I have decades of experience with investments, both my own, and as a financial advisor. And with all of that experience, two significant factors pushed me to develop the Dividend Hunter strategy.
First, in a world of ultra-low interest rates, there are no safe investments, such as CDs or government bonds, that will provide a reasonable return on your capital. And by “reasonable return,” I mean enough to live on while still outpacing inflation. Earning 1% to 2% won’t generate compound growth or provide an adequate retirement income.
The Fed now raising rates won’t change that. Even after the expected seven hikes this year, the Federal Funds rate will still be a measly 1.9% by 2023.
Between 1971 and 2022, the average was 5.45%.
Second, I have discovered it is much easier for individual investors to lose money in the stock market than it is for them to make it. And if you have a winning year, it’s almost impossible for individuals to repeat and produce attractive returns over time. Fear and greed are powerful forces that push investors to do the wrong thing at the precise wrong times.
This concept is the most crucial part, so I’ll repeat this. Most individual investors (people managing their own accounts and non-institutional investors) are skilled in “buying high and selling low.” Read that again. Most investors follow their emotions and end up “buying high and selling low,” losing a ton of their money along the way. The Dividend Hunter solves both of these issues.
Becoming a Dividend Hunter requires many investors and new subscribers to develop a different mindset. You may be one of them.
Here are the basic features of the Dividend Hunter income focused strategy:
- To earn dividends, you must own and hold shares of dividend-paying investments. To be a Dividend Hunter to a great extent, rules out market timing. But not completely. More on that shortly.
- The number of investment types that provide high (6% to double digits) is limited to a handful of categories. We’ll cover this in another report further into the Masterclass. It is vital to get as diversified as possible across the high-yield sectors. To a great extent, portfolio management and strategy is as or more important than individual investment selection.
- Tracking dividend income is the primary metric to determine the success of your individual strategy. Since our investment choices focus on dividend yield, it only makes sense to track results based on the income earned. This factor turns share price fluctuations into a secondary concern.
Research to Pick High-Yield Investments
When you start looking for high-yield investments, you find a bewildering array of different types of exchange-traded products, ranging from common stock shares to exotic strategy exchange-traded funds (ETFs). Out of the hundreds of available investments, how do you pick those that are safe, versus those that will slash dividends and destroy your investment principal?
You likely have heard that you should view a high yield as a warning sign of a potential dividend cut. The concept to grasp is that warning signs may or may not be valid. Our task as high yield investors are to dig out those high yield stocks where the market is wrong, and the dividend is secure.
The determination of dividend safety only comes from detailed research into how the company generates revenue and free cash flow to continue to pay dividends. I dig into the type of business, the sustainability of revenues and profits, and how much cash the business produces to pay dividends. A large and somewhat subjective part of the analysis is to determine the sustainability of the cash flows.
In the high-yield world, we do not judge dividend sustainability from the GAAP metric of earnings per share (EPS). The nature of the industries in the high-yield world results in actual free cash flow that does not show up in the restricted definition of earnings per share. As an income-focused investor, you will become familiar with the high-yield cash flow metrics of funds from operations (FFO), distributable cash flow (DCF), and cash available for distribution (CAD). Companies in the different high-yield sectors use one of these metrics to give investors a picture of the money available to pay and sustain dividends.
Lessons from the COVID Stock Market Crash
As is the case with financial crises, the early 2020 stock market crash triggered by the COVID-19 outbreak was unpredictable and looked a lot different compared to previous market crashes. The market crash in February and March 2020 was especially brutal to high-yield investments. Across the board, high-yield investments crashed harder and recovered slower compared to most other types of stock market investments. Several factors caused the underperformance (at least since the COVID hit the United States through early Fall 2020).
In hindsight, it is clear that at the start of 2020, numerous hedge funds and other private investment funds were using a high leverage strategy to boost the already high yields of REITs, MLPs, and other high yield investments. As the market started to fall, these funds were forced to dump shares at any price, pushing down share prices without regard to investment potential.
At the start of the coronavirus crisis, fear about the economy was rampant, and many companies chose to reduce or eliminate dividends to retain cash. As many companies reported 2020 second and third-quarter financial results, it became apparent that the dividend cuts were not necessary. However, because of the cautious moves early in 2020 to reduce dividends, share prices remain below pre-crash levels.
The economic shutdown severely disrupted some business sectors in the first half of 2020. Consider the plight of movie theaters, cruise ship lines, and hotels. Hotel REITs are one high-yield sector that suspended dividend payments across the board, and now in the last quarter of 2020, the prospects of restarting dividends are not on the visible horizon.
The early 2020 crash affected the full gamut of high-yield investment sectors and now provides us with a tremendous opportunity. When investing, the times to “buy low” are when the investing public is most fearful. With the slow recovery in high-yield share prices, the current market gives income-focused investors the potential to lock in historically high yields, with the potential for dividend growth. Here are a couple of late 2020 income investing themes.
Buy shares of stocks that slashed dividends in February and March, where it turns out the crisis did not materially affect business results. These companies will soon increase dividends, giving investors the double benefit of share price increases on the dividend news and a growing dividend income stream.
As noted above, the February-March crash in high-yield investments pulled down every type of income investment. The crashed sectors included very safe preferred stocks. In April 2020, I sent Dividend Hunter subscribers a list of preferred stocks to buy, locking in excellent yields, with upside potential as share prices recovered. You will read more about preferred stock investing in the “Proper Portfolio Management for the Income Investor” report.
Conclusions
Here are the major concepts to take away from this report:
A high-yield focused investment portfolio should be diversified across the handful of high-yield sectors. Different types of high yield have various risk factors, and a balanced portfolio reduces the overall effects of those risks on your portfolio and income earnings.
Selecting individual high-yield investments requires deep-dive analysis of each. You need to understand how the underlying business operates and how it generates free cash flow to pay dividends. The goal is to find investments with both a high current yield and sustainable dividend payments.
As an income-focused investor, you need to have the right mindset. The goal is to earn a large and continued income stream. Stock price thinking turns upside down. When prices go down, your first thought should be, “Can I buy more shares to grow my income stream?” Investing for income makes it easier to buy dividend-paying shares when they go “on-sale.”