Stocks are up, the economy is in shambles and lockdowns are making a comeback. But people are also being vaccinated as I write this, just 12 months after we learned that COVID-19 was even a thing.
How do we invest through this transitional market? Iâ€™ve got a three-point plan for you that works in any economyâ€”not just the Twilight Zone one weâ€™re living in now.
Step 1: Start With â€œTollbooth Stocksâ€ and Build From There
Tollbooth stocks are the kinds of companies we safety-conscious dividend investors love: they hold the infrastructureâ€”think pipelines, warehouses and data networksâ€”big players like, say, Amazon.com (AMZN) must have to operate.
These quiet â€œtoll collectorsâ€ hand over most of the cash they collect to us as dividends. Another benefit of these stocks is that buying them is much safer than trying to pick individual winners in competitive industries.
To show you what I mean, letâ€™s say that, five years ago, you wanted to buy into the trend toward surging mobile-device use and data consumption. You could have bought the go-to US telecom stock, AT&T (T), which is renowned for high yields: it paid around 5.5% then.
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But that high yield wouldnâ€™t have saved you from a lousy return. In the last five years, AT&T has been run over by the S&P 500â€”even with dividends included!
What about Verizon Communications (VZ)? It typically yields a bit less than AT&T. But it did make up for that in price gains over the last five years, crushing Ma Bellâ€™s stock. Even so, it still fell well short of the S&P 500.
Now letâ€™s compare this duo to our tollbooth play, Crown Castle International (CCI). Itâ€™s a real estate investment trust (REIT) with 40,000 cell towers and 70,000 small-cell nodes. The latter are â€œmini-towersâ€ that boost capacity and service quality in a particular area and are vital to the deployment of next-gen 5G networks. All the major telcos pay â€œrentâ€ to CCI, including AT&T and Verizon.
The stock roared past both of themâ€”and the market, to boot!
Crown Castle is just one example of an effective tollbooth play. There are plenty more out there, including pipelines, owners of corporate data centers, and utilities.
Step 2: Add Growth With â€œRelative Strengthâ€
Tollbooth plays can provide a great base for your portfolio. Now letâ€™s add upside (in both share prices and dividends) with stocks showing what I call â€œrelative strength.â€
Relative strength means that strong stocks tend to stay strong, giving them a solid base from which to jump. Forget the bargain binâ€”weâ€™re not looking for low P/E ratios hereâ€”just stocks that have momentum.
Everybody loves betting on a long shot, but the trouble is, these underdogs simply donâ€™t come in enough to pay. We like strong stocks, smart management and megatrends. But everybody wants those, so where do we find our edge?
In two places:
- We findÂ underappreciatedÂ and henceÂ undervaluedÂ stocks in popular sectors. Think: firms with a technology edge that are notâ€”yet!â€”priced like go-go tech stocks.
- Or we look at an out-of-favor sector and find a stock that has beenÂ mislabeled. REITs are one place to searchâ€”many people associate them with (dying) shopping malls, but there are many kinds of REITs, like Crown Castle, for example, or landlords of other specialized properties, like lab owner Alexandria Real Estate Equities (ARE).
Cleaning-supply company Ecolab (ECL) provides a good example of the kind of fast return a relative-strength stock can deliver.
Pre-COVID, most investors saw it as too boring to bother with. But its stock was getting set to soar in early 2018. Look at the right side of this chartâ€”you can see the stock (orange line) establishing a base and then springing past the market.
With the pattern firmly established, I recommended Ecolab in my Hidden Yields service in April 2018. When we sold in December 2019, we took a 31% return with us, easily besting the S&P 500â€™s 24% return in that timeâ€”all thanks to a â€œboringâ€ cleaning-supply company!
Now letâ€™s move on to the final key in our dividend-investing plan:
Step 3: Take Out Some Inflation â€œInsuranceâ€
With the Fedâ€™s money-printing quantitative easing likely to stick with us, it doesnâ€™t hurt to build some inflation protection into our portfolios.
Most investors think gold is the best inflation hedge, but it doesnâ€™t work for us because coins and bars donâ€™t pay dividends! (In fact, youâ€™ll probably have to pay to store them.) Gold miners arenâ€™t exactly dividend machines, either. Major producer Newmont Corp. (NEM) yields just over 1%.
Instead, weâ€™ll look for stocks with:
- Dividends that outrun inflation: To maintain our lead over rising prices, we need stocks with growingâ€”and ideally acceleratingâ€”payout growth. Steady dividend growth grows your yield on cost over time. That can mean that a 3% current yield could grow to 10%+ years down the road. (Iâ€™ll show you this yield gain in action below.)
- A low beta rating: Beta is a volatility measure. A rating below 1 means a stock is less volatile than the S&P 500; above 1 is more volatile. We want a rating of 1 or below so we can enjoy our dividends in peace.
The utility sector is a good place for us contrarians to hunt for stocks that tick these two boxes. Midwestern utility WEC Energy (WEC), for example, boasts a payout thatâ€™s surged 161% in the last decade. As a result, folks who bought back then donâ€™t care a bit about the 2.9% yield the stock offers todayâ€”the inflated dividend theyâ€™re collecting now amounts to a much bigger percentage of their original purchase priceâ€”9.7%, to be exact!
Theyâ€™ve also seen a nice gain as investors have followed that surging dividend and bought the stock, driving it up 216% in that time.
Finally, the beta ratingâ€”WECâ€™s five-year beta is 0.5, meaning WEC investors have to contend with half the volatility the typical S&P 500 investor does. That means they can enjoy their growing payouts with much less risk of the stock price falling out from under them.
Brett Owens is chief investment strategist forÂ Contrarian Outlook. For more great income ideas, get your free copy his latest special report:Â Your Early Retirement Portfolio: 7% Dividends Every Month Forever.