In our last Dividend Edition, I introduced the chart below, which I’m calling the Income Portfolio Pyramid.
It works more or less like the food pyramid: near the bottom are the safer, lower-risk asset types that should make up the steady, dividend-paying foundation of your portfolio; as you move up the pyramid the yields get higher but so does the risk.
One reader responded to the pyramid with this question:
“What are the percentages in each stage of the income portfolio pyramid? I think very close to what I have! Thanks, Jim”
I told Jim that the percentage of your portfolio in each pyramid stage should depend mostly on your risk tolerance. If you’re already retired and living off your investment income, you’ll want most of your principal to be safe in blue-chip stocks, utilities, telecoms and other low-risk, low-volatility investments like those on the bottom two levels of the pyramid.
If you’re still earning, have other income or savings, or are comfortable taking greater risk with your nest egg, you can shift more of your portfolio into the higher levels of the pyramid to boost your income. That’s what Jim is doing, he told me. In a second email message, he wrote, “Since I’ve maintained a 6% yield in my portfolio for 25 years with Schwab, my pyramid seems upside down.”
That’s okay. Active investors with high risk tolerance might be able to get even higher than 6% yields from their portfolios by concentrating on high-yielding stocks, MLPs, REITs and funds. If you think your pyramid is upside down, just be aware of the risk you’re taking on.
For the second part of today’s Dividend Edition, I took a look through the latest Dividend Digest issue for an investment that fit each level of the Income Portfolio Pyramid. Here’s what I found.
Level One: Blue Chip Dividend-Paying Stocks and Dividend Aristocrats
Archer Daniels Midland Co. (ADM)—While this stock is in the “Speculative Growth” category according to Morningstar, I think it’s appropriate for the bottom level of the Income Portfolio Pyramid because the company has paid a dividend every quarter for 81 years, and has a strong history of dividend increases. In fact, the company is on S&P’s list of “dividend aristocrats.” So while the stock price may display some volatility, the dividends should keep rolling in like clockwork. Archer Daniels just increased their dividend again last month, to $0.76 annually, from $0.70, for a current yield of about 2.3%.
ADM was recommended in the latest Dividend Digest by Patrick McKeough, editor of Wall Street Stock Forecaster. He wrote in part:
“Archer Daniels Midland processes corn, wheat, soybeans, canola, flax seed, peanuts, cocoa and other crops into a variety of food ingredients, such as flour, oils and sweeteners. It is also the largest maker of ethanol from corn in the U.S. In its fiscal 2013 first quarter, which ended September 30, 2012, the company earned $182 million, or $0.28 a share. That’s down 60.4% from $460 million, or $0.68 a share, a year earlier. Lower profits from its ethanol business offset higher earnings from its oilseeds operations. Revenue fell 0.4%, to $21.8 billion from $21.9 billion. The latest earnings included a $146-million write-down of its investment in a Mexican maker of corn flour and tortillas. Without this charge and other unusual items, the company would have earned $0.50 a share in the latest quarter, down 13.8% from $0.58 a year earlier. ... Rising prices for corn and other grains will increase Archer Daniels’ costs. That’s why the stock trades at just 12.0 times its projected 2013 earnings of $2.42 a share. However, Archer Daniels should keep profiting from rising demand for more and better foods. It also has a long history of annual dividend increases. Archer Daniels Midland is a buy.”—Patrick McKeough, editor of Wall Street Stock Forecaster, February 2013
Level Two: Financials, Telecoms, Energy Stocks, Turnarounds, Undervalued Stocks and Other High Dividend Payers
This level is a flexible place for stocks that pay high dividends and have just a little more risk than the blue chips and dividend aristocrats on level one. We had a bunch of ideas from this level in the latest Dividend Digest, but one I like is AbbVie, Inc. (ABBV).
AbbVie was spun off of Abbott Laboratories, which is a dividend aristocrat, just a few months ago. Abbott kept the medical device, generic drug, nutrition and diagnostics parts of the business, while AbbVie got the proprietary pharmaceutical assets and operations, including blockbuster rheumatoid arthritis drug Humira. Humira is likely to face generic competition within a few years, so investors and analysts are somewhat anxious about how AbbVie will replace the billions of dollars it generates every year.
DRIP Investor Editor Charles Carlson addressed this risk in his recent Dividend Digest recommendation of AbbVie, writing:
“Humira accounts for nearly 50% of AbbVie’s sales, so the firm has a lot riding on the drug in the near term. The patent on Humira expires in 2016. That is the major risk in the stock—that the firm’s pipeline of new drugs will not be enough to offset the decline in Humira sales once it goes off patent. The firm is planning 15 major regulatory submissions in the next five years, including four more indications for Humira. Overall, about 30% of the pipeline is biologics.
“Wall Street is looking for per-share profits of $3.06 in 2013. Based on the estimate, the stock trades for 12 times earnings, a fairly moderate multiple but one reflecting some of the risks inherent in the stock. One development that will certainly get investors’ attention is the company’s recent dividend announcement. The firm plans to pay a quarterly dividend of $0.40 per share, with the first dividend to be paid February 15. Based on that quarterly dividend, the yield is a healthy 4.5%. I expect that yield to draw plenty of attention from yield-hungry investors and keep AbbVie competitive with other high-yielding plays in the pharmaceutical sector.
“The stock has behaved fairly well since it began trading. I was a fan of the ‘old’ Abbott Laboratories, and I believe AbbVie has some interesting potential. The company’s prospects are not likely to be as stable as the ‘new’ Abbott. Still, AbbVie has merit as a yield play with upside potential.”—Charles B. Carlson, CFA, DRIP Investor, February 2013
Level Three: MLPs, BDCs, and REITs
I had several options to choose from in from this category too, but my favorite right now is Navios Maritime Holdings (NM), a master limited partnership (MLP) that currently yields about 5.8%. Here’s part of the recommendation, from The Wealth Advisory, edited by Brian Hicks:
“Navios Maritime Holdings is a dry bulk shipper. It owns 31 ships and charters another 26. Navios’ average vessel operating cost is $4,300 a day. The industry average is $6,400. Clearly, Navios benefits greatly from its modern fleet that averages five years of age, versus the industry average of 11. In 2012, Navios generated $262 million in charter revenue, for a gross profit of $30 million.
“However, charters aren’t Navios’ only source of revenue. Navios owns a 25% stake in Navios Maritime Partners (NMM). Navios gets around $28 million a year from this holding. Navios also owns 54% of Navios Maritime Acquisition Corp. (NNA), which is worth around $5 million a year. Together, these two pay Navios Holdings $33 million a year—which more than covers the current dividend payment. So, even if 2013 is another bad one for the shipping industry, we are confident Navios will continue to pay its dividend. ... But is there reason to be bullish on the Navios Maritime Holdings share price?
“Yes, there is reason to be bullish on the Navios Maritime Holdings share price! Navios Maritime Holdings is a dry bulk carrier, as stated before. And considering the fact that overcapacity is worse for the oil tanker segment of the industry, we expect dry bulk shipping rates to be the first to recover. In fact, that recovery may have already started. There’s evidence that suggests iron ore shipments to China are improving. Prices are certainly up. Coal shipments are steady. And we might expect some upside for copper.
“In essence, Navios is a hedged play on an improving global economy. Its stake in Navios Maritime Partners gives it added exposure to dry bulk shipping prices. Its stake in Navios Acquisitions gives it exposure to crude tanker prices, which will be slower to rebound than dry bulk. And finally, its cash position protects it from further weakness in pricing. ... There is pretty good support at $3.50. So let’s set our entry target at $3.50. Buy NM at $3.50. Our one-year price target is $5.”—Brian Hicks, The Wealth Advisory, 1/18/13
Level Four: High-Yielders
This category, as I mentioned when I introduced the pyramid, is comparable to the “oils, sweets and fats” category in the traditional food pyramid. These high-yielding assets are the sprinkle of dressing you add to your salad, or your dessert after a nutritious meal. We had a great idea from the category in the latest Dividend Digest: a real estate investment trust (REIT) currently yielding a whopping 17%. Here’s part of the recommendation, from Andrew Snyder, editor of Unconventional Wealth:
“Two Harbors Investment Corp. (TWO) is a mortgage REIT (or mREIT, as it is sometimes known). It buys, owns and manages both agency-backed (guaranteed by Fannie and Freddie) and non-agency-backed residential mortgages. It then generates revenues for shareholders primarily by the interest it earns on the mortgage loans. Two Harbors has a total portfolio of residential mortgage-backed securities of over $15 billion—84% of which are agency-backed mortgage bonds and the remaining 16% are non-agency-backed (privately issued) mortgage bonds. And it’s been a great strategy. From October 2009 though November 2012, TWO’s total shareholder returns have been 77%. And as of October 2012, its year-to-date returns were 32%. At writing, this stock trades at $10.95 and pays a quarterly dividend of $0.55—giving it a dividend yield of 20%.”—Andrew Snyder, Unconventional Wealth, February 2013
TWO’s 17% yield could certainly give your portfolio’s overall yield a nice boost, but the REIT’s business model opens it up to a lot of risk factors, including interest rate risk, default risk and its own high leverage. That’s why it’s on level four of the Pyramid.
As always, if you want more income investing ideas like the ones above, I encourage you to try a subscription the Dividend Digest, which provides 25 great ideas like the ones above every month.
Wishing you success in your investing and beyond,
Chloe Lutts
Editor of Investment of the Week
