Stock Smarts: Stick To Your Plan Amidst Rising Interest Rates
Don’t be too concerned about falling prices. The key points to watch are continued profitability and sustainable distributions.
At my recent Toronto Money Show workshop I was asked what income investors should do in the face of rising interest rates. My answer was to stick with your plan.
It’s no secret that when rates rise, income-sensitive stocks tend to decline in value. All things being equal, the ones that fare best are those companies with a long history of dividend increases and a strong commitment to future hikes. But even they can see a price retreat.
The important thing to remember is that you invested in these securities for cash flow. As long as the dividend/distribution appears to be secure, don’t worry about the day-to-day or even month-to-month movement in the share price.
We are seeing an example of the inverse relationship between interest rates and share prices in my High-Yield Portfolio, which was created for readers of my Income Investor newsletter. It outperformed its target by a wide margin in its first five years but in the latest six-month review period it suffered a setback.
The portfolio was launched in March 2012 for readers who wanted above-average cash flow and could handle a higher level of risk.
It invests all its money in stocks, so it is best suited for non-registered accounts where any capital losses can be deducted from taxable capital gains. Also, a high percentage of the payments will receive favourable tax treatment as eligible dividends or return of capital.
The initial value was $24,947.30, and I set a target average annual rate of return of 7 per cent to 8 per cent annually. Here is a review of the securities we own and how they have performed in the six months since my last review in March. Results are to Sept. 7.
The Keg Royalties Income Fund (TSX: KEG.UN, OTC: KRIUF). The units are trading at about the same price as they were in March, having pulled back from a mid-year high of around $23 due to pressure from rising interest rates. We continue to receive monthly distributions of $0.0917 per unit. The yield is 5.5 per cent at the current price.
AltaGas (TSX: ALA, OTC: ATGFF). This stock was added to the portfolio a year ago with the purchase of 100 shares at a price of $33.46. Unfortunately it has been downhill since, with the shares hit by a double-whammy of rising interest rates and softness in the energy sector. However, we continue to receive dividends of $0.175 per month and the yield is up to 7.6 per cent as a result of the price retreat.
Vermilion Energy (TSX, NYSE: VET). This is another energy stock that was hard-hit in the past six months, as the entire sector has struggled through a bear market. However, the monthly dividend remains unchanged at $0.215. The yield is now up to 6.2 per cent.
The table below shows what the portfolio looked like as of the close of trading on Sept. 7. The weighting is the percentage of the market value of the security in relation to the total market value of the portfolio. The gain/loss shows the performance of the security since inception, or since it was added to the portfolio. Sales commissions are not taken into account, and the U.S. and Canadian dollars are treated as being at par for ease of tracking.
Comments: The majority of our holdings lost ground in the latest period. Only Premium Brands posted a strong gain, up more than $20 a share. Morneau Shepell was ahead by a modest amount and we did slightly better than breakeven (including distributions) on The Keg and Chemtrade.
Overall, the total value of the portfolio fell by $798.77, or 1.8 per cent. That gives us a cumulative gain of 78.1 per cent in five and a half years, which works out to an average annual compound rate of return of 11.08 per cent. Although this is down from our last review, it is still well in excess of our target.
Changes: Premium Brands has performed exceptionally well for us from a capital gains perspective but I am uncomfortable allocating such a high percentage of the portfolio to a stock with a current yield of only 1.7 per cent. Therefore, we will sell another 20 shares at $99.69 for a total of $1,993.80. That will reduce our position to 50 shares.
We will also sell our position in Exchange Income. It is off its lows but is still under a lot of pressure. We will realize $4,153.50 from the sale, including retained dividends. That gives us a total of $6,147.30 to reinvest.
We will spend $3,444.70 of that to buy 70 shares of Enbridge (TSX, NYSE: ENB) at $49.21. The stock has been in decline recently and now yields 5 per cent. I think the shares have been oversold and any time you can get a quality company with that kind of yield and a long-term commitment to dividend hikes we should take advantage of it. The annualized dividend is $2.44.
We will spend another $2,464.50 to purchase 150 shares of Pizza Pizza Royalty Corp. (TSX: PZA, OTC: PZRIF) at $16.43. The shares have held up reasonably well in the rising rate environment and yield 5.3 per cent on an annual dividend of $0.82 per share.
After these buys, we will be left with $238.10, which will be added to our cash account.
Our poorest performing stocks right now are Medical Facilities and AltaGas. The former bounced off their bottom recently, which is encouraging. AltaGas seems deeply oversold and the yield is very attractive. Therefore, we will hold our positions here for now.
We will use some of our retained earnings to add to a few positions, as follows: