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| Monday, April 7, 2014 | Issue #2265 | |
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The Best Income Investment for the Next Five Years Alexander Green, Chief Investment Strategist, The Oxford Club
A Note From the Editorial Director: You've surely noticed something different about Investment U today. We've given the newsletter a fresher, cleaner design. You'll still find everything you've come to love about Investment U in this space - including insightful commentary from some of the world's best-known investment experts every day, and access to the very best of our expanded InvestmentU.com - but with less clutter and an easier-to-read format. Enjoy.
- Andrew Snyder
 At the Investment U Conference in Carlsbad, Calif., recently, each speaker was asked to name their "Single Best Income Idea for the Next Five Years."
I wrestled with this one for a few weeks, but I believe my final candidate was a good one. We don't ordinarily give specific investment recommendations in our Investment U columns. That's generally reserved for paid subscribers, not free e-letters.
But I am going to share this recommendation with you today because I want to reveal the thought process that went into it. Let me start at the beginning...
Five years is an eon in the investment world. (You might recall that the consensus five years ago was that the world was coming to an end.) No one knows what the investment landscape will look like in 2019.
And it is especially tough for income investors. As I've mentioned before, we are now in a period of what I call "administrative markets." Both stocks and bonds are being influenced nearly as much by the government - and especially Fed policy - as by inflation, economic growth or corporate earnings.
Why is it tougher for income investors? Because I don't think enough investors realize that when the Federal Reserve holds interest rates artificially low with its quantitative easing program, it is simultaneously holding bond prices (and especially Treasurys) artificially high.
Why would anyone want to buy something whose price is being artificially propped up by the government? Five years from now, quantitative easing is likely to be as much a distant memory as TARP (the Troubled Asset Relief Program) is now. Interest rates will normalize. Bonds, almost certainly, will produce meager returns for the next five years.
Anything that is highly sensitive to interest rate changes is likely to be negatively impacted. That includes not just high-grade bonds but preferred shares, utilities, real estate investment trusts, etc.
What to Do
So where does an income investor put his money to work for the next five years? My answer is in dividend-paying stocks.
"But wait," you might rightly ask, "what if we're in the midst of a bear market in five years?" In that case, the five-year total return on a dividend stock may well be negative. Of course, you run this risk with any stock you buy at any time, but it would clearly be safer to buy a stock in an asset class that was down instead of near a five-year high.
And we have just that in emerging markets today, an equity class that has been quietly pounded while U.S., European and Japanese stocks have pushed higher.
That means emerging markets - whatever their performance in the near term - might be a good place to look for a high-dividend-paying stock over the next five years. But we want a margin of safety. We want a company whose products are virtually guaranteed to be in demand five years from now.
Certainly energy - and especially oil and gas - fits the bill. And so I ended up recommending Ecopetrol (NYSE: EC).
Based in Bogota, Columbia, Ecopetrol is a $17 billion oil and gas producer that accounts for almost two-thirds of that country's energy sector. Earnings are likely to hit nearly $4 a share this year. That means it sells at just nine times prospective earnings.
Other financial metrics look good too. The company's operating margin is 31%. Management is earning a healthy 19% return on equity. And the company is sitting on nearly $6 billion in cash.
The stock is down over the past year for three primary reasons. The first is that oil and gas companies have underperformed worldwide. The second is that emerging markets have sold off. The third is that investors have legitimate concerns about Columbia's political situation. But this company will survive any political turmoil. And it is globally diversified, with operations in Brazil, Peru and the U.S.
Prospects Brightening
Things are looking up in Columbia from an economic standpoint. The central bank there has cut interest rates seven times in 10 months. The result is robust economic growth. The Columbian economy is growing at 5.1%.
At Ecopetrol, average daily production is up. The company's proven reserves just reached 1.9 billion barrels. That's an increase of 74% over the last four years.
What if the company depletes its reserves? Not likely. Its reserve replacement ratio is currently 139%. That means it is adding 1.39 barrels to its reserves for every barrel it produces.
And the dividend? Ecopetrol currently yields 8%. And with production rising, that dividend is likely to be maintained or increased in the years ahead.
I certainly can't tell you what the best-performing income investment will be over the next five years. But I'm willing to bet that Ecopetrol outperforms 90% of the alternatives.
Treasurys yield less than 3% and money markets pay next to nothing. Ecopetrol could drop 3% a year for the next five years and - with its dividend - still generate a higher total return than these.
Is there risk here? Of course. We can't control oil prices or the performance of emerging markets or the government of Colombia.
But emerging markets are cheap. Ecopetrol is undervalued. The dividend is secure. And this stock is likely to generate a very attractive total return over the next five years.
Good investing,
Alex
P.S. As Alex notes, the next five years could be difficult for bondholders as interest rise (and they will). Income seekers' best bet will likely be dividend stocks. And finding the best dividend payers is as easy as following the path Marc Lichtenfeld lays out in The Oxford Income Letter. Marc's fascinating new report about the "private" stock market used by the nation's wealthy elite to rake in billions of dollars is available now. To get the details, click here. | |
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Every month, The Oxford Club's editors get together to discuss what trends they expect to see in the upcoming month. From the sectors to watch to Alex Green's taxes, The Editors Roundtable will give you the inside scoop on what the experts are thinking - and what they're investing in. Read On... | |
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The U.S. grid is a century-old patchwork of 450,000 miles of high-voltage transmission lines and 5,800 major power plants. According to a White House report, most of the current transformers are two years older than their predicted lifespans and the entire system has had very little TLC. Read On... | |
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