Review of Parts 4-5
In Parts 4 and 5, we looked at two of the four strategies investors like me use to increase income. (There are certainly more than four investing strategies. Also, I might be quite different from most investors because of my use of options trades for additional income.)
Part 4 talked about a high-yield investments strategy, and I used ARCC as an example of a high-yield dividend stock. Ares Capital Corporation is a business development company (BDC). ARCC is not a dividend growth stock, as the dividend payout ratio is very high, and the average annual compound dividend growth for the last five years is a paltry 2.5%. However, the yield is 9.8% according to the following Stock Rover information. The ARCC high-yield dividend provides significant fuel for buying other investments that can grow income. I sacrifice price appreciation to get the income sooner rather than later.
In Part 5 the focus was an easy way to get diversified dividend growth using ETFs like VYM, SCHD, and DGRO. This segment of our investment portfolio is the largest in terms of total investment. The dividend growth portion includes these ETFs and individual stocks like ABBV, PFE, and HD.
The image above shows the payout ratio for pharmaceutical companies ABBV and PFE. Both are within my desired range, and there is better dividend growth. Furthermore, while ARCC’s 5-year return was a respectable 93.4%, ABBV realized a 5-year return of 112.2%. That is far better than the industry as a whole. PFE (Pfizer) has actually lagged both ABBV and ARCC in 5-year return at 76.4%. However, that is still far better than the industry’s 58.6% return.
If we compare the dividend history for all three from 2007-2022 it looks like this.
Stocks without Income
But there is another back door to income growth. It starts in an unlikely place for most focused dividend growth investors. Some good investments don’t pay a dividend. In our current accounts we have a total of twenty-one unique growth stock positions that don’t pay a dividend. However, some of them have already been a successful source of income. Our top seven growth investments are AMD, AMZN, CCRN, FLGT, PRPH, SAVA, and TITN. None of these is for the faint-hearted investor and none of them pays dividends. There is zero income without special action.
Growth Stocks as Income
When does an investor realize a profit? When you are in a bull market, growth stocks can be very profitable. However, you cannot say you have a profit until you sell your investment. Before Covid struck, many investors looked like experts or savants. Their accounts were shooting up on the back of some big names like Amazon, Facebook, Tesla, Netflix, and Google. Some of these growth stocks pay a dividend, but the yield is poor even if the dividend growth is praiseworthy.
Apple (AAPL) has a puny dividend yield of 0.65% and a not-very-spectacular dividend growth rate of 8.15%. To add insult to injury, AAPL shares are down 18.67% YTD. If you needed to sell AAPL shares to get some income, now would be the wrong time to sell.
Bear in mind that Apple shareholders did not realize any profit (other than a small dividend) if they did not sell any of their shares. When it comes to growth stocks, I am less likely to take the buy-and-hold approach. When AAPL shares were high, I sold my shares. The Annual Payout (FWD) of $0.92 was worth far less than the gain from the sale of my shares. That was real income that I could reinvest or give away.
Titan Machinery Does Not Pay a Dividend but…
One recent example is our investment in TITN. TITN is a growth investment and they don’t pay dividends. I have 400 shares of Titan Machinery Inc in my traditional IRA. I purchased the shares in March and April of this year as shown in this illustration.
At the market close today it looks like my shares are worth $17,612. My cost basis is $10,945. However, I don’t have a “profit” just yet because I have not sold my shares. However, I have had income from my shares, even though TITN does not pay a dividend. I have been selling covered call options on the 400 shares and have collected $631.78 since August on those sales. Therefore, my artificial “yield” in cash income has been 5.8% on my cost basis. If my shares are called away at the current contract price of $40, I will book another $5,055 in capital gains which is another 46% return on my investment.
In other words, my $11K investment is likely to generate $5,686.78 in total cash received even thought TITN does not pay a dividend. That is a very satisfactory return on my investment in nine months.
Cassava Sciences Inc Does Not Pay a Dividend but…
We received $9,120 in options income during 2021 on our SAVA shares. YTD 2022 we have received $9,364 in options income on those SAVA shares. That sounds good unless I were to tell you my cost basis for the 1,000 shares we own. Right now, if I sold those shares we would have a loss, not a profit. However, because most of our investments pay us a dividend, there is no urgent need to sell. Therefore, I can afford to wait for a recovery, which is likely if SAVA’s products in development are successful and come to market.
Note: Cassava Sciences, Inc., is a clinical stage biotechnology company that develops drugs for neurodegenerative diseases. Its lead therapeutic product candidate is simufilam, a small molecule drug, which is completed Phase 2b clinical trial; and investigational diagnostic product candidate is SavaDx, a blood-based biomarker/diagnostic to detect Alzheimer’s disease. However, this “growth” stock is also extremely risky.
Remember at least two important realities when you invest in growth stocks that do not pay a dividend. The first is that you don’t really have any profits until you sell your investment. Secondly, in a bear market you may only have two choices: 1) ride the market out and hope the price of your shares recovers, or 2) sell your shares at a profit or loss if you need the cash for other investments or for living expenses. Your third option is to trade options, but that is for a future discussion.
What Might You Do?
If you invest in ETFs or mutual funds, you would do well to look at your mix of investments. Are any of them dividend growth? Do any of them have huge concentrations in growth stocks in the top ten investments? For example, if you are invested in an S&P 500 index, you have a large allocation of your investment in Apple Inc, Microsoft Corp, Amazon.com Inc, Alphabet Inc A, Berkshire Hathaway B, Alphabet Inc C, and Tesla, Inc. Only two of the top six pay a dividend, so you would be a growth investor by default. Is that what you have as your primary goal?
A Reminder from King Solomon
Having more and having great treasure will not satisfy or bring joy. You cannot take it with you. Don’t waste this life chasing treasures that don’t last and that will never meet your deepest needs.
“Better is a little with the fear of the Lord than great treasure and trouble with it.” Proverbs 15:16 ESV