The market seems to be following the old investment idiom, sell in May and go away. The S&P 500 has fallen almost 6% since the beginning of May and the 10 Yr US Treasury note has seen its yield slide 12% in the same time frame, as investors flock to fixed income safe havens. Foreign bond options appear increasing destitute as economic uncertainty shake their financial positions and the US treasury yields look to be a much more attractive option for foreign investors facing negative interest rates, further driving down US Treasury rates.
I discussed the negative implication that these lowering interest rates have on banks in my article, Global Interest Rates Fall: Banks Aren't Happy. In this article, I will take a look at stocks that thrive as interest rates decrease. More specifically, high yield stocks that investors will flock to as bond yields tumble.
Utility Stocks
Utility stocks have a similar flight-to-quality effect that treasury bonds do because of their consistent cash flows and dividend payouts, which is typically higher than the yield that treasury bonds can boast. In this uncertain market period, it is important to have some type of low beta utility stock in your portfolio to hedge some of the risks. Here I will take a look at a utility stock I like as well as entry and exit strategies.
Dominion Energy D
I’ve been watching Dominion energy for about a year now, and over the past 52-weeks this utility powerhouse has outperformed not only the utility sector but also the broader market. Below you can see D’s (blue) 52-week performance, having gained 16.7%, compared to the S&P (red), which has only been able to return investors 2.2% in the same time frame.
Utility stocks like Dominion will continue to outperform the broader market in times of volatility. Dominion is able to boast of a 4.8% dividend, considerably higher than 3% average in the utility industry. As investors see rocky waters in the equity market and treasury yields dropping, a 4.8% yield in a growing utility company appears to be a savvy buy. D’s beta is 0.23, making it an excellent portfolio hedge.
Dominion has been bouncing around the mid-70s range for the past month. I would buy D closer to $70 and hold until the equity market stabilizes.
MLPs
Master limited partnerships are set up so that profits are only taxed when they are distributed to investors. All available income is required to be distributed to shareholders making these stock very high yield. These types of firms are useful in capital intensive sectors such as energy. These won’t have the low beta hedge of utility stocks but they achieve a much higher yield.
Enterprise Products Partners EPD
EPD is a midstream oil and natural gas firm that focuses on connecting producers with consumers. Its operations include 49,200 miles of pipeline and have a capacity of approximately 260 million barrels to store crude, LNG, and other commodities/products.
Enterprise Products has been able to grow its margins considerably over the last 5 years, from below 8% gross margins in 2014 to the north of 15% that EPD is able to achieve today. Their bottom line has been able to attain very consistent growth with profits more than quadrupling in just 10 years.
EPD has shown investors 17% total returns so far in 2019 and it looks like these returns may endure. This stock has beaten the last 4 quarters of earning by double-digit percentages and analysts have continued to raise EPS estimates propelling this stock into a Zacks Rank #1 (Strong Buy).
EPD has a beta very close to 1, implying that it will follow the broader equity market closely. This is a great buying opportunity if you believe that the equity market will stay afloat for the next 12 to 18 months.
REITs
Real estate investment trusts are very similar to MLPs in that they are required to distribute almost all of their earnings to investors, meaning that these stocks will return investors a hefty dividend. There are all types of REITs, including residential, commercial, medical, or even tech REITs that are used to house servers. REITs will typically do better as interest rate fall due to the higher yield becoming sufficient return for the added risk of an equity investment.
The GEO Group GEO
GEO is a REIT that focuses on private correction & detention facilities, making up 64% of their top-line. They also have a business segment called GEO Care, which assists with rehabilitation as well as proprietary electronic monitoring business that they are able to contract out to the government. Their fasted growing business unit is their international segment which, has grown 30% in the past year.
GEO has shown consistent top line returns over the past 5 years as well as a strong bottom line, but the stock has not been able to reflect this performance. Over the last 52-weeks, this stock has fallen more than 15%, far below any benchmarks performance.
With this poor performance comes low valuation metrics across the board. GEO’s forward P/E is 8x, far below the industry average of 17.1x. The firm is also trading at a forward EV/EBITDA of 10.9x significantly below the industries 18.8x. GEO is estimated to grow both bottom and top lines in the mid to upper single digits this year and continue that growth moving forward. GEO still boasts an 8.8% dividend yield which should make any investor feel warm and fuzzy inside.
Analysts have increased full-year estimates a significant amount in the past month propelling this stock into a Zacks Rank #1 (Strong Buy). This stock is perceivably undervalued and would make a great value buy with the bonus of a massive yield.
Take Away
Falling interest rates create an opportunity for investors to get long in some high yield options. As American and foreign investors continue to drive up bond prices and pull down yields these investments that I have discussed appear increasingly attractive. Make sure your investment strategy lines up with the high yield investment option, whether you are trying to hedge risk with a utility stock, follow the market with the MLP or take a chance with my low cap REIT option.
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