You wouldn’t know it looking at the market, but income investors are in a tough spot.
While prices for stocks keep reaching higher, yields on bonds and other safety investments keep falling lower. Nearly half (45%) of all government bonds globally are yielding less than 1% and just 14 of the 54 companies in the S&P 500 Dividend Aristocrats Index pay a 3% yield or higher.
[ad#Google Adsense 336×280-IA]Not only are yields lower but the potential return awaiting investors in stocks may not offer the kind of appreciation required to meet your spending needs.
Research shows that at its current price of 18.97 times trailing earnings, the S&P 500 has gone on to post nominal returns of just 2.3% over the subsequent 10 years.
What is an income investor to do when traditional investments fail to live up to their promise of cash returns or price appreciation?
My best bet: follow the lead of one of the world’s richest men.
Death, taxes and waste removal
They say that the only certainty in life is death and taxes.
To this short list, I would also add waste removal. No matter how much people try, no matter how loud the calls get for “reduce, reuse, recycle,” we will always need someone to haul away the things we no longer want.
That kind of certainty is leading Cascade Investments, Bill Gates’ private investment company, to increase its multi-billion dollar stake in Republic Services, Inc. (NYSE: RSG). The investment firm bought another 1.2 million shares of stock last week for $47.4 million. The company now owns 102.2 million shares, worth more than $4 billion and nearly 29% of the company. In just the last 3 months, Cascade Investments has bought 12.35 million shares at an average price of $38.31 per share.
Republic Services is the second largest waste management company in the United States with 339 collection operations in 43 states and Puerto Rico. More than 80% of the company’s revenue has an annuity-type profile with long-term guarantees built into the contracts. The collection business represents 75% of revenue with nearly equal exposure to commercial and residential customers.
The company’s reliable contracts and stable growth make for extremely dependable cash flow and low risk on the shares. Volatility in the shares was just 11% greater than last year and the stock has a beta of 0.53 with the general market, meaning it is about half as risky as stocks in the S&P 500.
A value-play with upside potential
The company is the least expensive among peers at an enterprise value of 8.5 times earnings before interest, taxes, depreciation and amortization (EBITDA) against a multiple of 11.9 times on shares of Waste Connections, Inc. (NYSE: WCN) and a multiple of 10.0 times EBITDA on Waste Management, Inc. (NYSE: WM).
Approximately half of the company’s service revenue contains pricing restrictions based on the rate of consumer inflation. Low inflationary pressures have limited sales growth over the last four years but this could turn around quickly if pricing pressures increase along with employment and the economy.
On top of the company’s problem with price increases, volume is closely correlated with housing and has followed the tepid rebound in the sector. While the housing market may never again see gains like it did in the years leading up to the bust, demand should continue to post solid increases as the market returns to normal.
Shares of Republic Services pay a stable 3% dividend yield that has grown at an annual rate of over 9% in the last three years. The payout ratio of 52% is relatively high but still below the five-year average of 63%, leading to the possibility for future payout growth. Adjusting for dividends, shares have returned an annualized 9.6% over the last decade — against an annualized return of 8.2% for the S&P 500 over the period.
The stability of income and potential for share appreciation at almost half the risk of the general market is why I include Republic Services in a very short list of ‘goldilocks’ investments. These companies offer the best of both the bond and stock markets while minimizing the disadvantages like limited growth or risk in falling share prices.
Risks to Consider: Shares of Republic Services are trading around the 52-week high and may pull back in the short-term. You should still see strong long-term returns at this point, but you may have to wait for the yield and appreciation to make up any short-term pain.
Action to Take –> Bill Gates has invested a sizeable chunk (5.3%) of his total net worth into Republic Services and is cashing in on this stable cash machine. A stronger return than bonds at half the risk of stocks make this a great addition to your long-term retirement portfolio.
— Joseph Hogue
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Source: Street Authority