I’m revealing my three favorite monthly dividend stocks as well as what to look for and the risks in dividend investing.
By the end of this video, you’ll not only have three stocks to start your dividend portfolio but how to value three special types of dividend companies.
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Why I Love Monthly Dividend Stocks
Now I love dividend stocks but most only pay out four times a year. That can make it difficult to plan for paying expenses or as a passive income stream.
That’s where monthly dividend stocks come in,companies with a policy and a history of returning cash to investors everysingle month. Even better, these stocks have a median yield over 8% annually,that’s over four-times the dividend yield of the broader market.
These are some great opportunities to createthat monthly cash flow that’s either going to grow your portfolio or give youthat extra cash each month to pay the bills.
Now I am going to warn you, these monthlypayers tend to be in just a few business types. We see here that about 40% ofmonthly payers are real estate investment trusts, another 38% are businessdevelopment companies and then some energy companies, usually master limitedpartnerships.
There’s a reason for this we’ll talk about andwhy these cannot be your only investment in dividend stocks. Again, do notthink you can put together a portfolio of just these monthly dividend stocksbecause it’s going to put your money at risk.
In this video, we’ll look at how to find thesemonthly dividend stocks and how to get started investing. I’ll reveal theprocess I use for picking stocks along with the warning signs. I’m then goingto highlight my three favorite monthly dividend stocks and why I’m investing.
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How to Invest in Monthly Dividend Stocks
So subscribers already know why I lovedividend stocks. Those cash returns are always positive even when the markettanks and dividends account for as much as 70% the total return to stocks insome years.
Now you can create a nice monthly payment fromregular dividend stocks but the planning it takes to match those quarterlypayments means you want some monthly payers to fill in the gaps.
The downside is that you don’t want all your portfolio in these monthly payers. Like we saw in that graphic, putting all your money here is going to grossly expose you to just a few business structures.
These companies set up as BDCs, REITs or MLPs get special tax breaks but have to pay out almost all their earnings as dividends. That means they tend to have volatile share prices, they have to raise money regularly through debt or equity and they are highly exposed to rising interest rates.
These monthly payers also tend to be much smaller companies than other stocks.
For example, of the 28 legit monthly payers I follow, the average size is just $723 million with the largest only a $20 billion company. That might seem like a lot but it’s miniscule next to a trillion dollar company like Amazon or Apple and none of the S&P 500 companies pay monthly dividends.
The fact that they are smaller companies with less financial flexibility means you need to stay up on all the usual warning signs for dividend stocks. These include sales growth, debt leverage and some other signs you need to watch.
I published a video on the three warning signs for a dividend cut a few months ago that I highly recommend to all dividend investors and you can watch here.
Another thing you have to understand investingin these monthly dividend stocks is you have to understand the business andcan’t value them like other stocks. The real estate and energy companies takehuge amounts of depreciation that makes their reported earnings completelyuseless so you can’t use the price-to-earnings ratio you use on other stocks.
You also need to understand the management structure in those business development companies, the BDCs. It’s either going to be external or internal management which is going to make a big difference on their compensation.
External management is usually compensated by growth in the company’s invested assets, so they want to make as many investments as possible even if they aren’t necessarily great investments. Internal management compensation is tied more directly with investor returns.
Being able to understand these business modelsand what makes for a solid competitive advantage at a company means it’susually better to focus your individual stock investing on no more than a fewindustries or business models.
Most investors don’t know it but this isactually the way Wall Street works and how most analysts invest. They have deepknowledge and maybe even work experience within a specific industry. Those are thestocks they analyze and invest, then the rest of their money is in broadermarket funds.
This is what Peter Lynch was talking aboutwhen he said ‘Invest in what you know.’ Most people think it’s merely a matterof buying and liking a product but it actually means having deeper knowledgeinto how that business runs.
Yeah, sorry. Liking Campbells’ chicken noodlesoup isn’t a good reason to invest in the stock.
So let’s look briefly at those three businessmodels; MLPs, BDCs and REITs including how to value these companies and what towatch for. Then I’ll reveal my three favorite picks from the group to get yourdividend portfolio started.
What are MLPs?
MLPs are a company set up to own energyassets, usually oil or natural gas pipelines and storage facilities. MLPs get afee from energy companies for letting them use those pipelines and storage.
This is one of the benefits to MLP investing is that profits don’t necessarily depend on the price of oil. The stock price is going to bounce around a little if the price of oil jumps or crashes but the company is still collecting those fees on the volume of oil pumped through the pipelines.
Compared to an oil company where sales are directly affected by the price of oil, MLPs are a little safer here because of those fees.
Since MLPs pass their income and expenses on to investors through special reporting, the company doesn’t pay taxes. That’s a very efficient way to hold the assets and it’s why many oil companies have sold off their pipelines into an MLP company.
With MLPs you don’t get that double taxes problem you get with regular companies where the company pays taxes on profits first then investors pay taxes again on any returns.
Another benefit to MLPs is that the cashreturn you receive isn’t all taxed in the same year either. Some of thosedividends count to lower your cost in the shares so you don’t pay taxes on themuntil you sell the stock. And if you pass these through to your heirs in anestate, taxes are never paid on that portion of the return.
Because they pass almost all the income on to investors, MLPs have some of the highest cash return of any types of stocks. The dividend on the Alerian MLP ETF, a fund that holds shares of MLPs, pays an 8.4% annual dividend yield.
There is one downside to MLPs I want to pointout before getting to how to value these stocks and my two favorite MLP picks.MLP investors get a K-1 form, a special tax form each year, from the companythat details the return. This means a little more work at tax time to reportthe investment but any online tax software makes it easy to file taxes onthese.
Now on to how to value an MLP. Remember, youcan’t use the price-to-earnings ratio here. These companies have a huge amountof depreciation that makes earnings misleading but it doesn’t affect actualcash flow.
So what we’re going to do is use what’s calledprice-to-distributable cash flow or price-to-DCF. Finding this value fordistributable cash flow, the amount of money the company has available toreturn to investors, is important also because it gives us an idea ofsustainability. A company can’t pay out more than is available forever so it’sa good metric to make sure that dividend isn’t going to be cut any time soon.
I’ll show you how to calculate DCF yourself butall MLPs will calculate it on their reporting. I do it myself only because Ilike to double-check the numbers coming out of the company and make sure I’mcomparing stocks with the same calculation.
Here’s the table, and again don’t get freakedout because this is always provided to you in reporting. To find how much moneythe company has available to distribute, you take the cash flow fromoperations, this is all going to be found on the Statement of Cash Flows, andyou remove any spending on capital and income from non-controlling interests.That gives you sustainable DCF which is what the company can return toinvestors and still keep operations running smoothly.
While sustainable DCF is a better measure, most people use the DCF as reported because it’s sometimes the only number reported. To get to DCF, you also add back that income from non-controlling interests as well as working capital reported.
The big one here is adding back this proceeds from asset sales. This is technically proceeds the company can return to investors, a company can’t forever be selling its assets and still keep business running so that’s why we use that sustainable DCF if it’s available.
With this number, you can find that valuationwith the price-to-DCF or you can find how much the company is returning toinvestors for what’s called the distribution coverage ratio. This is how muchDCF the company earns versus how much it pays out.
This last measure is important because an MLPthat pays out more than it’s Distributable Cash Flow can’t do so forever. Yousee here the coverage ratio for a group of MLPs and that the average is arounda DCF that’s 1.2 times the distribution. This means the company has cash flowabout 20% higher than what it’s returning but you also see some companies herethat save back more or much less.
What are REITs?
For real estate investment trusts or REITs, REITs are special companies set up to manage commercial real estate and pay out the cash flow to investors. REITs can specialize in a property type so apartments, office, retail, warehouse and self-storage or they can hold a mix of properties.
Most REITs hold properties across the country so it’s a great way to diversify your portfolio of individual properties, getting exposure to other regions and property types.
REITs pay no corporate taxes as long as theypay out at least 90% of income to investors so like MLPs this makes for a greatway to manage property, avoid that double taxation and means huge cashdividends for investors.
There are primarily two types of REITs, anequity REIT which actually owns the properties and a mortgage REIT whichinvests in real estate loans. Now these mortgage REITs pay higher dividends butthey tend to be more volatile, especially when interest rates are rising. I’veinvested in mortgage REITs but prefer equity REITs as a better long-terminvestment.
Just like with MLPs, you can’t rely onreported earnings for a REIT because of that high amount of depreciation theyget from real estate. Instead, we use a measure called Funds from Operations orFFO.
FFO is very similar to that DCF we saw withMLPs. You take the reported net income of the REIT and add back depreciationbut minus out any gains they made on property sales. Those property sales are asource of income but not something the REIT can do forever and expect to stayin business.
Investors also look at the adjusted funds fromoperations this AFFO, which takes out capital expenditures. Capex here is moneythe company spends to keep its properties in good shape so maintenancespending. Remember, the idea is to find how much cash the company has availableto distribute without cutting into money it needs to run the business.
What are BDCs?
Finally, Business Development Companies arespecial financing companies that fill the gap for loans and small business.These companies set up a closed end investment fund to make debt and equityfinancing to small and medium-sized companies.
After the financial crisis, regulation likeDodd-Frank and Basel III made it harder for traditional banks to make loans tosmall business. Banks had to keep only higher-quality assets on their balancesheet which meant they couldn’t make these riskier loans. So BDCs stepped up tofill that gap and provide huge dividend yields in the process.
The most important thing to consider whenlooking at BDCs is the management structure. Most of these are externallymanaged which means management doesn’t actually work directly for the company.Compensation for these is usually based on a base fee plus performance of thenet asset value. This means a higher cost structure and management rewards thataren’t necessarily aligned with shareholder returns.
Besides the higher cost, external managementisn’t required to disclose its compensation which can mean conflicts ofinterest. These managers have to reach for riskier loans and investments tojustify their higher costs so that can mean a lot more risk for investors. Thisis why I generally only invest in BDCs with internal management so I can seeexactly what management is earning and how it’s compensated.
Looking at BDCs, you want to look at the portfolio yield in the financial statements. This is the average rate earned by the company on its different loans and there’s two things you want to look at here. First, it’s a good sign when a company’s portfolio yield is at or below industry averages.
That might seem counterintuitive looking for a lower-than-average yield but that lower yield usually means less risk in the loans and a more conservative management. You also want to check the portfolio yield against the dividend yield on the stock. A portfolio yield above the dividend means management can easily support that payout and your dividend isn’t in danger of being cut.
Besides that portfolio yield, with BDCs, youalso want to look at the company’s net asset value or NAV. BDCs issue newshares frequently to raise money for growth so even if the NAV is growing, youwant to make sure the NAV-per-share is growing. That means you’re not gettingdiluted by new shares being issued. NAV-per-share might not grow much fasterthan low- or mid-single digits a year but just consistent positive growth iswhat you’re looking for.
The Best Monthly Dividend Stocks for 2019
So I know this has been a lot to look at butthese are very different types of companies with their own advantages andrisks. I’m going to reveal my favorite monthly dividend stocks next but I wantyou to be ready to look at these stocks yourself and understand exactly whatyou’re getting into.
Our first monthly stock is GladstoneCommercial, ticker GOOD, a diversified real estate investment trusts withindustrial and office property across the U.S.
Gladstone operates in the net leased marketfor its properties meaning the tenant pays almost all the costs. This meansrates are lower but also much lower risk and operating costs for the company.
Occupancy on 99 properties in 24 states is97.9% which is excellent for a real estate portfolio. The fact that it isalmost 100% leased speaks to the quality of property and management. Averagelease term remaining on the properties is 7.5 years with average term onmortgage debt of 6.5 years.
Gladstone pays out an 8% annual dividend on amonthly basis and has returned 9.2% a year over the last five years. Thecompany has produced a fairly consistent funds from operations of $1.54 pershare which is just slightly over the annual dividend paid.
Our next dividend stock is Sabine RoyaltyTrust, ticker SBR, an energy trust established in 1982 on landowner’s royaltiesand other energy assets.
The company has an oil and gas portfolio thatcovers over two million acres in Florida, Louisiana, Mississippi, New Mexico,Oklahoma and Texas. Reserves on the assets are estimated to produce for atleast another eight to ten years and the parent company regularly explores fornew assets.
The trust grew distributable income by morethan 28% to $2.32 per share in the first nine months of 2018 versus the sameperiod in the previous year. It pays out nearly all that in the distribution,so I’d like to see a little more leeway, but that’s an amazing increase andshares pay a solid 8.4% dividend.
Our third dividend stock is Main StreetCapital, ticker MAIN, a business development company specializing in long-termdebt and equity investments.
Main Street reports one of the lowestmanagement fees as a percentage of its portfolio in the industry and isinternally managed. The company is one of the few legacy BDC companies frombefore the financial crisis. I like that because it means managementunderstands the loan cycle and how a recession is going to affect the business.
Main Street’s portfolio yield is around 11% which is under the industry average of 14% and well above the dividend. The shares pay a marginally lower dividend yield at 6.2% but with price appreciation have produced a 10.3% annualized return over the last five years.
I’d love to hear about your favorite monthly dividend stocks and what you look for in dividends. Be sure to scroll down and tell us in the comments, how do you invest in dividends.
