The Money Tree

Safely Generating Income in Retirement

Archive for March, 2018

New Investment – KMI

Posted by mounddweller on March 30, 2018

Fellow Investors,

Over the past few weeks I have been looking to make one or two opportunistic additions to my long-term investment portfolio.  In a previous post I mentioned an interest in IBM and OKE.  I still have both of these on my radar screen.  However, my interest in OKE and the fact that mid-stream O&G companies in general have fallen out of favor on Wall Street led me to expand my research.  In addition to OKE, I also began to keep an eye on ENB and KMI.

All 3 companies are leaders in the mid-stream space of the O&G industry.  While I really like OKE, I decided to do more due diligence on ENB and KMI because, in my opinion, they represented a better value.  Then, after comparing ENB and KMI, I decided I liked KMI just a bit better than ENB for the following reasons:

(1) ENB pays dividends in Canadian dollars, thus there is a currency risk,

(2) KMI is further along in strengthening its balance sheet.

Thus, last week when it appeared pessimism was at a peak I made two trades.  First, I bought 200 shares of KMI at $14.84 per share.  Second, I STO 2 KMI SEP 15 puts at $1.30.  KMI currently pays a $0.50 dividend.  Thus, my initial dividend yield is 3.37%.  Nothing to get too excited about, right?  However, if you’ve followed KMI in the past you know that they have had a few rough years.  They grew too fast and incurred too much debt.  As recently as 2014 KMI had paid quarterly dividends at an annual rate of $2.00 per share.  In order to restructure their balance sheet and get back in the good graces of the analysts on Wall Street, they cut their dividend by 75% and used the savings to pay down debt and become self-funding.  By that I mean their plan going forward is to fund all of their future growth out of existing cash flow without having to access the debt or equity markets.  Having done that for the past couple of years KMI is now positioned to again begin growing its dividend.  For 2018, they have announced plans to increase the dividend from $0.50 to $0.80.  Barring unforeseen events the plan calls for further increases to $1.00 in 2019 and $1.25 in 2020.  If these plans come to fruition my yield on cost in 2020 will be a very impressive 8.42%.

Now, let’s take a look at the puts I sold.  As referenced above, I STO 2 KMI SEP 15 puts at $1.30.  I decided to sell these puts for a couple different reasons:

(1) I wanted to leg into a full position in KMI over time, and

(2) the relatively high VIX gave me an opportunity to make a higher ROIC than if I had just bought another 200 shares of stock.

Since these are cash secured puts my ROIC is 8.67% (1.3/15).  That is significantly higher than 5.39% (0.8/14.84) return I would have gotten had I just purchased the shares outright.  Better yet, my annualized return on the puts is 17.57%, since my maximum holding period is only 180 days.

If I have KMI shares put to me in SEP at $15, my cost basis will only be $13.70.  This will give me a yield on cost of 5.84% in 2018, 7.30% in 2019, and 9.12% in 2020.

At these prices and rates of return I am very happy to have added KMI to my long-term portfolio.  I am continuing to keep an eye on OKE and hope to make an equally attractive entry in it later this year.  I’d like to own OKE at $45 or less.  Thus, it will take a bit more volatility in the market before I can hope to achieve this price target.

Best Regards,

Troy

 

 

 

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“Dividend House” – Lack of Diversification – A Rebuttal

Posted by mounddweller on March 1, 2018

Fellow Investors,

I received a comment on my recent post entitled Building a “Dividend House”.  The commentor took issue with the lack of sector diversification in the selections I had made for the foundation of a dividend growth and income (DGI) portfolio.  Specifically, he took issue with what he saw as an overweighting in the Consumer Goods sector and a lack of any positions in the Information Technology (IT) and Financial sectors.  The purpose of this post is to provide a rebuttal and explain why I feel diversification should not be an overriding concern in this type of portfolio.

First, let us recall the objective of the “Dividend House” portfolio.  The overall goal of the portfolio is to provide a safe and growing stream of income in retirement. A dividend king stock, regardless of its sector or industry has proven to be resilient in all kinds of markets and economic conditions. That is why they make great candidates for forming the foundation of a portfolio.  As long as you can reasonably expect its business model to continue to be successful and its growth to exceed the rate of inflation nothing else should really matter.

Now let us look more closely at the sectors and industries of the stocks I chose to include in the foundation portion of the “Dividend House” portfolio.

As shown above the stocks selected for the foundation of the “Dividend House” portfolio, despite diversification not being an objective, are spread across 5 different sectors and 9 different industries.  Why did I not select any stocks from the IT sector?  Simple, there are no dividend king stocks in that sector.  Why no financial stocks?  Well, of the 27 stocks classified as Dividend Kings, there are only 3 in the Finance sector, two banks and one insurance company.  They are Cincinnati Financial, Commerce Bancshares, and Farmer’s and Merchant’s Bank.  Their 10-year annualized dividend growth rates are respectively, 2.82%, 4.35%, and 2.72%.  Compare those rates to the 16.25% average dividend growth rate of the 10 selected stocks and it is easy to see why they weren’t chosen.  Choosing one of them simply for the purpose of diversification would have resulted in a higher probability of mediocre returns in the future.

There is one other rule you ought to keep in mind and that is to concentrate, and not only in the Zen sense. Sweet are the uses of diversity, but only if you want to end up in the middle of an average” Adam Smith, the Money Game 1968

If you can identify six wonderful businesses, that is all the diversification you need. And you will make a lot of money. And I can guarantee that going into a seventh one instead of putting more money into your first one is gotta be a terrible mistake. Very few people have gotten rich on their seventh best idea. But a lot of people have gotten rich with their best idea. So I would say for anyone working with normal capital who really knows the businesses they have gone into, six is plenty, and I probably have half of what I like best. I don‘t diversify personally. ” Warren Buffett

Now, one final point with regard to my rebuttal on the lack of diversification in the foundation of the “Dividend House” portfolio.  The total portfolio does not consist of just these 10 foundational stocks.  Readers of my original post will recall that the “Dividend House” will also have walls, a roof, and even a garden.  Perhaps the best stocks for these parts of the “Dividend House”, will include positions from the IT and Financial sectors, or perhaps not.  Like the foundation, those sections will include stocks that offer the best opportunity for high, safe dividend growth.

 

Best Regards,

Troy

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