If you are an income-focused investor, and you appreciate the price appreciation potential of a good contrarian opportunity, then you may want to consider some of the ideas highlighted in this article. Specifically, we provide an overview (and data) on “Dogs of the Dow,” “Dividend Aristocrats," retail REITs, healthcare REITs, MLPs, closed end funds, and options strategies, including ten of our favorite high-yield, contrarian, blue chip opportunities right now.
Dogs of the Dow
The Dogs of the Dow strategy is a contrarian, income-focused, method for identifying attractive blue chip opportunities. Specifically, the strategy advocates investing annually in the ten members of the bellwether Dow Jones Industrials Average with the highest dividend yield (these are the dogs). The argument is that blue chip companies don’t alter their dividends based on market conditions therefore the ones with the highest yield represent companies at a lower point in their market cycle and are therefore the best value opportunities. For your reference, the following table ranks the 30 Dow Jones stocks by dividend yield (the ten highest are the “dogs”), and it also includes a variety of other financial metrics for your consideration.
10. Verizon Communications (VZ), Yield: 5.1%
Of the current Dogs of the Dow, Verizon is attractive, in our view. It is not surprising that Verizon’s current dividend yield is so high considering it has faced a variety of challenges recently ranging from the troubled Yahoo acquisition to investors’ preference for growth stocks (not dividend stocks) following the Trump election. In our view, the biggest challenge for Verizon going forward will be adapting to a changing technological landscape. Specifically, as investors cut off their land lines, Verizon must invest heavily to maintain its wireless network while simultaneously finding new growth opportunities to continue supporting its big dividend.
Verizon is not the same company it used to be as it continues to take on new risks to keep up with the times. However, assuming Verizon can adapt, it should be able to support the dividend and achieve some growth and price appreciation. As the table (above) shows, analysts have high growth expectations for the company over the next five years. We believe Verizon will likely be a little more volatile in the future than it was in the past, but we suspect its dividend is very safe, and its returns will be nice too.
For your reference, we’ve written about Verizon a couple times already this year, and you can read those articles here:
Master Limited Partnerships (“MLPs”)
MLPs currently offer a variety of attractive, contrarian, blue-chip opportunities for income-focused investors. If you are not aware, MLPs are publicly-traded limited partnerships that must generate at least 90% of their income from qualifying sources of depletable natural resources and minerals. And considering the challenging market conditions in recent years for many natural resource commodities (e.g. lower oil prices, lower natural gas prices) many MLPs are still on sale. For your reference, the following table includes a variety of data on publicly traded MLPs, including distribution yields, recent price performance, and current market capitalization, to name a few.
9. Enterprise Products Partners (EPD), Yield: 6.1%
If you are looking for big stable growing income, Enterprise Products Partners (EPD) is worth considering. This midstream energy services provider (and MLP) offers an attractive 6.1% distribution yield, and the shares are on sale, in our view. Considering the company’s large and strategic footprint, stable fee-based income, vertical integration, and growth (both in assets and distributions), we believe the distribution is safe, and will continue to grow. The price is attractive too. You can read our full write-up on EPD here:
Enterprise Products Partners: Big (6.1%) Stable Growing Income.
To be included in the S&P High-Yield Dividend Aristocrat index, a company must have increased its dividend payout every year for at least 20 years in a row (it must also be included in the S&P 1500). Income-focused investors are often attracted to Dividend Aristocrats because of the perceived safety of the growing income payments. We believe many of the Dividend Aristocrats currently offer attractive contrarian opportunities. For example, the following table includes a list of Dividend Aristocrats along with a variety of additional metrics.
8. International Business Machines (IBM): Yield: 3.9%
IBM is a Dividend Aristocrat that is currently hated by many, and it has been for a long-time. Despite the company’s strategic growth initiatives, IBM’s legacy business continues to decline, and its total revenues are declining too. And as the following chart shows, IBM’s stock price has declined more than 20% over the last five years while the S&P500 has experience significant gains. Yet, despite the declining stock price, IBM has continued to increase its dividend, and the dividend yield currently sits at a very attractive 3.95%.
One of the biggest negative narratives about IBM is that it is a financially engineered dinosaur that will die a long slow painful death. And while legacy business is shrinking, let’s not forget its enormous $120 billion backlog of service revenue will not go away overnight, and in the meantime the company is also enormously profitable (+$11.9 billion net income in 2016). Plus, the legacy business gives IBM unique insights into customer environments and needs. And even though IBM hasn’t pursued the same aggressive cloud strategy as many other large companies in the space, IBM does have growth potential via its analytics and big data business built on top of applications like Watson. Further, considering IBM’s large consulting business and extensive existing relationships, we believe profits will grow, and the recent price decline this year provides a more attractive entry point for contrarian income-focused investors. We wrote about IBM the last time we thought the shares had gotten too cheap (read: Stop Hating IBM, It’s Enormously Profitable), and we believe it’s starting to get a little too cheap again.
Many healthcare REITs offer big steady dividend yields, and they’ve also underperformed the broader market lately for a variety of reasons such as investor fear related to rising interest rates and potential changes to the Affordable Care Act. For your consideration, the following table shows the performance (and a variety of other metrics) for big-dividend healthcare REITs.
7. Welltower (HCN), Yield: 4.7%
Welltower is one of the more blue-chip opportunities in the healthcare REIT space, and its price has recently declined, and its valuation has become significantly more attractive. Besides being the largest healthcare REIT, it pays a big, growing dividend. It's also well diversified across senior housing (triple-net and operating), outpatient medical, and long-term post-acute. The "post-acute" is somewhat risky considering other healthcare REITs (such as HCP (NYSE:HCP) and Ventas (NYSE:VTR)) have been shedding "skilled nursing" exposure because they don't want to deal with the regulatory reimbursement risks. However, we like that Welltower has some exposure to the upside in that segment.
In recent months, Welltower’s business has remained strong, and its price to FFO ratio has dropped to a compelling 15.2x. We also like that Welltower rents properties under group leases rather than separate per property leases, because this makes it harder for tenants to drop underperforming properties. Also, we’d be remiss not to point out the strong demographics on Welltower’s side (i.e. the aging US population, and the growing needs for healthcare). If you’re looking for a compelling blue chip healthcare REIT with a big dividend yield that has also underperformed the rest of the market (as measured by the S&P 500) over the last year (but is recently perking up and showing signs of life) we believe Welltower is worth considering.
Business Development Companies (“BDCs”)
Business Development Companies are yet another category of investment that often interests income-focused contrarian investors because they offer high yields and can trade at discounted prices. If you don’t know, BDCs were formed by congress in 1980 to invest in (and help grow) small and mid-sized businesses. And they pay little or no corporate income tax as long as they meet certain distribution requirements (i.e. most BDCs avoid corporate income tax by distributing at least 98% of taxable income). And it is this distribution requirement that helps keep the yields so high.
Before investing in BDCs, it’s important for investors to consider the unique market cycle risks as we have highlighted in this recent article: 3 Overcrowded High-Yield BDCs: Prospect, Main Street and Fidus. However, despite changing market cycle conditions, many BDCs continue to offer healthy dividend yields and attractive valuations.
Ares Capital Corp (ARCC), Yield: 9.2%
Ares Capital is a big dividend BDC that has experienced a significant sell-off this month as shown in the following chart.
In particular, the shares were down after a sluggish first quarter earnings release (in this case it isn’t all about the macro, it’s company-specific too). Specifically, core earnings were only $0.32 per share versus $0.37 a year ago, and estimates of $0.38. CEO Kipp deVeer attribute the declines to a competitive market environment. In our view, the BDC industry as a whole faces challenges such as high valuations, less opportunities, and more competition (for more information, please see our recent article: 3 Overcrowded High-Yield BDCs: Prospect, Main Street And Fidus. However, ARCC is a large BDC with deep relationships to source deals, and we like that the recent price decline brings its shares back closer to par with its book value. You can read our earlier report on ARCC here: Ares Capital: Big Dividend, 3 Big Risks.
There’s a false narrative going around that the Internet is going to put all “brick and mortar” stores out of business. And while this may be true for some stores, it’s certainly not true for all of them. For your consideration, the following table includes a variety of data (including the big dividend yields and recent price performance) for a variety of Retail REITs.
6. Realty Income (O), Yield: 4.7%
For example, we believe big-dividend (4.2% yield) Realty Income (O) isn’t going out of business anytime soon. In fact, O is growing, its shares have inappropriately sold off, and it currently presents a very attractive buying opportunity for income-focused investors that would like to see some capital appreciation too.
Realty Income is an income-investor favorite because it pays big safe monthly dividends. And as the following chart shows, its price came down significantly last week.
Additionally, the dividend payment has increased for 77 consecutive quarters. We believe O is worth considering now because its business remains strong but its valuation has also come down. Specifically, the following chart shows that Realty Income's price versus its Funds from Operations (“FFO”) has come down significantly since last summer (i.e. the shares are on sale).
Plus, Realty Income only expects to pay out ~ 83% of its adjusted FFO as dividends in 2017, which is a healthy margin of safety for this low beta company. If you are a long-term, income-focused, value investor, Realty Income is worth considering, especially after this week’s decline.
The Top 5:
The top 5 "Attractive High-Yield Blue Chips for Contrarians" are reserved for members-only. We believe the investment ideas presented thus far are worth considering, but the top 5 are extremely attractive for income-focused value investors. In fact, we own all five of the top five. If you are not currently a member, consider joining today.