monthly dividend stocks investing

3 Best Monthly Dividend Stocks for Passive Income

Note: Post may contain affiliate links.

I’m revealing my three favorite monthly dividend stocks as well as what to look for and the risks in dividend investing.

By the end of this video, you’ll not only have three stocks to start your dividend portfolio but how to value three special types of dividend companies.

We’re building a huge community of people ready to beat debt, make more money and make their money work for them. Subscribe and join the community to create the financial future you deserve. It’s free and you’ll never miss a video.

Join the Let’s Talk Money community on YouTube!

Why I Love Monthly Dividend Stocks

Now I love dividend stocks but most only pay out four times a year. That can make it difficult to plan for paying expenses or as a passive income stream.

That’s where monthly dividend stocks come in, companies with a policy and a history of returning cash to investors every single month. Even better, these stocks have a median yield over 8% annually, that’s over four-times the dividend yield of the broader market.

These are some great opportunities to create that monthly cash flow that’s either going to grow your portfolio or give you that extra cash each month to pay the bills.

Now I am going to warn you, these monthly payers tend to be in just a few business types. We see here that about 40% of monthly payers are real estate investment trusts, another 38% are business development companies and then some energy companies, usually master limited partnerships.

Types of Monthly Dividend Stocks
Types of Monthly Dividend Stocks

There’s a reason for this we’ll talk about and why these cannot be your only investment in dividend stocks. Again, do not think you can put together a portfolio of just these monthly dividend stocks because it’s going to put your money at risk.

In this video, we’ll look at how to find these monthly dividend stocks and how to get started investing. I’ll reveal the process I use for picking stocks along with the warning signs. I’m then going to highlight my three favorite monthly dividend stocks and why I’m investing.

Join us for the 2019 Grow Your Dough Challenge! Watch the first video in this year-long stock market challenge with some of the biggest names on YouTube!

How to Invest in Monthly Dividend Stocks

So subscribers already know why I love dividend stocks. Those cash returns are always positive even when the market tanks and dividends account for as much as 70% the total return to stocks in some years.

Now you can create a nice monthly payment from regular dividend stocks but the planning it takes to match those quarterly payments means you want some monthly payers to fill in the gaps.

The downside is that you don’t want all your portfolio in these monthly payers. Like we saw in that graphic, putting all your money here is going to grossly expose you to just a few business structures.

These companies set up as BDCs, REITs or MLPs get special tax breaks but have to pay out almost all their earnings as dividends. That means they tend to have volatile share prices, they have to raise money regularly through debt or equity and they are highly exposed to rising interest rates.

These monthly payers also tend to be much smaller companies than other stocks.

For example, of the 28 legit monthly payers I follow, the average size is just $723 million with the largest only a $20 billion company. That might seem like a lot but it’s miniscule next to a trillion dollar company like Amazon or Apple and none of the S&P 500 companies pay monthly dividends.

The fact that they are smaller companies with less financial flexibility means you need to stay up on all the usual warning signs for dividend stocks. These include sales growth, debt leverage and some other signs you need to watch.

I published a video on the three warning signs for a dividend cut a few months ago that I highly recommend to all dividend investors and you can watch here.

Another thing you have to understand investing in these monthly dividend stocks is you have to understand the business and can’t value them like other stocks. The real estate and energy companies take huge amounts of depreciation that makes their reported earnings completely useless so you can’t use the price-to-earnings ratio you use on other stocks.

You also need to understand the management structure in those business development companies, the BDCs. It’s either going to be external or internal management which is going to make a big difference on their compensation.

External management is usually compensated by growth in the company’s invested assets, so they want to make as many investments as possible even if they aren’t necessarily great investments. Internal management compensation is tied more directly with investor returns.

Being able to understand these business models and what makes for a solid competitive advantage at a company means it’s usually better to focus your individual stock investing on no more than a few industries or business models.

Most investors don’t know it but this is actually the way Wall Street works and how most analysts invest. They have deep knowledge and maybe even work experience within a specific industry. Those are the stocks they analyze and invest, then the rest of their money is in broader market funds.

This is what Peter Lynch was talking about when he said ‘Invest in what you know.’ Most people think it’s merely a matter of buying and liking a product but it actually means having deeper knowledge into how that business runs.

Yeah, sorry. Liking Campbells’ chicken noodle soup isn’t a good reason to invest in the stock.

So let’s look briefly at those three business models; MLPs, BDCs and REITs including how to value these companies and what to watch for. Then I’ll reveal my three favorite picks from the group to get your dividend portfolio started.

monthly dividend stocks investing

What are MLPs?

MLPs are a company set up to own energy assets, usually oil or natural gas pipelines and storage facilities. MLPs get a fee from energy companies for letting them use those pipelines and storage.

This is one of the benefits to MLP investing is that profits don’t necessarily depend on the price of oil. The stock price is going to bounce around a little if the price of oil jumps or crashes but the company is still collecting those fees on the volume of oil pumped through the pipelines.

Compared to an oil company where sales are directly affected by the price of oil, MLPs are a little safer here because of those fees.

Since MLPs pass their income and expenses on to investors through special reporting, the company doesn’t pay taxes. That’s a very efficient way to hold the assets and it’s why many oil companies have sold off their pipelines into an MLP company.

With MLPs you don’t get that double taxes problem you get with regular companies where the company pays taxes on profits first then investors pay taxes again on any returns.

Another benefit to MLPs is that the cash return you receive isn’t all taxed in the same year either. Some of those dividends count to lower your cost in the shares so you don’t pay taxes on them until you sell the stock. And if you pass these through to your heirs in an estate, taxes are never paid on that portion of the return.

Because they pass almost all the income on to investors, MLPs have some of the highest cash return of any types of stocks. The dividend on the Alerian MLP ETF, a fund that holds shares of MLPs, pays an 8.4% annual dividend yield.

There is one downside to MLPs I want to point out before getting to how to value these stocks and my two favorite MLP picks. MLP investors get a K-1 form, a special tax form each year, from the company that details the return. This means a little more work at tax time to report the investment but any online tax software makes it easy to file taxes on these.

Now on to how to value an MLP. Remember, you can’t use the price-to-earnings ratio here. These companies have a huge amount of depreciation that makes earnings misleading but it doesn’t affect actual cash flow.

So what we’re going to do is use what’s called price-to-distributable cash flow or price-to-DCF. Finding this value for distributable cash flow, the amount of money the company has available to return to investors, is important also because it gives us an idea of sustainability. A company can’t pay out more than is available forever so it’s a good metric to make sure that dividend isn’t going to be cut any time soon.

I’ll show you how to calculate DCF yourself but all MLPs will calculate it on their reporting. I do it myself only because I like to double-check the numbers coming out of the company and make sure I’m comparing stocks with the same calculation.

Here’s the table, and again don’t get freaked out because this is always provided to you in reporting. To find how much money the company has available to distribute, you take the cash flow from operations, this is all going to be found on the Statement of Cash Flows, and you remove any spending on capital and income from non-controlling interests. That gives you sustainable DCF which is what the company can return to investors and still keep operations running smoothly.

how to value mlp stocks

While sustainable DCF is a better measure, most people use the DCF as reported because it’s sometimes the only number reported. To get to DCF, you also add back that income from non-controlling interests as well as working capital reported.

The big one here is adding back this proceeds from asset sales. This is technically proceeds the company can return to investors, a company can’t forever be selling its assets and still keep business running so that’s why we use that sustainable DCF if it’s available.

With this number, you can find that valuation with the price-to-DCF or you can find how much the company is returning to investors for what’s called the distribution coverage ratio. This is how much DCF the company earns versus how much it pays out.

This last measure is important because an MLP that pays out more than it’s Distributable Cash Flow can’t do so forever. You see here the coverage ratio for a group of MLPs and that the average is around a DCF that’s 1.2 times the distribution. This means the company has cash flow about 20% higher than what it’s returning but you also see some companies here that save back more or much less.

What are REITs?

For real estate investment trusts or REITs, REITs are special companies set up to manage commercial real estate and pay out the cash flow to investors. REITs can specialize in a property type so apartments, office, retail, warehouse and self-storage or they can hold a mix of properties.

Most REITs hold properties across the country so it’s a great way to diversify your portfolio of individual properties, getting exposure to other regions and property types.

REITs pay no corporate taxes as long as they pay out at least 90% of income to investors so like MLPs this makes for a great way to manage property, avoid that double taxation and means huge cash dividends for investors.

There are primarily two types of REITs, an equity REIT which actually owns the properties and a mortgage REIT which invests in real estate loans. Now these mortgage REITs pay higher dividends but they tend to be more volatile, especially when interest rates are rising. I’ve invested in mortgage REITs but prefer equity REITs as a better long-term investment.

Just like with MLPs, you can’t rely on reported earnings for a REIT because of that high amount of depreciation they get from real estate. Instead, we use a measure called Funds from Operations or FFO.

how to value reit stocks

FFO is very similar to that DCF we saw with MLPs. You take the reported net income of the REIT and add back depreciation but minus out any gains they made on property sales. Those property sales are a source of income but not something the REIT can do forever and expect to stay in business.

Investors also look at the adjusted funds from operations this AFFO, which takes out capital expenditures. Capex here is money the company spends to keep its properties in good shape so maintenance spending. Remember, the idea is to find how much cash the company has available to distribute without cutting into money it needs to run the business.

What are BDCs?

Finally, Business Development Companies are special financing companies that fill the gap for loans and small business. These companies set up a closed end investment fund to make debt and equity financing to small and medium-sized companies.

After the financial crisis, regulation like Dodd-Frank and Basel III made it harder for traditional banks to make loans to small business. Banks had to keep only higher-quality assets on their balance sheet which meant they couldn’t make these riskier loans. So BDCs stepped up to fill that gap and provide huge dividend yields in the process.

The most important thing to consider when looking at BDCs is the management structure. Most of these are externally managed which means management doesn’t actually work directly for the company. Compensation for these is usually based on a base fee plus performance of the net asset value. This means a higher cost structure and management rewards that aren’t necessarily aligned with shareholder returns.

Besides the higher cost, external management isn’t required to disclose its compensation which can mean conflicts of interest. These managers have to reach for riskier loans and investments to justify their higher costs so that can mean a lot more risk for investors. This is why I generally only invest in BDCs with internal management so I can see exactly what management is earning and how it’s compensated.

Looking at BDCs, you want to look at the portfolio yield in the financial statements. This is the average rate earned by the company on its different loans and there’s two things you want to look at here. First, it’s a good sign when a company’s portfolio yield is at or below industry averages.

That might seem counterintuitive looking for a lower-than-average yield but that lower yield usually means less risk in the loans and a more conservative management. You also want to check the portfolio yield against the dividend yield on the stock. A portfolio yield above the dividend means management can easily support that payout and your dividend isn’t in danger of being cut.

Besides that portfolio yield, with BDCs, you also want to look at the company’s net asset value or NAV. BDCs issue new shares frequently to raise money for growth so even if the NAV is growing, you want to make sure the NAV-per-share is growing. That means you’re not getting diluted by new shares being issued. NAV-per-share might not grow much faster than low- or mid-single digits a year but just consistent positive growth is what you’re looking for.

The Best Monthly Dividend Stocks for 2019

So I know this has been a lot to look at but these are very different types of companies with their own advantages and risks. I’m going to reveal my favorite monthly dividend stocks next but I want you to be ready to look at these stocks yourself and understand exactly what you’re getting into.

Our first monthly stock is Gladstone Commercial, ticker GOOD, a diversified real estate investment trusts with industrial and office property across the U.S.

Monthly Dividend Stocks REITs
Monthly Dividend Stocks REITs

Gladstone operates in the net leased market for its properties meaning the tenant pays almost all the costs. This means rates are lower but also much lower risk and operating costs for the company.

Occupancy on 99 properties in 24 states is 97.9% which is excellent for a real estate portfolio. The fact that it is almost 100% leased speaks to the quality of property and management. Average lease term remaining on the properties is 7.5 years with average term on mortgage debt of 6.5 years.

Gladstone pays out an 8% annual dividend on a monthly basis and has returned 9.2% a year over the last five years. The company has produced a fairly consistent funds from operations of $1.54 per share which is just slightly over the annual dividend paid.

Our next dividend stock is Sabine Royalty Trust, ticker SBR, an energy trust established in 1982 on landowner’s royalties and other energy assets.

Monthly Dividend Stocks MLPs
Monthly Dividend Stocks MLPs

The company has an oil and gas portfolio that covers over two million acres in Florida, Louisiana, Mississippi, New Mexico, Oklahoma and Texas. Reserves on the assets are estimated to produce for at least another eight to ten years and the parent company regularly explores for new assets.

The trust grew distributable income by more than 28% to $2.32 per share in the first nine months of 2018 versus the same period in the previous year. It pays out nearly all that in the distribution, so I’d like to see a little more leeway, but that’s an amazing increase and shares pay a solid 8.4% dividend.

Our third dividend stock is Main Street Capital, ticker MAIN, a business development company specializing in long-term debt and equity investments.

Monthly Dividend Stocks BDCs
Monthly Dividend Stocks BDCs

Main Street reports one of the lowest management fees as a percentage of its portfolio in the industry and is internally managed. The company is one of the few legacy BDC companies from before the financial crisis. I like that because it means management understands the loan cycle and how a recession is going to affect the business.

Main Street’s portfolio yield is around 11% which is under the industry average of 14% and well above the dividend. The shares pay a marginally lower dividend yield at 6.2% but with price appreciation have produced a 10.3% annualized return over the last five years.

I’d love to hear about your favorite monthly dividend stocks and what you look for in dividends. Be sure to scroll down and tell us in the comments, how do you invest in dividends.

Sharing is caring!

Leave a Reply

Your email address will not be published.

Scroll to Top