2 Steady Dividend Compounders To Form The Core Of Your Portfolio
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Co-produced by Austin Rogers
Do you want to know what the most powerful force in the universe is?
Compound interest.
Quotes to this effect, calling compound interest the “most powerful force in the universe” or “the eighth wonder of the world,” are usually attributed to Albert Einstein. Truthfully, it is doubtful whether Einstein ever actually said this. But that doesn’t make the notion any less true.
Compound interest is the concept that investment income reinvested will build upon itself over time to result in exponential growth in income.
Here’s an illustration of the concept, showing the difference between income reinvested (compound) versus income not reinvested (simple):
Simple vs compound interest (Corporate Finance Institute)
Investing this way is similar to the famous Ernest Hemingway quote about bankruptcy (which Hemingway did actually write in his book The Sun Also Rises). When a character is asked how he went bankrupt, the reply is:
Two ways. Gradually, and then suddenly.
When one is investing for compound returns through reinvested income, the process can feel arduously slow and unfruitful. It seems painfully gradual for a long time. But eventually, the exponential growth of one’s income stream kicks in, and what feels like all of a sudden, one’s investment income is growing by leaps and bounds.
It takes time and patience, but it is one of the surest ways to create wealth and the best way to create passive income.
Though the concept of compounding has traditionally been associated with investments in bonds and other interest-bearing assets, the financial markets today are not what they historically have been. In the past, one would invest in bonds for income and stocks for capital gains.
But since bond yields fell following the COVID-19 outbreak, dividend-paying stocks like real estate investment trusts (“REITs”) (VNQ) now offer significantly higher income than bonds:
Dividend stocks vs. bonds (YCHARTS)
In today’s world, most investors would do well to forget about “compound interest” and instead focus on “compound dividends,” because it would be nearly impossible to see the exponential effects of compounding through bonds with interest rates so low.
For better or worse, investors aiming to tap into “the most powerful force in the universe” will need to seek income outside of the bond market. Luckily, there are some great options to consider in the realm of real estate.
Steady Compounders Vs. High Upside Plays
At High Yield Investor, we love uncovering hidden investment opportunities with high upside. These special opportunity REITs have played a large part in our portfolio’s outperformance over the broader market since its inception:
High Yield Investor historic performance (High Yield Investor)
But we don’t invest only in high upside plays. We like finding the sturdiest and most reliable compounders for long-term dividend growth as well. These companies may not double or triple in value over the course of a year, but they can be relied on for steady growth in cash flow and dividends well into the future.
Sometimes these are the long-established, slow-and-steady type companies with higher dividend yields and lower average annual growth rates, and sometimes these are the more dynamic companies with somewhat lower dividend yields but long runways of high growth ahead.
Today, we take a look at one of each type of company:
National Retail Properties
When it comes to steady compounders, it rarely gets steadier or more conservative than NNN.
This is a triple-net lease REIT, which means that its lease contracts put tenants in charge of all property maintenance, insurance, and taxes, leaving the landlord to sit back and collect the monthly check. By selling their real estate with a triple-net lease attached, tenants can free up capital for their core business. And for the landlord, it is a way of generating high-margin cash flow by financing deals at a spread above its cost of capital.
As the name implies, NNN invests only in single-tenant retail properties. Though retail overall has had a rough time in recent years competing with e-commerce, NNN spent most of the 2010s crafting a portfolio that would be maximally resistant to the threat of online competition. The key for NNN was to focus on experience-based or service-oriented tenants and property types.
NNN tenants (National Retail Properties )
Though having a largely experiential and/or service-oriented portfolio proved uniquely vulnerable during a pandemic, this foresight and conservatism on the part of management has played a part in NNN’s ability to continuously raise its dividend through thick and thin for 32 consecutive years.
NNN dividend growth record (National Retail Properties )
What’s more, this excellent dividend growth track record appears poised to continue for many years to come, as the dividend is very safely covered with a payout ratio of 69%.
The BBB+ balance sheet is another area of high conservatism. NNN has no debt maturities until 2024, and the REIT’s unsecured bonds are well-laddered with a weighted average maturity of roughly 15 years. That is one of the longest average debt maturities in all of REITdom, as management has fixed NNN’s interest rates as far out as 2052 at levels well below its property yields.
NNN debt maturities (National Retail Properties )
The REIT also has over $500 million in cash and no amount of money drawn on its $1.1 billion credit facility, giving it plenty of ability to pounce on attractive investment opportunities when they arise.
Perhaps what we love most about NNN is the REIT’s long-term mindset. This is exemplified by its 32-year dividend growth streak and its 15-year average debt maturity, but it is also exemplified by the long tenured management team. Among senior managers, the average tenure at NNN is 21 years, and among all employees, it’s 11 years. That says something not just about the consistency of NNN’s vision but also about the company’s ability to attract and retain talent.
If you want to invest for long-term compounding, there are few better or more reliable ways to do it than through NNN.
Crown Castle International
While NNN takes the slow-and-steady approach with a higher dividend yield, CCI takes the fast-and-steady approach with a somewhat lower (but still attractive) dividend yield.
CCI is a cell tower and data transportation REIT that owns over 40,000 cellular towers, 80,000 small cell nodes, and 80,000 miles of fiber across the United States. Its small cell nodes basically act as mini-cell towers, attached to telephone poles, light poles, billboards, or buildings. And the fiber lines connect these small cells to the broader wireless network.
CCI infrastructure network (Crown Castle)
Despite having “International” in the title, CCI is focused exclusively on its home market of the US. We like this focus, because we believe the four major US wireless carriers – AT&T (T), Verizon (VZ), T-Mobile (TMUS), and DISH Network (DISH) – will be investing a lot of money on infrastructure in the coming years as they roll out their 5G networks.
One of the most attractive aspects of CCI’s portfolio is its emphasis on small cell nodes, which are used to boost wireless capacity in densely populated, high demand areas. Adding a small cell node to an urban area is like adding a lane onto a busy highway.
CCI small cell nodes (Crown Castle)
These should prove useful as 5G ramps up and carriers look to deploy more capacity in urban areas.
The growth in consumer demand for wireless data and the carriers’ demand for the infrastructure to facilitate this wireless data usage has been a massive boon to CCI’s portfolio of wireless infrastructure around the country.
Though management targets 7-8% growth in adjusted funds from operations (“AFFO”) and dividends, they have a strong record of over-delivering. In the last two years, AFFO per share has risen 11-12% per year while the dividend has been upped 11% per year.
CCI dividend growth record (Crown Castle)
Going forward, it would not be surprising to see CCI continue to compound shareholders’ capital with more above-target dividend hikes. But even if they don’t, 7-8% annual dividend growth is nothing to sneer at!
Bottom Line
About 20% of our Portfolio is today invested in deep value type opportunities that have the potential to meaningfully boost the long-term upside of our Portfolio.
However, the vast majority of our investments are still in companies similar to NNN and CCI that have a clear path to above-average returns with below-average risk.
That’s the key to our long-term success.
