Note from Daily Trade Alert: As long-time readers are aware, Dave Van Knapp is a highly-respected authority in the dividend growth investing (DGI) space. He wrote our Dividend Growth Investing Lessons. Since 2008 Dave has maintained and made public a real-money Dividend Growth Portfolio. It demonstrates the results available from a sound dividend growth strategy. In the following article Dave reveals another stock featured in his special eBook, Top 40 Dividend Growth Stocks for 2014.
This is the fourth and final article in a series about stocks in the new edition of my eBook, Top 40 Dividend Growth Stocks for 2014.
In the first two articles, I described a pair of iconic stocks that have made it into the Top 40 all seven years that I have produced the eBook. These stocks are Coca-Cola (KO) (click here for the article) and Procter and Gamble (PG) (click here for the article).
In the third article, I told you about Sunoco Logistics Partners (SXL). SXL is much smaller than the first two, but it has also been in my Top 40 all seven years that I have published my eBook.
Now I want to introduce a fourth stock, another one that is lesser-known than the two icons Coca-Cola and Procter & Gamble.
The stock is a Real Estate Investment Trust (REIT): Ventas (VTR). Not only is Ventas a good dividend growth company, but it is decently valued at the moment.
This discussion will help us to round out our knowledge of the three major business forms that you will encounter in dividend growth investing:
- C-Corporations (that is, traditional large corporations) like Coke and P&G
- Master Limited Partnerships (MLP) like Sunoco Logistics
Ventas Business Model
As you know by now, we need to understand Ventas’ business model before we would consider investing in it. In this company’s case, it is pretty easy to understand: It acquires, owns, operates, and collects rent on properties whose values are tied to two of the biggest trends today: The aging of the population and healthcare.[ad#Google Adsense 336×280-IA]Ventas, an S&P 500 company, is a real estate investment trust that holds a portfolio of more than 1400 seniors’ housing and healthcare properties in the United States, Canada, and the U.K.
Its business is diversified from a variety of perspectives, including asset type, tenant/manager mix, revenue source, operating model, and geography.
Senior housing facilities represent more than 50% of Ventas’ assets.
Skilled nursing facilities, medical offices, and hospitals make up the rest.
Private-pay assets deliver about 84% of revenue.
In the senior housing segment, about half of VTR’s facilities are triple-net leases.
This is a common model in REITs. The triple-net lease is an arrangement on a property where the tenant (the lessee) agrees to pay all real estate taxes, building insurance, and maintenance costs on the property in addition to any normal fees that are expected under the agreement (rent, utilities, etc.). The other half of VTR’s housing properties are operated by VTR.
Ventas has made approximately $22 billion in accretive investments since 2004, making it (in its own words) “the leading healthcare REIT and one of the largest REITs overall.” It is pursuing a “roll-up” strategy, acquiring businesses in the fragmented $1 Trillion seniors housing and healthcare real estate market. This chart shows how fragmented the market is, meaning that there is lots of opportunity for Ventas to grow through further acquisitions.
Again in Ventas’ own words:
These opportunities are supported by powerful demographic and financial forces: aging Baby Boomers; a sharply rising 85+ population; increased healthcare spending; and growing demand for lower-cost outpatient settings….
Aging Baby Boomers and the 85+ population are expected to grow at three times the rate of the overall population, supporting the projected increase in healthcare spending from 18% to 20% of GDP by 2022.
In the first quarter of this year, Ventas made its first acquisition in the United Kingdom. The company invested $183 million in three private pay hospitals. These assets are subject to long-term triple-net leases. The tenant, Spire, is the second-largest private hospital operator in the U.K. Debra Cafaro, CEO of Ventas, stated that the company intends to build its presence in the U.K. over time, because the health care and senior housing real estate market there is highly active and evolved.
My only real concern about Ventas’ business model is that its top four tenants account for about 50% of revenue. Management recognizes this, and I believe that as the company expands, we will see that concentration become diluted. The U.K. acquisition is an example of that. I like to see diversified revenue streams in the businesses that I own, just as I like to see them in my own portfolio.
In my Top-40 scoring, I gave Ventas 10 points (out of a possible 15) for its “Story.” Overall, VTR earned 45 points for Company Quality. That placed it near the bottom of the select group of 40 companies.
Part of the reason for the low score results from Ventas’ dividend history, which is not as extensive as the other companies in this series. Let’s talk about VTR’s dividend profile.
Ventas is an unusual stock for me, in that it does not have a current five-year streak of dividend increases. It froze its dividend for one year during the financial crisis, holding it steady in 2009 compared to 2008. But prior to that, it had been in my Top 40 twice, and it now has four consecutive years of increases under its belt.
By the end of the year, I expect VTR to have re-entered the five-year club. (This is the only time I have made an exception to the 5-year rule in compiling my Top 40.)
Here are the four companies’ dividend increase records:
Ventas is the blue line. (You can ignore the dip in 2011, that is a data anomaly.) You can see the flat period from 2008-2009 when the dividend was frozen. That aside, VTR’s dividend has been increased staeadily over the past 10 years. I view the dividend freeze in 2009 as a prudent move by management during uncertain conditions, not as a black mark against the stock. Management resumed dividend increases in 2010, and the overall upward slope in the line was not changed much by the freeze in 2009.
In terms of yield, VTR is at the top of the four stocks.
As we have seen in previous articles, Step 1 in deciding about a stock is determining the quality and excellence of the company. That only gives us part of the picture as a potential investment. Step 2 is determining the valuation of its stock.
I value stocks using two tools: Morningstar and FASTGraphs.
Morningstar rates Ventas as undervalued right now. That means that they think it is a good buy compared to what they think is its fair price.
On Morningstar’s five-star system, four stars indicates undervaluation. Let’s see what FASTGraphs says.
The black price line is just about at the orange fair-value line, meaning by this method, VTR is fairly valued now.
Combining the two valuation methods suggests that VTR is fairly valued or a little undervalued at the moment.
I do not own Ventas, but I will consider it for purchase later this month when I will have enough dividends accumulated in my Dividend Growth Portfolio to make another purchase. It would be fine with me if VTR’s price takes a nosedive before then, assuming that it is not based on any fundamental problems popping up with the company.
Summary of This Series
We have now looked at four dividend growth companies from my Top 40. Let’s compare them on multiple data points. (I have updated yields based on current prices and the latest dividend projections.)
The table above illustrates some of the various factors that a dividend growth investor encounters. You will often be making choices and trade-offs between form of organization, yield, annual rate of increase, dividend growth rate, and other factors.
I like to diversify within reasonable limits. My public Dividend Growth Portfolio and my wife’s and my retirement portfolio contain traditional companies, REITs, and MLPs; current yields ranging from 2.3% to 5.3%; dividend growth rates from 2%/year to 15%/year; and stocks with increase streaks from the single digits all the way up to several decades.
Personally, I prefer to have this sort of diversification rather than be reliant upon just a few sources of income, or sources that are all in one industry or sector.
Funds from Operations
As we saw in the article about Sunoco Logistics Partners, valuations for REITs are more useful if they are based on funds from operations (FFO) instead of earnings. The reason is similar: REITs are constantly making capital investments – buying properties – and this distorts their “official” earnings. It is uniformly accepted that in valuing REITs, FFO is the metric to use. I did that in the FASTGraph presented above. You can tell, because the data points on the orange fair-value line are marked with “O’s” rather than the triangles that are used for earnings data.
Taxation of Dividends
Dividends from REITs are not “qualified” under the Internal Revenue Code for special tax treatment.
No special tax forms are involved, but under the tax code, dividends from REITs are treated as ordinary income. That is because the dividends were not taxed at the company level, so they do not qualify for special treatment at your level.
I am not a tax expert, so please consider this simply an overview for general understanding. Consult your own tax adviser for detailed information.
In the article on SXL, I stated that although the stock is overvalued right now, I had no intention of selling it from my wife’s and my personal portfolio.
I want to let you know that upon further review, I changed my mind. The stock had nearly tripled for us, and I decided to take some of that money off the table. We sold a portion of our SXL, and I redeployed the proceeds into a couple of other stocks. In so doing, I increased the yield of the portfolio slightly, but my main motivation was to rebalance it.
We still have a substantial amount invested in SXL, and everything that I said about it being a great dividend growth company still holds. But for the purposes of balancing our portfolio, I decided that a better move for us was to bring SXL back to a more level weight with our other holdings.
On a Personal Note
I hope that this series of four articles has been educational. Investors thirst for investing ideas, and articles about individual stocks invariably “pull” better than articles based on strategies or processes.
But one of my personal goals in writing about dividend growth investing is to teach, and to encourage readers to think critically and for themselves. So even though these articles have been about specific investment ideas, I have tried to convey in each one a broader thought or two: Why FFO is a better metric for some companies, or why I was willing to “break” my usual five-year rule for Ventas.
Writing these articles has helped me in the sense that I realize that there are more topics that should be added to the Dividend Growth Investing Lessons. That is where I will turn my attention next: To valuation and to answering the question, when should you sell?
Dave Van Knapp
Author of Top 40 Dividend Growth Stocks