Investors Alley

Today we’re going to talk about “shareholder yield” and other things that will help you be a better investor (read: make more money)…

We’ll cover value investing, diversification, foreign stocks, and more.

And I’m doing it all with fellow value-oriented quant, Meb Faber of Cambria Investments. I’ve known Meb for years, and believe me when I tell you, if you want to be a successful investor in the months and years to come, you want to hear what he has to say.

Let’s get to it…

Meb Faber is a co-founder and the Chief Investment Officer of Cambria Investment Management. He is the manager of Cambria’s ETFs and separate accounts, and also hosts The Meb Faber Show podcast in addition to having authored numerous white papers and leather-bound books.

He is a frequent speaker and writer on investment strategies and has been featured in Barron’s, The New York Times, and The New Yorker. Mr. Faber graduated from the University of Virginia with a double major in Engineering Science and Biology.

Many expect that hydrogen can and will be a carbon-free substitute for natural gas. My research shows that existing manufacturers and energy midstream companies could handle much of the transition.

These facts heighten the long-term investment potential of the companies that will produce and deliver hydrogen to utility companies.

Let’s talk about what “green hydrogen” is – and what the companies that could profit from its rise are…

Hydrogen, as a single molecule gas, burns without emitting any carbon. The current primary use of hydrogen is to produce ammonia, which is used as a fertilizer. Typical hydrogen production involves breaking down natural gas to capture the hydrogen. If the hydrogen producers capture the released carbon rather than allowing it to enter the atmosphere, the hydrogen is called blue hydrogen.

Green hydrogen, on the other hand, comes from the electrolysis of water. Burning blue or green hydrogen produces clean electric power.

The challenge with hydrogen is that it is tough to transport and store, which brings us back to ammonia. The chemical formula for ammonia is NH3—one molecule of nitrogen with three of hydrogen. An article on the ETF Trends website noted that it is less flammable than hydrogen and can be stored at higher temperatures. These features make ammonia potentially the optimal way to transport and store hydrogen that will be used to generate electrical power.

Ammonia is already widely used as a fertilizer. It is the best way to deliver nitrogen as a plant nutrient. As hydrogen grows in popularity as a power source, the demand for ammonia should grow tremendously. In the U.S., CF Industries (CF) is by far the largest producer of NH3.

The ETF Trends article highlights that energy midstream companies that process, transport, and store natural gas already own and operate the infrastructure to deliver ammonia or hydrogen to end-user utility companies.

The article mentioned Canadian pipeline company Enbridge (ENB), which will build a blue hydrogen ammonia production facility at its energy center in Texas. Also mentioned was the transportation network, EnLink Midstream (ENLC).

From my Dividend Hunter recommended portfolio, ONEOK, Inc. (OKE) operates one of the nation’s largest natural gas distribution networks.

The trend of using ammonia as a fuel source to generate electric power is just starting. It is one to watch.
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Sometimes large block options trades can leave you scratching your head. For example, why would Nikola (NKLA), a publicity- challenged electric truck company, have a 50,000-lot 3-way spread trade in its options? After all, the stock is only trading around $1 per share. It looks like this could be a cheap put spread collar for

The 2022 bear market took the real estate investment trust (REIT) sector down, along with the broader stock market. Most of the stock market bottomed in October 2022, but has recovered a significant portion of the bear market losses.

REITs have not participated in the recent market gains, with share prices remaining near their 18-month lows.

Here’s why – and why now is the perfect time to buy REITs, especially this one…

REIT share prices are very interest rate sensitive, so as the Fed kept increasing rates, the REIT sector kept falling. For example, the Vanguard Real Estate Index Fund ETF Shares (VNQ) peaked around Christmas 2021 and even now is trading near its October 2022 lows. VNQ currently trades down 28% from the 2021 high.

When a market sector declines steeply, it takes the good companies down with the bad. Now that the Federal Reserve has announced the bulk of its expected rate increases, it is an excellent time to pick up beaten-down REIT shares.

The best REITs are those that will steadily grow their dividend rates. Investors often just think about dividend yields when researching REITs. The truth is that dividend growth can drive very attractive total returns. I look for REITs that will grow annual dividends by at least high single digits. Double-digit growth is even better (and rare).

National Storage Affiliates (NSA) is a $4.5 billion market cap self-storage REIT. The company owns 1,117 properties located in 42 states. Sixty-six percent of these properties are located in Sunbelt states.

National Storage employs its unique Participating Regional Operators (PROs) strategy to grow the business. PROs are self-storage companies that have contributed their properties to the company in exchange for equity, while continuing to function as property managers. PRO companies benefit from ownership of NSA stock and corporate support and earn from their contributed properties. The PROs often use the structure to move to full retirement eventually.

The PRO deals plus third-party acquisitions allowed National Storage to post the fastest growth in the self-storage REIT space. NSA’s five-year return through the 2023 first quarter was more than 50% greater than the second-best self-storage REIT (185% to 120%).

However, at $35, National Storage is down about 50% from the 2021 peak value. Self-storage was a hot pandemic sector, and the stock went from $25 in early 2020 to $70 in late 2021. The wind-down of the pandemic trade pulled a lot of investor money out of the self-storage stocks.

The NSA dividend continues to grow. The current dividend is 70% higher than the 2020 first-quarter payout. The dividend increased by 10% over the last year, even as the share price tanked. NSA has a five-year compounding dividend growth rate of 14.7%.

NSA currently yields over 6%, compared to a pre-pandemic average of 4%. From here, with a 6% yield and 10% dividend growth, an investment in National Storage should generate a CAGR of at least 15%. As interest rates moderate, the stock could quickly return to $50 per share.

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The stock market offers pockets of opportunity in sectors that combine a decent dividend yield with a good quality business. In other words, growth and income.

One such sector is the pharmaceuticals sector, which overall has lagged the S&P 500 in the past five years, although not by much.

There are, no doubt, some world-class companies in this sector. One candidate that caught my attention is Merck & Co. (MRK), even though its yield is just 2.67%. Let me tell you why…

Merck’s Blockbuster Drug

The company’s stock—trading at about $110 a share—is up 87% over the past five years and nearly 25% over the past year, although it is slightly down year-to-date. Merck’s share price has beaten the S&P index by 60% in the past 12 months.

The key factor behind the rise in Merck’s share price rise is its blockbuster cancer immunotherapy treatment, Keytruda, accounting for more than a third of Merck’s sales. In the first quarter, Keytruda accounted for 40% of revenues, coming in at $5.8 billion, up 20% year-on-year.

The treatment, approved in 2014, harnesses the body’s own immune system to fight cancers. And the results have been impressive, to say the least: it has led to a five-year survival rate in about one-quarter of advanced lung cancer patients, compared to 5% of people historically.

In 2022, Keytruda’s sales hit almost $21 billion and looks to be on its way to an annual figure that industry analysts suggest will top out at almost $60 billion. This growth comes despite the cost of Keytruda being very controversial in some circles—its list price is about $185,000 per patient per year.

Merck is looking to keep this gravy train on track. That’s why it’s looking to patent a new formulation of Keytruda that can be injected under the skin, allowing it to protect its best-selling drug from biosimilar competition, expected as soon as 2028.

The company is running clinical trials on two versions of the drug that can be injected under the skin. This is a quick alternative to infusions, the current delivery method, in which patients receive an intravenous drip in a health office once every three or six weeks. The new formulation will likely replace the current one in most cases, and its success will be crucial to Merck’s future.

On average, Wall Street analysts expect Keytruda revenues to top $30 billion in 2026 and $35 billion by 2028, according to Refinitiv data. However, BMO Capital’s Evan Seigerman told Reuters that private insurers in the U.S. may balk at paying for the more expensive branded product and prefer a biosimilar infusion version. Nevertheless, he believes the new formulation could allow Merck to hold onto as much as 20% of its Keytruda revenue into the 2030s.

Merck’s Long-Term Prognosis

The company’s future looks healthy.

Importantly for longer-term cash flows, Merck’s core products—Keytruda, as well as the human papillomavirus vaccine (HPV) Gardasil (sales up 35% to $2 billion in the first quarter)—continue to post strong gains.

Despite being on the market for a relatively long time, these products should continue to drive growth thanks to their high efficacy and expanding markets. These include adjuvant indications for Keytruda and expansion into the world’s developing markets for Gardasil.

The company has some potential future blockbuster drugs in the pipeline too. For instance, Merck’s phase 3 data for the pulmonary arterial hypertension (PAH) drug sotatercept was excellent, with an improvement of 84% in event-free survival. A key unmet need in pulmonary arterial hypertension is a lack of disease-modifying, curative therapies. But that may now change soon, thanks to sotatercept.

Originally developed by Acceleron Pharma, sotatercept is the only drug to have achieved breakthrough therapy designation in the U.S. for PAH, alongside orphan designation in the U.S. and the EU. Merck acquired Acceleron Pharma and its pipeline of therapies in September 2021 for $11.5 billion, with sotatercept being the key drug.

It looks like this acquisition has paid off for Merck, which has positioned it as a top competitor, with the potential to overtake the current leader in the PAH space, United Therapeutics. I believe the drug will be a home run for Merck.

MRK Stock

Regarding distributions to shareholders, Merck’s dividends and share repurchases are secure. Merck has generally targeted close to a 50% payout in dividends as a percentage of normalized earnings, which seems right for a mature industry. And Merck has shown a willingness to buy back stock at generally favorable time periods.

Morningstar analyst Damien Conover put it this way: “Merck supports a strong dividend yield that looks secure based on a wide diversified portfolio of drugs.”

MRK stock is a buy anywhere in the $105 to $115 price range.
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Due to the collapse of multiple banks in March, we’ve seen regional banks stay depressed in pricing.  There’s been little pop back to the upside.  And, as more people wake up to the fact that keeping your money in low-interest checking accounts isn’t smart… We could keep seeing more deposits flee the small banks.  However

For dividend growth investors, above-average dividend growth plus an above-average dividend yield equals a stock to buy and hold forever. Simple math will turn this type of stock into a long-term wealth builder.

That may sound too good to be true. But it doesn’t have to be. Take today’s stock…

The dividend growth from NextEra Energy Partners LP (NEP) may appear too good to be true. Also, with this company, traditional financial analysis does not work. How the company is organized gives investors confidence that the dividend growth can continue.

NEP increases its dividend every quarter and has grown its payout for 27 consecutive years. Annual dividend growth has averaged in the low teens.

The company’s website gives this overview of the NEP business:

NextEra Energy Partners, LP (NYSE: NEP) is a growth-oriented limited partnership formed by NextEra Energy, Inc. (NYSE: NEE). NextEra Energy Partners acquires, manages, and owns contracted clean energy projects with stable, long-term cash flows. Headquartered in Juno Beach, Florida, NextEra Energy Partners owns interests in wind and solar projects in the U.S.

How NextEra Energy has structured its businesses has turned it into a renewable energy juggernaut.

Florida Power and Light is the regulated utility subsidiary of NextEra. FPL currently operates 4,600 MW of solar power generation. The company’s ten-year plan included adding 20 GW of renewable energy.

NextEra Energy Resources is the development subsidiary of NextEra Energy. This business has 31 GW of clean energy in operation. The assets are valued at $75 billion. The owned assets cover the U.S., and the power is sold to many different utility companies. Energy Resources has a 20,400 MW backlog of development projects.

NextEra uses NextEra Energy Partners to monetize assets developed by the Energy Resources division. Renewable energy assets with long-term contracts to deliver power are sold to NEP at a price to allow NEP to sustain the dividend growth target. This structure enables NEP to generate steady growth. The company is now the world’s seventh-largest generator of wind and solar power.

NextEra Energy Partners currently owns and operates 9.3 GW of wind and solar power. Assets located in 30 states provide contracted power to 98 customers. The contracts have an average remaining life of 14 years.

The business model under which Energy Resources develops new renewable energy assets and then, when they are contracted, sells assets to NextEra Energy Partners, means that the NEP revenue and profit growth are close to 100% predictable. Energy Resources has up to 58 GW that could be transferred to NEP.

The NEP dividend has grown by about 3% per quarter, giving mid-teens annual growth. NextEra management forecasts 12% to 15% yearly growth through 2026. They update this forecast several times a year, so it always goes two to three years out. NEP currently yields 5%.

Over the long run, the annual compounding total return will end up very close to the average yield plus the average dividend growth rate for a dividend growth stock. In the case of NEP, investors have the potential to earn close to 20% per year through at least 2026.

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Last week, the Federal Reserve decided to pause its rate hiking efforts to slow down inflation.Fed Chair Jerome Powell made it clear that the central bank is not done fighting inflation yet, and that this is just a brief pause to allow the committee to observe how the rate hikes impact the economy.From where I sit, they are slowing economic activity without pushing inflation back to the 2% level.Here’s what that means for stocks…

The Fed made it clear that it is not done raising rates, as the infamous dot plots call for two more rate hikes this year, increasing the terminal rate to 5.6%.

Fed officials expect to see rate cuts starting in the first quarter of next year and continue until Fed funds rates are back under 3%.

Over at the Chicago Mercantile Exchange, the Fed Watch tool shows that traders expect similar results. Traders expect hikes in July and see the possibility of more hikes later in the year.

By the first quarter, market participants expect to see rate cuts with Fed funds dipping below 4%.

What does this mean for stocks?

That is probably the wrong question, with the index at 25 times earnings and the NASDAQ 100 PE now well over 30. Markets are overvalued, and the economy is expected to slow.

This is not a recipe for broad market success.

Putting cash into undervalued sectors like banking and real estate investment trusts is fantastic, however—especially on pullbacks. (Of course, you must avoid most office REITs until we see pricing that better reflects the reality of big city downtown office properties.)

The biggest opportunity is right in front of you, and most people are going to ignore it.

Unfortunately, most investors will pay attention to the headlines, click chasers, and focus on AI stocks at nosebleed valuations.

Historically chasing these big stories could work out better.

Many of you will embrace your inner Jesse Livermore and decide that you are a trader and use options to lock in these huge gains using the secrets of the ultra-elite to get rich.

But the ultra-elites’ real secret is that they do not use options trading to build their wealth. They own assets and businesses that produce cash flows.

Right now, one of the biggest opportunities for high total returns is not in stocks. In fact, current valuations, persistent inflation, and expectations for slowing economic activity as the year progresses, make the most popular stocks a poor bet.

The path for the fed funds rate laid out by both traders at the Chicago Mercantile Exchange and officials at the Federal Reserve are very bullish for fixed income.

Buying higher-grade corporate bonds and preferred stocks will pay off with outstanding total returns over the next year as rates peak and begin to normalize.

Even if they peak and plateau, investors who use market volatility to put money into fixed income should see returns that make equity investors blush with envy over the next year or two.

In my not-always-so-humble opinion, the best way to take advantage of this opportunity is with the heavily discounted fixed-income funds we have been buying in Underground Income. Both our taxable and tax-free portfolios have the potential for monster gains, in addition to high levels of current income.

While I prefer closed-end funds to exchange-traded funds, some ETFs can help you participate in the opportunities I see in fixed-income markets.

One is the Virtus InfraCap U.S. Preferred Stock ETF (PFFA). Jay Hatfield, the manager of this fund, is the best manager of preferred stocks in the entire ETF in the money management business. The fund currently yields more than 10% right now, and there is solid upside potential in response to eventual interest rate cuts.

I also like the JPMorgan Core Plus Bond ETF (JCBP) at its current levels. This ETF invests in high-quality bonds, including U.S. Treasuries, and will be a major beneficiary of the pause, hike, cut scenario.

Be smart with this ETF and make volatility your friend. Buy a few shares on days when bonds are down big in response to headlines. Accumulate on down days, collect the income, and plan on selling much higher next year.

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In the first part of my look at Nvidia (NVDA), I stated that most of the hype surrounding the company comes from the belief it will be the leader in the parallel computing era.

Jefferies analyst Mark Lipacis refers to this as “the fourth tectonic shift in computing.” The first computing era was that of mainframes. This was followed by a move to minicomputers, then PCs, and finally mobile phones.

Now, according to Lipacis, we are moving into the era of parallel computing. And that’s going to pay off big for Nvidia…

Graphics processing units, or GPUs, allow faster computing because they use matrix calculations rather than linear calculations. This is known as parallel computing. To process this much information, the GPUs need hundreds of “cores” as opposed to the handful that sit on central processing units (CPUs).

In simple terms, the more GPUs that can be strung together, the more computing power there is. The largest computers currently will have around 10,000 GPUs.

Nvidia’s Plan Comes Together

Nvidia did not end up on top of the AI world at the moment by chance. The company has literally been working for decades to command the parallel computing ecosystem, much as Apple (AAPL) ended up controlling the mobile phone era.

In the popular 80s TV show, The A-Team, the leader of the eponymous squad was Colonel John “Hannibal” Smith, played by actor George Peppard. His catchphrase became very popular: “I love it when a plan comes together.”

I feel certain Nvidia’s co-founder and CEO Jensen Huang says that phrase every day.

Looking back, it is easy to see how Nvidia’s plan came together.

In 2006, the company invented an interface called CUDA, which is needed to write programs for its GPUs. Most AI engineers now use CUDA, which means it is difficult for them to work with other parallel computing chips and they are pretty much locked into the Nvidia ecosystem.

The next key step in Nvidia’s plan came with the $6.9 billion acquisition of Mellanox in 2019. This is a company that sells its specialized Infiniband cables that connect GPUs to each other. A single GPU is fine for a gaming computer, but to train a large language model with billions of parameters you need to string together thousands of GPUs. For example, the Microsoft supercomputer used to train ChatGPT has more than 10,000 Nvidia GPUs strung together via Mellanox cables.

Apple has dominated the mobile phone era by selling both the hardware and software, which is just what Nvidia’s plan wants to accomplish in parallel computing.

Next let’s look at what is powering Nvidia’s rise to the top of the AI world, its H100 chip. It is based on a new Nvidia chip architecture called “Hopper,” named after the American programming pioneer Grace Hopper.

Hopper was the first architecture optimized for “transformers,” the approach to AI that underpins OpenAI’s “generative pre-trained transformer” chatbot. It was Nvidia’s close work with AI researchers that allowed it to spot the emergence of the transformer in 2017 and start tuning its software accordingly.

The unusually large chip is an “accelerator,” designed to work in data centers. It has an incredible 80 billion transistors—five times as many as the processors that power the latest iPhones! While this new chip is twice as expensive as its predecessor, the A100 (released in 2020), early adopters say the H100 boasts at least three times better performance.

And while the timing of the H100’s launch was a bit lucky, Nvidia’s breakthrough in AI can be traced back directly to its innovation in software—the aforementioned Cuda software, created in 2006, allows GPUs to be repurposed as accelerators for other kinds of workloads beyond graphics.

Again, I want to emphasize how Nvidia was prepared for this AI-led generation of computing. Even back in 2012, Ian Buck, currently head of Nvidia’s hyperscale and high-performance computing business, said, “AI found us.”

Nvidia today has more software engineers than hardware engineers. This enables it to support the many different kinds of AI frameworks that have emerged and make its chips more efficient at the statistical computation needed to train AI models.

GPUs’ Skyward Growth Path

Jefferies analyst Mark Lipacis said: “The data shows that each new computing model is 10 times the size of the previous one in units. If cell phone units are measured in the billions, then the next one must be in the tens of billions.”

Lipacis’s analysis suggests much higher revenues are on the way for Nvidia—and he looks to be correct. Here’s why…

Language models get better by increasing in size. GPT-4, the latest system powering ChatGPT, was trained on tens of thousands of GPUs, and the forthcoming GPT-5 is reportedly being trained on 25,000 Nvidia GPUs.

The tech research firm TrendForce estimates that the GPU market will grow at a compound annual growth rate of 10.8% between 2022 and 2026, as companies scale up capacity to meet demand.

Meanwhile, a lack of hardware (GPUs) could put a limit on the number of models that can be trained. This shortage of supply enables Nvidia to charge a high price for its GPUs. Analysts are expecting its operating margin to rise to 41% next year, compared with a five-year average of 29%.

It was not long ago—in 2022—when Nvidia released the H100, one of the most powerful processors it had ever built…and one of its most expensive, costing about $40,000 each.

The launch seemed badly timed, just as technology businesses sought to cut spending amid recession fears. But then in November 2022, ChatGPT launched, and the tech world changed in an instant. OpenAI’s hit chatbot created instant demand. ChatGPT’s popularity triggered a rush among the world’s leading tech companies and start-ups to obtain the H100, which CEO Huang describes as “the world’s first computer [chip] designed for generative AI”.

Nvidia had the right product—the H100—at the right time. The company had just begun manufacturing it at scale a mere few weeks before ChatGPT debuted.

In summary, Nvidia arguably saw the future before everyone else with its pivot into making GPUs programmable. It spotted the opportunity and bet big, allowing it to easily outpace its competitors.

That’s why today Nvidia sits on top of the AI mountain, with probably a two-year lead over its rivals. Whether it can continue to see the future and remain ahead of the competition is the only open question. But I would not bet against them.

Nvidia’s stock is a buy on any weakness, ideally below $400 a share.
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