Monday, November 23, 2015

Three Dividend Seeds I Planted Last Week

I view each investment I make as a seed that I plant for the long-term. Some seeds could turn into a tree that would provide fruit (dividend income) for decades to come. My goal as an investor is to ensure that I plant those seeds in a systematic way that increases the odds of success. My definition of success is the ability to live off dividends when I decide to stop working.

In the past week, I managed to add to my positions in the following three companies:

Target Corporation (TGT) operates as a general merchandise retailer in the United States. Target is a dividend champion which has raised dividends for 48 years in a row. Over the past decade, the company has raised dividends by 20.30%/year.

The stock is selling at 15.20 times expected earnings for 2015 and yields 3.20%. Check my analysis of Target at Seeking Alpha.

The most interesting thing is that I sold two-thirds of my Target position in early 2015. Now I am able to get back in at lower prices. This happens very rarely, and is more of an exception rather than the norm.

HCP, Inc. (HCP) is a hybrid real estate investment trust that invests in properties serving the healthcare industry including sectors of healthcare such as senior housing, life science, medical office, hospital and skilled nursing. The fund also invests in mezzanine loans and other debt instruments. HCP, Inc. is a dividend champion which has raised dividends for 30 years in a row. Over the past decade, the company has raised dividends by 2.70%/year. The REIT expects to generate $3.12/share in FFO in 2015. This REIT sells for 11.20 times expected FFO and yields 6.50%. Check my analysis of HCP.

Omega Healthcare Investors, Inc. (OHI) is a real estate investment trust that invests in long-term healthcare facilities in the US. Omega Healthcare Investors is a dividend achiever which has raised dividends for 13 years in a row. Over the past decade, the company has raised dividends by 10.90%/year. The REIT expects to generate $3.06/share in FFO in 2015. This REIT sells for 11 times expected FFO and yields 6.60%. Check my analysis of Omega Healthcare.

Approximately one year ago, I discussed that I was interested in building out my position in three REITS – HCP, Omega Healthcare Investors and W.P. Carey. I discussed that prices were too high, and that I expected them to gradually decrease due to interest rate fears. I also discussed how I wanted to slowly build out positions in each of those companies. I have made several purchases in the past year in each of the three REITs. So far I have been correct. I believe that further declines would provide better opportunities for investors. It is possible however that a large portion of those interest rate increases have already been incorporated into the prices of Real Estate Investment Trusts.

You might be surprised that I didn’t add to my position in WP Carey (WPC). As a result of my evaluation of the dividend growth, I am noticing that the REIT is growing distributions every quarter at a nominal amount. I view the slowing dividend growth as a negative, since the rate of increases barely covers inflation. At an annual dividend growth rate of 1.60%, even a high current yield of 6.20% is not enough. The REIT expects to generate $4.83/share in FFO in 2015. This REIT sells for 12.80 times expected FFO and yields 6.20%. Check my analysis of WP Carey.

I didn’t believe that interest rates will be raised in 2015. Based on news stories I am hearing, it looks like the Federal Reserve might increase rates in December. I won’t believe it until I see it however – the global economy is not as hot as the US one, and global central bankers are not raising rates. This provides some pressure on the US central bank policy makers. The pressure is that rising interest rates will make US cost of capital higher, and make US exports more expensive abroad if the dollar strengthens

Even if rates increase however, the raises are going to happen gradually and be spread out over time. An increase in interest rates is not an automatic sell for REITs. Increases in interest rates could also show that the economy is doing well, which means higher occupancy rates. Higher occupancy rates could soften the blow from increasing cost of interest financing. On the other hand, companies with long-term fixed interest rates on mortgages or bonds will not really feel the effect on existing borrowings until 5 – 10 years down the road. Either way, I plan to add to those REIT investments in a few months, as long as they offer compelling entry prices to me.

However, if dividend yields start exceeding 7%, I would start refraining from those investments. This is because pass-through entities like REITs grow by issuing shares and bonds in order to obtain capital to purchase real-estate. If their cost of capital is too high, then any additional real estate added might not provide the incremental benefit of increases to FFO/share and dividends growth to all shareholders. Good allocators of capital would not dilute existing owners too much to grow at a high cost especially when the market for real estate is overheated.

What have you been buying lately? Do you believe REITs to be good values today?

Thank you for reading

Full Disclosure: Long TGT, OHI, HCP, WPC

Relevant Articles:

Five Things to Look For in a Real Estate Investment Trust
Three REITs I Picked Last Week
Dividend Companies I am Considering this Month
Should Dividend Investors Worry About Rising Interest Rates?
Rising interest rates affect all businesses, not just dividend paying ones

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