Make Money While You Sleep, 2 Fat Dividends For A Retirement Dream

Co-authored with Hidden Opportunities.

To make money when you sleep, you need a “set and forget” investment strategy. This is where an investor makes purchases intending to hold it for a long period, often without actively managing or monitoring it regularly. Here are some criteria that investors should consider when seeking a set-and-forget investment:

1. Extensive moat for the underlying business: Behind every public ticker is a business that reports its financials to the Securities and Exchange Commission. To be a successful investor, you must understand how this company makes money (if it is actually making any) and if it has significant competition in the market. A highly competitive landscape leads to unprofitable investments. You may have heard of price wars. Any way you look at it, a price war is the ultimate in self-destructive, lose-lose behavior.

Behind every stock, there is a company. Find out what it’s doing.” – Peter Lynch.

Every stock has ups and downs. If you don’t understand the underlying business, you will not be able to hold the stock when it falls.

2. Low Maintenance: Trading based on chart patterns isn’t a method for making money while you sleep. Choose investments that require minimal ongoing maintenance or management but ensure alignment with your goals and requirements. You could pick passive investment options like index funds or ETFs (Exchange-Traded Funds) that automatically track a market index, but please remember the reliance on market prices when you sell to raise usable cash. It would be great to have cash deposited into your account regularly.

3. Income Generation: As we just discussed, it is important to consider investments that provide a steady stream of income, such as dividend-paying stocks, bonds, or funds focused on distributions to shareholders. These can help provide ongoing cash flow without the need to actively sell assets.

4. Diversification: Despite all of the above, unexpected situations like COVID-19, changes in the political or regulatory climate, or strategic and management changes could impact individual investments. It is imperative to maintain a diversified portfolio to spread risk across different asset classes, sectors, and geographic regions. Our Investing Group holds over 45 securities to keep our income flowing despite volatility and market downturns.

We will now discuss two picks that reflect the four qualities discussed, providing you steady income to empower your retirement. Let’s dive in!

Pick #1: PFFA – Yield 9.9%

Current market uncertainty over interest rates is a fixed-income investor’s best time to be a buyer. Preferred securities typically sport higher yields than common stock, making them attractive for our income needs despite prevailing rates. When interest rates are low, it is not uncommon to see several preferreds trade at significant premiums to par value because investors are ready to pay up to lock in some above-market income.

Virtus InfraCap U.S. Preferred Stock ETF (PFFA) makes an excellent investment to obtain diversified exposure into preferreds. This is because the ETF’s strength lies in its leverage and active management. PFFA can boost those returns with leverage, thereby delivering higher yields than an average portfolio can achieve economically. This is the reason for the ETF’s solid performance in past low yield and near-zero rate conditions.

PFFA is actively managed, and the ETF’s portfolio is likely to experience changes very regularly. Management releases an updated “top holdings” chart almost every week. It is always impressive how closely aligned PFFA’s holdings are with our preferred stock portfolio. We directly own 6 out of its top ten holdings. Source.

PFFA invests in undervalued assets that are quite certain to experience upside with rate cuts. Employing leverage to boost returns is a no-brainer, especially when the asset yield is significantly higher than the borrowing cost. The problem for most individual investors is the high borrowing costs and margin calls. PFFA can obtain borrowing costs that are out-of-reach for the average investor, reporting a 5.89% weighted average cost of borrowing for FY 2023.

For the year ended October 31, 2023, the average daily borrowings under the Agreements and the weighted average interest rate were $150,415,430 and 5.89%, respectively.” – PFFA Annual Report (October 31, 2023).

PFFA pays monthly distributions, which were recently raised to $0.1675/month, reflecting a 9.9% annualized yield. The ETF’s composition makes it a must-buy amidst quantitative tightening, and its structural and sustainable high yield makes it an excellent security to navigate rate cuts and low-interest environments.

Pick #2: EPD – Yield 7.3%

When uncertainty looms, people cling on to tried and tested things. Fee-based take-or-pay contracts for transporting energy commodities are basically money-in-the-pocket type business models, especially when export demand is at record high levels.

Midstream breathes stability in the energy sector, and while the media was obsessed with AI, Powell, and the economic data, our midstream picks have quietly outperformed the market (including the tech-heavy Nasdaq 100).

The opportunity is still solid in this asset-rich sector, and we will discuss a midstream superstar that is a must-have for income investors.

Enterprise Products Partners (EPD) operates a massive network of over 50,000 miles of pipelines in addition to some storage, handling, and processing facilities for NGL, crude oil, natural gas, petrochemicals, and refined products. Can you imagine building anything remotely comparable in the current political climate?

Note: EPD is a Master Limited Partnership that issues a Schedule K-1 for tax purposes

Recently, the firm announced an expansion in its Permian natural gas processing capacity with the construction of a new plant in the Delaware basin. This would bring the company’s total net natural gas processing capacity to 11.6 Bcf/d. In addition to the wide moat and irreplaceable asset base for EPD, we discuss six factors that make EPD an excellent long-term investment. Let’s discuss them one by one.

1. Immune to commodity price action

As a provider of midstream services, EPD can achieve terrific adj. EBITDA growth despite prevailing commodity prices. This is of tremendous benefit for those seeking passive income from the company’s steady operations.

2. Capex immediately accretive to earnings

EPD has ~$6.5 billion of approved major projects under construction, most of which are coming into service in the next 12-24 months. Source.

Such asset deployments are often 100% contracted before going live through long-term agreements, meaning the infrastructure will start earning revenues from Day 1 of operations commencement.

EPD has budgeted ~$3.25-3.75 billion for growth Capex for FY 2024, not including any acquisitions.

3. Unit repurchases

During FY 2023, EPD spent $187 million (7.2 million units) on unit repurchases, and the partnership spent another $40 million in Q1 2024. In total, EPD has used 48% of its 2019 buyback program, indicating much more repurchase activity in the coming years.

4. Growing distributions

EPD is an excellent dividend-steward, with 25 years of annual raises to shareholders. The partnership boasts an impressive 7% distribution growth CAGR during this period, and its current $0.515/unit calculates to a healthy 7.3% yield. Being a master limited partnership, EPD’s distributions qualify as return of capital, providing a much-desired deferred tax treatment on the proceeds.

5. Insider ownership

Enterprise Products Partners was co-founded by the late Dan Duncan in 1968, and roughly one-third of the units of the pipeline behemoth are owned by the Duncan family. We consistently see other company insiders add to their holdings, indicating that the leadership decision-making will be closely aligned with the interests of shareholders. Source.

6. Healthy balance sheet

EPD maintains an “A-” rated balance sheet with an industry-leading 3x leverage ratio at the end of FY 2023. The company ended the fiscal year with $29 billion in total debt outstanding, with 96% of the debt carrying fixed interest rates. The weighted average life of the debt portfolio was ~19 years, and the weighted average cost of debt stood at 4.6%. EPD maintains $3.9 billion in liquidity, including its cash assets and credit facility, meaning the company is fully capable of funding its capital requirements through its liquidity and predictable cash flows without having to tap into the equity or debt markets.

When borrowing costs are high, very few companies can deleverage, buy back shares, raise dividends, and focus on capital expenses simultaneously. This makes EPD a rare gem and a must-have for income investors.

Conclusion

You will only sleep well at night if your investing strategy is disconnected from day-to-day market movements. Our Investing Group accomplishes this by focusing on deriving consistent cash returns from our investments. We prioritize diversification to safeguard our income, favoring established companies and diversified funds with a proven history of rewarding shareholders.

As an income investor, my approach ensures a steady stream of predictable cash flow, affording me the freedom to pursue other interests and sleep soundly at night. My next dividend payment is right around the corner, and adopting the four steps outlined earlier can set you on the same path. Welcome to the Income Method, your gateway to financial serenity.