeating the process with short term options at strike prices slightly lower than the stock’s current price, you could make the same amount of money in approximately 9-10 months as you could by selling LEAP options with expiration dates 15 months out. Sure, there may be tax advantages over selling LEAPS over short term options, but I think the potential lower entry points and shorter term market risk might outweigh that advantage if you’re looking to stay in the stock for the long term if you happen to get exercised. I would love to hear your thoughts on this as I'm primarily utilizing a short term put selling strategy to get better entry points into the Dividend Aristocrats and Dividend Champions that I want to own for the long term.

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  2. DGI, I also added some BP to my taxable account not so long ago. While the company is still mired in legal issues, the compelling valuation discount and likely dividend growth potential makes this a very attractive play,for the reasons you outlined. I also see non renewable energy prices heading higher in the long term from here.

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  3. DGI,

    Been following you for a year, and I too really appreciate your though research. I suspect we're all to savey to allow this to become our "stock picking service." But I think sharing your purchases and sells can both alert us to options we'd missed, and awaken us to problems we may be missing. So I for one encourage you to continue to share your actions and the reasons that inform them.

    thanks,

    Ronn

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  4. Hi Paul,

    Thank you for reading the site. I am experimenting in ways to generate "float" by selling long-dated puts on stocks I want to purchase, and collecting the premium if options are not exercised.

    I don't think you can compare the results of selling a Jan 2015 put once with selling a near term put multiple times through Jan 2015 (14 -or 15 times per your example). This is because you don't know if you would be able to collect premium for 15 months by selling near term puts, as you don't know how often it would get exercised.

    You are also not taking into consideration the effect of commissions on your transactions. Assuming you keep selling a put once/month, and it never go exercised, you would end up paying $75 ( 15 transactions times 5 dollars/trade). With my example, I am paying just one commissions.

    You are not taking into consideration the float I am generating - this is $500 I can invest in something ( and I did use it as a downpayment on my actual BP purchase). Given the 5% yield at the moment, I can reasonably expect to earn about $30 or so in dividends on that amount.

    Last but not least, you are not taking into consideration the fact that if BP trades below $42 in January 2015, I would be able to purchase the stock essentially at prices below $37. This is 42 strike prices minus $5, equals a $37 effective cost. This was specifically mentioned in the article.


    Integrator,

    You hit the nail on the head! I think that the stock is priced for failure. In reality, BP will likely outlive every one of us. (even if we are still here 50 years from now). That is a lot of dividend checks to collect, and yes, they will amount to much more than the purchase price today.

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  5. Hi DGI,
    I would also like to see your process in selecting and purchasing a stock. Also the options strategies are helpful as I'm trying to learn similar strategies.

    You have one of the best sites and I have recommended it to a number of DGI's I know. I already own O and BP but it is good to have more confirmation of my opinion.

    Thanks for the great work.

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  6. i'm curious why your purchased O for your taxable account and have its divies taxed at your ordinary tax rate. To be honest I've also considered to buy in my taxable account but haven't yet. I mostly read that REITs are best suited in the Roth IRA (other tax deferred accounts are OK if the tax rate on your income falls in your retirement or if you can convert them into Roth gradually). Another reason why I've avoided adding to my portfolio is the potential paperwork at the tax time. Do they send a regular 1099 that it's straight forward for 1040? Schedule B is not involved at all since it's not qualified dividends, but do they point out how much of my $ is returned as a portion of my capital invested (it can happen with a REIT, right?) and not reportable to the IRS? I haven't been in the AMT situation, but if it occurred, having a REIT in a taxable account would probably become another layer of a hassle, no?
    Since I prepare my own taxes, I like simple stuff like 1009-DIV. I basically fret about the complexity of the tax return if I added O to the mix of blue chips DG stocks. Hiring a CPA would cause a high increase in my expense ratio of my DGI. Thanks for your answers in advance.

    ReplyDelete
  7. DGI,

    I agree that you shouldn't turn your blog into a stock-picking website. It is nice to see every now and then what stocks you're buying as it shows that you've got skin in the game. Also, I think seeing your entire portfolio helps newbies (like me) see what stocks are worth looking at.

    I know you ideally want 6% growth and 4% yield. As this is an average value, I would like to see an article about how you achieve this average. I'd like to see your thought process behind how you mix high growth dividends (FDO for example), with higher yield dividends.

    Does that make sense?

    -Zach

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  8. Last Anon,

    The short answer is, because I don't have a lot of funds in tax-advantaged accounts. The added paperwork is not too bad.

    The long answer is: The problem is that there are limits on how much you can put in a Roth or Sep IRA, and limits on what I can put my money in a 401 (k).

    Therefore, if I want to have an allocation to the stock in a meaningful for my portfolio way, I have to put it in a taxable account.

    REITs are a breeze at tax time when compared to MLPs. But if you have never done REITs, then probably the first time i would be a hassle. The next year, you should be fine.

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  9. I am a long time reader. I appreciate your well written articles. I vote for continuation of publishing your buys and sells and your thought process. Do not worry about being a stock picking service. I think that most of the DGI community makes its own decisions, but appreciates hearing why others are buying or selling a particular DG stock.

    ReplyDelete

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