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3 Best Monthly Dividend Stocks for Passive Income - YouTube
Channel: Let's Talk Money! with Joseph Hogue, CFA
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I’m revealing my three favorite monthly
dividend stocks as well as what to look for
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and the risks in dividend investing.
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By the end of this video, you’ll not only
have three stocks to start your dividend portfolio
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but how to value three special types of dividend
companies.
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We’re talking the best monthly dividend
stocks today on Let’s Talk Money.
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Joseph Hogue with the Let’s Talk Money channel
here on YouTube.
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I want to send a special shout out to everyone
in the community, thank you for taking a little
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of your time to be here today.
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If you’re not part of the community yet,
just click that little red subscribe button.
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It’s free and you’ll never miss an episode.
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Now I love dividend stocks but most only pay
out four times a year.
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That can make it difficult to plan for paying
expenses or as a passive income stream.
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That’s where monthly dividend stocks come
in, companies with a policy and a history
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of returning cash to investors every single
month.
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Even better, these stocks have a median yield
over 8% annually, that’s over four-times
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the dividend yield of the broader market.
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These are some great opportunities to create
that monthly cash flow that’s either going
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to grow your portfolio or give you that extra
cash each month to pay the bills.
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Now I am going to warn you, these monthly
payers tend to be in just a few business types.
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We see here that about 40% of monthly payers
are real estate investment trusts, another
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38% are business development companies and
then some energy companies, usually master
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limited partnerships.
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There’s a reason for this we’ll talk about
and why these cannot be your only investment
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in dividend stocks.
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Again, do not think you can put together a
portfolio of just these monthly dividend stocks
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because it’s going to put your money at
risk.
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In this video, we’ll look at how to find
these monthly dividend stocks and how to get
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started investing.
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I’ll reveal the process I use for picking
stocks along with the warning signs.
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I’m then going to highlight my three favorite
monthly dividend stocks and why I’m investing.
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So subscribers already know why I love dividend
stocks.
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Those cash returns are always positive even
when the market tanks and dividends account
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for as much as 70% the total return to stocks
in some years.
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Now you can create a nice monthly payment
from regular dividend stocks but the planning
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it takes to match those quarterly payments
means you want some monthly payers to fill
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in the gaps.
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The downside is that you don’t want all
your portfolio in these monthly payers.
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Like we saw in that graphic, putting all your
money here is going to grossly expose you
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to just a few business structures.
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These companies set up as BDCs, REITs or MLPs
get special tax breaks but have to pay out
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almost all their earnings as dividends.
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That means they tend to have volatile share
prices, they have to raise money regularly
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through debt or equity and they are highly
exposed to rising interest rates.
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These monthly payers also tend to be much
smaller companies than other stocks.
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For example, of the 28 legit monthly payers
I follow, the average size is just $723 million
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with the largest only a $20 billion company.
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That might seem like a lot but it’s miniscule
next to a trillion dollar company like Amazon
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or Apple and none of the S&P 500 companies
pay monthly dividends.
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The fact that they are smaller companies with
less financial flexibility means you need
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to stay up on all the usual warning signs
for dividend stocks.
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These include sales growth, debt leverage
and some other signs you need to watch.
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I published a video on the three warning signs
for a dividend cut a few months ago that I
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highly recommend to all dividend investors
and I’ll link to in the video description
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below.
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Another thing you have to understand investing
in these monthly dividend stocks is you have
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to understand the business and can’t value
them like other stocks.
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The real estate and energy companies take
huge amounts of depreciation that makes their
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reported earnings completely useless so you
can’t use the price-to-earnings ratio you
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use on other stocks.
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You also need to understand the management
structure in those business development companies,
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the BDCs.
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It’s either going to be external or internal
management which is going to make a big difference
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on their compensation.
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External management is usually compensated
by growth in the company’s invested assets,
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so they want to make as many investments as
possible even if they aren’t necessarily
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great investments.
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Internal management compensation is tied more
directly with investor returns.
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Being able to understand these business models
and what makes for a solid competitive advantage
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at a company means it’s usually better to
focus your individual stock investing on no
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more than a few industries or business models.
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Most investors don’t know it but this is
actually the way Wall Street works and how
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most analysts invest.
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They have deep knowledge and maybe even work
experience within a specific industry.
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Those are the stocks they analyze and invest,
then the rest of their money is in broader
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market funds.
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This is what Peter Lynch was talking about
when he said ‘Invest in what you know.’
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Most people think it’s merely a matter of
buying and liking a product but it actually
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means having deeper knowledge into how that
business runs.
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Yeah, sorry.
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Liking Campbells’ chicken noodle soup isn’t
a good reason to invest in the stock.
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So let’s look briefly at those three business
models; MLPs, BDCs and REITs including how
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to value these companies and what to watch
for.
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Then I’ll reveal my three favorite picks
from the group to get your dividend portfolio
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started.
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MLPs are a company set up to own energy assets,
usually oil or natural gas pipelines and storage
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facilities.
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MLPs get a fee from energy companies for letting
them use those pipelines and storage.
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This is one of the benefits to MLP investing
is that profits don’t necessarily depend
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on the price of oil.
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The stock price is going to bounce around
a little if the price of oil jumps or crashes
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but the company is still collecting those
fees on the volume of oil pumped through the
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pipelines.
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Compared to an oil company where sales are
directly affected by the price of oil, MLPs
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are a little safer here because of those fees.
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Since MLPs pass their income and expenses
on to investors through special reporting,
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the company doesn’t pay taxes.
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That’s a very efficient way to hold the
assets and it’s why many oil companies have
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sold off their pipelines into an MLP company.
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With MLPs you don’t get that double taxes
problem you get with regular companies where
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the company pays taxes on profits first then
investors pay taxes again on any returns.
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Another benefit to MLPs is that the cash return
you receive isn’t all taxed in the same
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year either.
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Some of those dividends count to lower your
cost in the shares so you don’t pay taxes
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on them until you sell the stock.
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And if you pass these through to your heirs
in an estate, taxes are never paid on that
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portion of the return.
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Because they pass almost all the income on
to investors, MLPs have some of the highest
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cash return of any types of stocks.
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The dividend on the Alerian MLP ETF, a fund
that holds shares of MLPs, pays an 8.4% annual
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dividend yield.
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There is one downside to MLPs I want to point
out before getting to how to value these stocks
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and my two favorite MLP picks.
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MLP investors get a K-1 form, a special tax
form each year, from the company that details
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the return.
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This means a little more work at tax time
to report the investment but any online tax
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software makes it easy to file taxes on these.
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Now on to how to value an MLP.
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Remember, you can’t use the price-to-earnings
ratio here.
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These companies have a huge amount of depreciation
that makes earnings misleading but it doesn’t
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affect actual cash flow.
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So what we’re going to do is use what’s
called price-to-distributable cash flow or
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price-to-DCF.
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Finding this value for distributable cash
flow, the amount of money the company has
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available to return to investors, is important
also because it gives us an idea of sustainability.
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A company can’t pay out more than is available
forever so it’s a good metric to make sure
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that dividend isn’t going to be cut any
time soon.
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I’ll show you how to calculate DCF yourself
but all MLPs will calculate it on their reporting.
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I do it myself only because I like to double-check
the numbers coming out of the company and
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make sure I’m comparing stocks with the
same calculation.
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Here’s the table, and again don’t get
freaked out because this is always provided
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to you in reporting.
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To find how much money the company has available
to distribute, you take the cash flow from
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operations, this is all going to be found
on the Statement of Cash Flows, and you remove
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any spending on capital and income from non-controlling
interests.
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That gives you sustainable DCF which is what
the company can return to investors and still
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keep operations running smoothly.
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While sustainable DCF is a better measure,
most people use the DCF as reported because
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it’s sometimes the only number reported.
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To get to DCF, you also add back that income
from non-controlling interests as well as
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working capital reported.
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The big one here is adding back this proceeds
from asset sales.
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This is technically proceeds the company can
return to investors, a company can’t forever
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be selling its assets and still keep business
running so that’s why we use that sustainable
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DCF if it’s available.
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With this number, you can find that valuation
with the price-to-DCF or you can find how
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much the company is returning to investors
for what’s called the distribution coverage
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ratio.
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This is how much DCF the company earns versus
how much it pays out.
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This last measure is important because an
MLP that pays out more than it’s Distributable
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Cash Flow can’t do so forever.
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You see here the coverage ratio for a group
of MLPs and that the average is around a DCF
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that’s 1.2 times the distribution.
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This means the company has cash flow about
20% higher than what it’s returning but
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you also see some companies here that save
back more or much less.
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For real estate investment trusts or REITs,
REITs are special companies set up to manage
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commercial real estate and pay out the cash
flow to investors.
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REITs can specialize in a property type so
apartments, office, retail, warehouse and
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self-storage or they can hold a mix of properties.
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Most REITs hold properties across the country
so it’s a great way to diversify your portfolio
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of individual properties, getting exposure
to other regions and property types.
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REITs pay no corporate taxes as long as they
pay out at least 90% of income to investors
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so like MLPs this makes for a great way to
manage property, avoid that double taxation
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and means huge cash dividends for investors.
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There are primarily two types of REITs, an
equity REIT which actually owns the properties
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and a mortgage REIT which invests in real
estate loans.
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Now these mortgage REITs pay higher dividends
but they tend to be more volatile, especially
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when interest rates are rising.
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I’ve invested in mortgage REITs but prefer
equity REITs as a better long-term investment.
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Just like with MLPs, you can’t rely on reported
earnings for a REIT because of that high amount
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of depreciation they get from real estate.
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Instead, we use a measure called Funds from
Operations or FFO.
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FFO is very similar to that DCF we saw with
MLPs.
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You take the reported net income of the REIT
and add back depreciation but minus out any
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gains they made on property sales.
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Those property sales are a source of income
but not something the REIT can do forever
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and expect to stay in business.
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Investors also look at the adjusted funds
from operations this AFFO, which takes out
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capital expenditures.
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Capex here is money the company spends to
keep its properties in good shape so maintenance
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spending.
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Remember, the idea is to find how much cash
the company has available to distribute without
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cutting into money it needs to run the business.
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Finally, Business Development Companies are
special financing companies that fill the
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gap for loans and small business.
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These companies set up a closed end investment
fund to make debt and equity financing to
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small and medium-sized companies.
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After the financial crisis, regulation like
Dodd-Frank and Basel III made it harder for
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traditional banks to make loans to small business.
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Banks had to keep only higher-quality assets
on their balance sheet which meant they couldn’t
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make these riskier loans.
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So BDCs stepped up to fill that gap and provide
huge dividend yields in the process.
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The most important thing to consider when
looking at BDCs is the management structure.
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Most of these are externally managed which
means management doesn’t actually work directly
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for the company.
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Compensation for these is usually based on
a base fee plus performance of the net asset
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value.
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This means a higher cost structure and management
rewards that aren’t necessarily aligned
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with shareholder returns.
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Besides the higher cost, external management
isn’t required to disclose its compensation
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which can mean conflicts of interest.
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These managers have to reach for riskier loans
and investments to justify their higher costs
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so that can mean a lot more risk for investors.
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This is why I generally only invest in BDCs
with internal management so I can see exactly
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what management is earning and how it’s
compensated.
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Looking at BDCs, you want to look at the portfolio
yield in the financial statements.
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This is the average rate earned by the company
on its different loans and there’s two things
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you want to look at here.
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First, it’s a good sign when a company’s
portfolio yield is at or below industry averages.
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That might seem counterintuitive looking for
a lower-than-average yield but that lower
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yield usually means less risk in the loans
and a more conservative management.
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You also want to check the portfolio yield
against the dividend yield on the stock.
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A portfolio yield above the dividend means
management can easily support that payout
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and your dividend isn’t in danger of being
cut.
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Besides that portfolio yield, with BDCs, you
also want to look at the company’s net asset
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value or NAV.
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BDCs issue new shares frequently to raise
money for growth so even if the NAV is growing,
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you want to make sure the NAV-per-share is
growing.
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That means you’re not getting diluted by
new shares being issued.
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NAV-per-share might not grow much faster than
low- or mid-single digits a year but just
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consistent positive growth is what you’re
looking for.
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So I know this has been a lot to look at but
these are very different types of companies
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with their own advantages and risks.
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I’m going to reveal my favorite monthly
dividend stocks next but I want you to be
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ready to look at these stocks yourself and
understand exactly what you’re getting into.
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Our first monthly stock is Gladstone Commercial,
ticker GOOD, a diversified real estate investment
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trusts with industrial and office property
across the U.S.
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Gladstone operates in the net leased market
for its properties meaning the tenant pays
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almost all the costs.
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This means rates are lower but also much lower
risk and operating costs for the company.
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Occupancy on 99 properties in 24 states is
97.9% which is excellent for a real estate
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portfolio.
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The fact that it is almost 100% leased speaks
to the quality of property and management.
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Average lease term remaining on the properties
is 7.5 years with average term on mortgage
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debt of 6.5 years.
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Gladstone pays out an 8% annual dividend on
a monthly basis and has returned 9.2% a year
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over the last five years.
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The company has produced a fairly consistent
funds from operations of $1.54 per share which
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is just slightly over the annual dividend
paid.
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Our next dividend stock is Sabine Royalty
Trust, ticker SBR, an energy trust established
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in 1982 on landowner’s royalties and other
energy assets.
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The company has an oil and gas portfolio that
covers over two million acres in Florida,
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Louisiana, Mississippi, New Mexico, Oklahoma
and Texas.
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Reserves on the assets are estimated to produce
for at least another eight to ten years and
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the parent company regularly explores for
new assets.
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The trust grew distributable income by more
than 28% to $2.32 per share in the first nine
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months of 2018 versus the same period in the
previous year.
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It pays out nearly all that in the distribution,
so I’d like to see a little more leeway,
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but that’s an amazing increase and shares
pay a solid 8.4% dividend.
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Our third dividend stock is Main Street Capital,
ticker MAIN, a business development company
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specializing in long-term debt and equity
investments.
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Main Street reports one of the lowest management
fees as a percentage of its portfolio in the
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industry and is internally managed.
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The company is one of the few legacy BDC companies
from before the financial crisis.
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I like that because it means management understands
the loan cycle and how a recession is going
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to affect the business.
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Main Street’s portfolio yield is around
11% which is under the industry average of
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14% and well above the dividend.
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The shares pay a marginally lower dividend
yield at 6.2% but with price appreciation
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have produced a 10.3% annualized return over
the last five years.
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I’d love to hear about your favorite monthly
dividend stocks and what you look for in dividends.
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Be sure to scroll down and tell us in the
comments, how do you invest in dividends.
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We’re here Mondays, Wednesdays and Fridays
with the best videos on beating debt, making
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more money and making your money work for
you.
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If you’ve got a question about money, just
subscribe to the channel and ask it in the
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comments and we’ll answer it in a video.
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