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Dividend Investor
Safe Income and Dividend Growth

Cabot Dividend Investor 418

The broad market has gotten jumpy again, but it’s no reason to panic. In today’s issue, we review why dividend stocks are better in downturns, add a conservative-aggressive stock to the Safe Income tier, and have earnings updates on all our stocks (four have already reported; the rest will over the next week.)

Cabot Dividend Investor 418

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Market Down, Rates Up

After turning lower at the end of last week, the broad market sold off sharply yesterday. The selloff followed Caterpillar’s (CAT) earnings call, during which management lowered their guidance for the rest of 2018. Combined with some other factors, the news triggered fears that this quarter’s strong earnings numbers could represent the peak for the year. The market selloff briefly turned REITs and utilities into top performers again, despite rising interest rates.

On the fixed income side, the odds that the Fed will hike rates four times this year have risen to about 40%, up from less than 20% a couple of months ago. The 10-year treasury yield topped 3% for the first time since January 2014, and remains above that psychologically important level as of this writing. And the yield curve has finally gotten a little steeper, which could lift some of the pressure that’s been weighing on banks and financial stocks.

[highlight_box]What To Do Now: Our portfolio is well prepared for whatever comes next, with the exception of our position in 3M (MMM), which fell apart Monday. The stock was already one of our weakest positions, so I’m selling another third of our shares today, and hoping to unload the rest on a bounce soon. Our three other holdings that have already reported earnings beat estimates and are doing well: American Express (AXP), BB&T (BBT) and UnitedHealth (UNH).

The rest of our portfolio companies will report by next Thursday. AllianceBernstein (AB), General Motors (GM), CME Group (CME), Intel (INTC) and Xcel Energy (XEL) will announce tomorrow. STAG Industrial (STAG), Cummins (CMI), Ecolab (ECL) and new addition McGrath RentCorp (MGRC) will report this Tuesday, May 1. And then we’ll wrap up our earnings season with results from ONEOK (OKE) on May 2 and ConEd (ED) on May 3. [/highlight_box]

Featured Buy

McGrath RentCorp (MGRC)

The market environment remains uncertain—improving one week and deteriorating the next. So we’re striking a comfortable balance between defensive and offensive this week with the addition of McGrath RentCorp (MGRC), a 25-year dividend grower with strong earnings growth expectations, to the Safe Income tier.

The Company
McGrath rents four different types of equipment: modular buildings, storage containers, electronic equipment and containment tanks and boxes. The company was founded in San Leandro, California in 1979 with a small stock of pre-fab, mobile buildings for rent. Modular buildings are used in a variety of applications—as on-site sales offices, job site construction trailers, temporary classrooms, overflow government offices and more.

McGrath listed on the Nasdaq in 1984. A series of acquisitions in the ’80s and ’90s expanded the company’s geographic reach and added electronic test equipment to its rental fleet. In the 2000s, McGrath acquired New Jersey-based Adler Tank Rentals, which rents containers used for temporarily storing liquid, solid and hazardous materials. Customers include oil fields, cities, airports, construction companies and disaster cleanup crews.

Revenues have grown consistently almost every year since 1984, with temporary pullbacks during the last two recessions. While Adler’s tanks and the electronic equipment rentals tend to be fairly short-term, modular building rentals are generally longer-term and add predictability to revenues.

If you look at McGrath’s earnings yourself, you’ll notice that the tax bill had a huge impact on last year’s results. The change in tax rates—McGrath expects their tax rate to drop from 38% to 27% in 2018—triggered a re-measurement of McGrath’s deferred tax liabilities (taxes they owe but haven’t had to pay yet). The reduction in the liability increased McGrath’s fourth quarter net income by a whopping $102.5 million, dwarfing the company’s pre-tax-bill net income for the quarter of $15.2 million. It also affected fourth quarter and full-year EPS numbers.

However, it’s easy to calculate what net income and EPS were before the huge non-cash benefit from the tax re-measurement. Ignoring it, fourth quarter EPS would have been $0.62, up from $0.40 in the fourth quarter of 2016. Full-year 2017 EPS would have been $2.12, up from $1.60 last year. Both numbers still reveal very solid growth that’s more in line with the company’s historical trend.

Going forward, that trend is expected to continue. The company will report first-quarter results on May 1, after the close. Analysts expect revenues to grow 5% and EPS to rise 42%, from $0.33 to $0.47 (but McGrath has beaten estimates in each of the last four quarters). For the full year, analysts are currently forecasting 28% EPS growth—thanks in part to the lower tax rate—and 2% revenue growth. Over the next five years, EPS are expected to grow by about 14% per year, on average.

The Dividend
McGrath started paying a dividend in 1990, and has increased the dividend every year for the past 25 years. The dividend increases have been slow and steady, with the boosts averaging 7% over the past five years. However, management just handed investors a huge 31% dividend increase in February, funded in part by the company’s big tax cut. McGrath’s payout ratio is a very reasonable 50%. Altogether, McGrath earns a Dividend Safety Rating of 9.3 and a Dividend Growth Rating of 8.7.

The Stock
MGRC has been in a steady uptrend since gapping up on an earnings beat in August 2017. The stock dipped below its 50-day line in December and again during February’s correction, but has been well above its 200-day since the August breakout. MGRC spent the March market pullback consolidating recent gains, then broke out to a new all-time high on unusually high volume last week. The stock is now a bit extended short-term, but momentum is strong, so even a small pullback—say to 57.50—would be a good buying opportunity.

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McGrath RentCorp (MGRC)
Price: 59
52-week range: 32.09-60.55
Market cap: $1.43 billion
P/E: 9
Current yield: 2.5%
Annual dividend: $1.36
Most recent dividend: $0.34
Dividend Safety rating: 9.3
Dividend Growth rating: 8.7
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Dividends since: 1990
Consecutive years of increases: 25
Qualified dividends? Yes
Payment Schedule:
Quarterly
Next ex-dividend date:
July 13, 2018 est.

Portfolio at a Glance

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Closing Prices on April 24, 2018

Portfolio Updates

High Yield Tier

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The investments in our High Yield tier have been chosen for their high current payouts. These ?investments will often be riskier or have less capital appreciation potential than those in our other ?two tiers, but they’re appropriate for investors who want to generate maximum income from their? portfolios right now.

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BUY – AllianceBernstein (AB 27 – yield 8.7%) – AB pulled back below its 50-day moving average last week but held up well during yesterday’s selloff, closing higher. The stock remains between overhead resistance around 27.5 and support at the 200-day moving average, currently around 25. AllianceBernstein will report first quarter earnings tomorrow, April 26; analysts expect revenues of $820 million and EPS of $0.68, up 7.2% and 47.8% year-over-year. Support looks solid and risk-tolerant investors can buy a little for high yield. Remember that AB’s distributions vary based on cash flow and don’t qualify for the lower dividend tax rate, and the partnership issues a K-1 at tax time.

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HOLD – General Motors (GM 38 – yield 4.0%) – GM will also report first quarter results tomorrow. Sales and earnings are both expected to be lower than in the same quarter last year, when GM hit a sales record. Sales are expected to fall 16% this quarter, to $34.6 billion, while EPS are expected to decline 27%, from $1.75 to $1.28. Unlike many companies reporting strong results this quarter, GM expects earnings to improve over the course of the year. Next quarter sales are expected to fall only 1%, and EPS are expected to rise 1.6%. And GM has beaten earnings estimates by double digits in each of the last four quarters, so results may be stronger than anticipated. However, GM’s technical action is still negative. After another selloff Thursday, the stock is now below both its 50-day and 200-day moving averages (although it held up well to yesterday’s selloff). We’ve already sold two-thirds of our position at higher prices, but if you still have a lot of exposure to GM, you might want to take some off the table now—even if that means taking a loss.

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HOLD – ONEOK (OKE 59 – yield 5.4%) – ONEOK just increased its dividend by 3%, to $0.795 per quarter. Investors who own the stock by tomorrow will receive the next dividend. OKE remains close to its highest level since early February, thanks to a rally in energy stocks. The company will report first quarter results May 2, and expectations are high. Analysts are expecting a 42.7% sales increase, to $3.92 billion, fueling 48.8% net income growth, to $0.61 per share. ONEOK owns 38,000 miles of natural gas and natural gas liquids (NGL) pipelines, as well as natural gas and NGL storage, processing and fractionation facilities (fractionation is the breaking down of NGLs into component liquids like ethane and propane.) The stock has been range-bound since the start of 2017, but yields a well-covered 5.3% and has increased its dividend every year since 2003.

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BUY – STAG Industrial (STAG 24 – yield 5.9%) – After popping to its highest level since February last week, STAG has pulled back to its 50-day moving average, which is normal. The 10-year yield has spiked over 3% since our last update, but REITs are holding up well. In part that’s because volatility in the equity markets drives investors toward income investments. STAG, a warehouse REIT, will report first-quarter earnings May 1, after the close. Analysts expect FFO (funds from operations) of $0.43 per share, up 5% from $0.41 per share in the same quarter last year. Revenues are expected to rise 19%, from $69.5 million to $82.6 million. Risk-tolerant high yield investors can buy STAG here for monthly income. Buy before the close tomorrow to receive the next monthly dividend payment of 11.83 cents per share.

Dividend Growth Tier

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To be chosen for the Dividend Growth tier, investments must have a strong history of dividend increases and indicate both good potential for and high prioritization of continued dividend growth.

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HOLD – American Express (AXP 100 – yield 1.4%) – AXP jumped over 7% Friday after the credit card company reported estimate-beating earnings. Revenues beat estimates and were up 12%, fueled by higher credit card spending, loans, and fee income. EPS of $1.86 were up 38%, thanks in part to a drop in AmEx’s tax rate from 32% to 22%, and beat the consensus estimate by 8%. AXP’s chart is looking much healthier now; the stock has strong support at its 200-day and is back near its January highs. I’d consider putting the stock back on Buy on a breakout past 102. Amex will hold its annual shareholder meeting May 7.

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HOLD – BB&T Corp (BBT 54 – yield 2.4%) – BBT has been heading higher since reporting estimate-beating earnings last Thursday, and broke through its 50-day line to the upside yesterday. EPS rose 22% year-over-year, thanks to lower taxes and expenses, beating analyst estimates by 5%. Revenue was about flat year-over-year, but still beat estimates slightly. Lending increased, but non-interest income fell. The stock is above its 50-day moving average now and at its highest level since the big selloff in late March. And BBT is outperforming other financials again. The stock’s trend is still sideways, but it’s looking a little healthier, short-term. BBT is a Hold for Dividend Growth investors. Note that the drop in the dividend line on BBT’s chart reflects the small special dividend paid on top of the last regular dividend (which has since been made a permanent increase) not a decrease in the dividend payout.

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HOLD – Broadridge Financial Solutions (BR 109 – yield 1.3%) – After last week’s breakout to new all-time highs, BR is pulling back normally. I’ll put it back on Buy once the market’s trend improves. For now, BR is a solid Hold for dividend growth. Broadridge provides investor communications and other technology to financial companies, and a large percentage of revenue is recurring.

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HOLD – Carnival (CCL 66 – yield 3.1%) – Carnival just increased its dividend by 11%, from 45 to 50 cents per quarter. It’s the fifth dividend increase in a row for the cruise company. The stock is recovering nicely from the oil price surge that caused cruise stocks to sell off a few weeks ago. CCL is now just a hair south of its 50- and 200-day moving averages, although yesterday’s pullback delayed a breakthrough. Oil prices are still elevated, but have been trading sideways for the past week. Hold.

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BUY – CME Group (CME 162 – yield 1.7%) – CME will report earnings tomorrow, April 26, before the market opens. Higher market volatility means more transactions on CME’s exchanges, and analysts expect the company to report EPS of $1.83, up 50.0% from $1.22 last year. Revenues are expected to rise 19.3%, to $1.11 billion. Technically, CME still looks healthy. The stock is trading around its 50-day moving average, and trending gradually up. Buy for dividend growth and large annual special dividends.

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HOLD – Cummins (CMI 161 – yield 2.7%) – The selloff in Caterpillar yesterday triggered a big pullback in CMI. The stock sold off less than CAT but more fiercely than the industrial average as a whole, and closed below its 50- and 200-day moving averages again. CMI had been trading above both lines for about a week after a positive article in Barron’s triggered a short rally. The one-day selloff hasn’t changed the technical picture substantially and I’ll keep CMI on Hold for now. Cummins, which makes engines, will report earnings on May 1. Analysts expect revenues of $5.18 billion, up 13.0%, and EPS of $2.92, up 23.7% from $2.36 last year.

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BUY – Intel (INTC 51 – yield 2.3%) – INTC has pulled back slightly from its new 10-year closing high hit last week, and is headed for its 50-day moving average around 50. The chipmaker will report earnings tomorrow, April 26. Analysts are expecting EPS of $0.72, up 9.1% from $0.66 last year. Sales are expected to rise a more modest 1.7%, to $15.05 billion. Intel is in an uptrend, and earnings are accelerating, so I’ll keep it on Buy for dividend growth investors.

Safe Income Tier

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The Safe Income tier of our portfolio holds long-term positions in high-quality stocks and other investments that generate steady income with minimal volatility and low risk. These positions are appropriate for all investors, but are meant to be held for the long term, primarily for income—don’t buy these thinking you’ll double your money in a year.

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SELL 1/3 – 3M (MMM 201 – yield 2.7%) – After its big selloff Monday (discussed in yesterday’s special bulletin), 3M held up pretty well to yesterday’s selling in industrials and the broad market. MMM’s big pullback was caused by management lowering the high end of 2018 guidance, shortly before the similar trouble with CAT. 3M’s first-quarter results were good: revenues rose in all segments, and were up 8% year-over-year, beating estimates. Adjusted EPS of $2.50 were up 16% over the same quarter last year, but missed estimates by one cent. However, the guidance reduction saw the stock drop to its lowest level since early September, following a series of big gaps down in February and March. We already took partial profits in MMM about three weeks ago because of the stock’s constant selloffs, and the latest big drop is the last straw. I’m going to sell another third of our position today, and we’ll try to unload the final third on a bounce in the days ahead.

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HOLD – PowerShares BulletShares 2018 High Yield Corporate Bond ETF (BSJI 25 – yield 4.0%)
BUY – PowerShares BulletShares 2019 Corporate Bond ETF (BSCJ 21 – yield 1.8%)
BUY – PowerShares BulletShares 2020 High Yield Corporate Bond ETF (BSJK 24 – yield 4.9%)
BUY – PowerShares BulletShares 2021 Corporate Bond ETF (BSCL 21 – yield 2.4%)
Guggenheim’s sale of their ETF business to Invesco has been completed, and the BulletShares funds are now called the PowerShares BulletShares funds (what a mouthful). Other than the name change, I don’t expect anything about the funds’ management to change, although if you’re looking for more information about how the BulletShares funds work or can be used, Invesco has launched a friendly new website at bulletshares.invesco.com. We’ve used the funds to construct a bond ladder, which is a conservative strategy for generating income by buying a series of individual bonds or defined-maturity bond funds that mature in successive years. Because the BulletShares funds mature at the end of the year in their name (at which point Invesco disburses the net asset value of the ETF back to investors), they are a good store of value even when interest rates rise. And if you reinvest the proceeds of the maturing fund in a new, longer-dated holding every year, you can secure a rising income stream as rates rise. You can construct your own ladder with either the investment-grade or high-yield funds, or a mix, as we’ve done. The 2018 fund’s yield will gradually decline over the second half of this year as Invesco moves the fund into cash, so if you’d like to construct your own bond ladder today, start with BSCJ or its 2019 high-yield counterpart, BSJJ.

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HOLD – Consolidated Edison (ED 78 – yield 3.7%) – ConEd will report first-quarter results May 3, after the close. Analysts are expecting EPS of $1.32 and revenue of $3.24 billion, up 3.9% and 0.3%, but the stock rarely reacts strongly to earnings. Instead, ED is driven by interest rates and appetite for low-risk stocks. After pulling back to its 50-day two weeks ago, ED bounced off the moving average and is now trading above it. Safe Income investors can Hold for slowly rising income, and I might put ED back on Buy again soon if support continues to hold.

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BUY – Ecolab (ECL 146 – yield 1.1%) – Ecolab, which sells chemicals, technology and services to a variety of industries, will report earnings May 1. Analysts are expecting revenue growth of 7.0%, to $3.38 billion, and EPS growth of 12.5%, to $0.90. ECL did pull back significantly yesterday, but has held most of its gains from last week’s gap up. The stock is now trading near new all-time highs and 6% above its highs from three months ago. Although there’s still no obvious reason for it, the strength is an excellent sign, and I’ll keep ECL on Buy for Safe Income investors.

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BUY – PowerShares Preferred Portfolio (PGX 14 – yield 5.8%) – PGX pulled back a little this week as the 10-year treasury yield surged to 3%. It’s a good buying opportunity for investors looking to add reliable monthly income to their portfolio. PGX is an ETF that holds preferred shares and pays monthly distributions. The fund has low volatility but no capital appreciation potential; it generally trades between 14 and 16. Currently trading around 14.40, PGX is buyable now for investors looking for a good store of value and regular income.

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HOLD – UnitedHealth Group (UNH 234 – yield 1.3%) – After last week’s earnings beat, UNH is back above its 50-day moving average, which has turned up. EPS were up 28% and beat estimates by 5%, and revenue rose 13% to $55.2 billion, beating the consensus estimate by $330 million. Even better, management increased their EPS guidance for the full year 2018 to $12.40-$12.65 per share, up from the previous range of $12.30-$12.60. The stock’s intermediate-term trend is still sideways, but it’s getting healthier, and held up well in yesterday’s market selloff. Hold.

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HOLD – Xcel Energy (XEL 46 – yield 3.2%) – Utility Xcel Energy is reporting first quarter earnings April 26. Analysts currently expect EPS of $0.51 and revenue of $2.96 billion, up 8.5% and 0.4% respectively. However, the stock’s reaction to earnings is typically muted; risk appetites and interest rates have a bigger influence on demand for utilities. XEL bounced off its 50-day line two weeks ago and is now trading above it. Investors whose primary goal is income can continue to Hold.


Closing Prices on April 24, 2018

Dividend Calendar

Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Dividend Investor for an explanation of how dates estimated.

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Dividends for Downturns

The halcyon days of 2017 are behind us; 2018’s stock market is volatile, fickle and can inflict plenty of pain, as we saw yesterday. But as dividend investors, we’re better insulated than most. In troubled markets, dividend-paying stocks tend to perform better than non-dividend-paying stocks.

During the 2008 crash, the S&P 500 declined around 37%, but S&P’s Dividend Aristocrats Index (a list of over 50 companies that have increased their dividends every year for 25 years) fell only 22%.

That’s a big difference when you consider the recovery from each of those declines: the Dividend Aristocrats Index had to rise 28% to reach its former peak, while the S&P 500 faced a climb of over 58% before it got back to breakeven.

2008 was just the latest episode in which dividend payers proved their value during market downturns. Since 1927, dividend-paying stocks have displayed meaningfully lower standard deviations than non-dividend payers in nearly every year, meaning that they are less volatile than the market overall (18.3% standard deviation from 1927-2014, compared to 30.1% for non-dividend-payers).

Coupled with dividend payers’ better long-term performance (10.4% annual return since 1927, vs. 8.5% for non-dividend-payers) this makes us comfortable holding high-quality dividend payers through even an extended bear market.

Not every investor has a long enough time horizon to remain invested during downturns. If you think you may face significant near-term cash needs, a larger cash position will likely be more appropriate for you. But for investors living comfortably off the dividend income from their portfolios, remaining invested in high quality dividend paying stocks through downturns is a solid long-term strategy.

The dividends of the highest quality stocks are rarely affected by market downturns. The Dividend Aristocrats, for example, have all increased their dividends every year for 25 years or more, through three recessions and two bear markets.

Remaining invested in high-quality dividend paying stocks means your investments will continue to reward you even during bear markets. That’s a benefit that should not be underestimated. Over the past 80 years, between 30% and 40% of stocks’ total returns have come from dividends, not price appreciation. Morningstar has crunched the numbers going back to 1927 to show that dividend income accounts for 41% of the annualized total return from large-cap stocks, 35% of the total return from mid-cap stocks and 31% from small-cap stocks.

For investors who rely on regular income from their investments, high-quality dividend payers are the best vehicle for maintaining a steady income during troubled times in the market. They lose less of their value during corrections, they’re less volatile overall and they keep paying you regardless of what prices are doing.

Still, if you feel too exposed to the market’s wild swings, you can consider increasing the portion of your portfolio dedicated to conservative and counter-cyclical investments, like preferred shares (for example through PGX) or a bond ladder.

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