Generating a specific amount of income from dividends is easier to quantify than getting a specific rate of return from your stocks, because you can get a return of 7% from your portfolio in year one and a return of 12% the next, for instance.
However, investors should still aim for a specific rate of return to see if they can achieve it over time. If they are not achieving it, then they either need to tweak their strategies or simply accept a lower rate of return.
Investors should keep in mind that, typically, the higher the rate of return they’re aiming for, the higher the risk they could be taking. With that in mind, let’s say we aim for a reasonable long-term rate of return of 8%. How can we aim to achieve that in today’s market?
The market is trading near its all-time high. So, let’s be more defensive. If you buy a dividend stock that offers a sustainable 4% yield, you only need that company to grow 4% to achieve the 8% rate of return. (This also assumes that you pay a fair price on the stock.)
The energy infrastructure company has a more diversified portfolio of pipeline (~58% of EBITDA), processing (~19%), and midstream (~23%) assets after acquiring Veresen. Based on product mix, it’s a nearly three-way split between crude oil (~30% of EBITDA), natural gas liquids (~35%), and gas (~35%). Further, Pembina generates about 28% of its earnings from the United States.
Pembina has a good record of execution, including making accretive acquisitions and completing projects on time and on budget. Throughout last year, it put ~$4.8 billion of projects in service, which have started to generate cash flow. There are ~$2 billion of projects underway. So, the company expects strong growth in earnings this year.
In fact, analysts estimate that Pembina will grow its earnings per share by at least ~17% per year for the next three to five years. If so, the stock is reasonably valued, as it trades at a multiple of ~32.
Pembina offers a monthly dividend. Based on the recent quotation of ~$43.90 per share, it offers a juicy yield of ~4.9%. Investors buying today only require the stock to have price appreciation of 3.1% per year to get the 8% rate of return, which is not too much to ask from this high-growth company.
If you can get a sustainable dividend yield of 3% from a stock investment, you only require the stock to grow 5% per year to get an 8% rate of return.
You can also get the 8% rate of return from price appreciation alone from a pure growth stock that doesn’t pay a dividend. However, returns based on the share price will be more unpredictable.
Pembina is a good buy at current levels and a better buy on any further dips. It offers a juicy yield of ~4.9% and double-digit growth potential for the next three to five years.
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*returns as of 5/30/17
Fool contributor Kay Ng owns shares of Pembina Pipeline.