The Best Dividend Play for the 21st Century?
These Companies Are Selling Shovels in the New Gold Rush
“Jing, how can I get in on the next big thing?” My neighbor Larry asked me during our block party last weekend.
Larry is not alone. Most investors want to make money from the “next big thing.” Looking back, people that managed to get in early before an industry took off often made huge profits. Just look at how much money early investors of Amazon.com, Inc. (NASDAQ:AMZN), Netflix, Inc. (NASDAQ:NFLX), or Facebook, Inc. (NASDAQ:FB) have pocketed over the years and you’ll see what I mean.
The problem is, Larry is a retirement investor who wants to collect dividends, and dividends come from profits. For an early-stage company that’s trying to build its presence, it will likely reinvest most of its profits (if it has any) to grow its business, leaving little resources to establish a regular dividend policy.
Even after building their presence, companies going after “the next big thing” may still choose to reinvest its cash. On the shareholder return side, management usually prefers buybacks to dividends because buybacks give them more freedom on the timing and amount of those cash returns. In fact, none of the three companies I mentioned above have a regular dividend policy.
So, if you’re like Larry, who wants to earn a steady income stream and still bet on “the next big thing,” where should you look?
Well, in today’s market, one of the fastest-growing areas is cloud computing. On the consumer side, people are uploading more pictures to their social media accounts than ever before. In the business world, companies are moving from on-premise deployment to cloud-based solutions.
Generating Income…from the Cloud?
According to IT research and advisory firm Gartner Inc (NYSE:IT), the worldwide market for public cloud services would grow 21.4% in 2018 to $186.4 billion. From then on, the market would keep expanding and is projected to grow to $302.5 billion by 2021. (Source: “Gartner Forecasts Worldwide Public Cloud Revenue to Grow 21.4 Percent in 2018,” Gartner Inc, April 12, 2018.)
So, how can income investors catch the profit train in cloud computing?
Well, instead of going after the cloud service providers, why not look at the companies that are selling shovels in this new gold rush?
I’m talking about companies that own data centers.
You see, in order to handle the ever-increasing amount of customer data, cloud service providers have an increasing demand for data centers. Some of them might be able to build and expand their own data centers, but for others, renting seems to be the most efficient solution.
For owners of data centers, strong demand has translated to a growing rental income stream.
Here’s the best part: companies that own data centers and rent them out are often structured as real estate investment trusts (REITs). In order to maintain their REIT status, these companies must distribute at least 90% of their profits to shareholders in the form of dividends.
And that, my dear reader, is how income investors can capitalize on the booming cloud computing industry.
Below, I have compiled a list of three data center REITs that offer shareholders a growing stream of dividend payments.
Three Data Center REITs for 2018 and Beyond
|Company Name||Stock Exchange||Ticker Symbol||Dividend Yield|
|Digital Realty Trust Inc||NYSE||DLR||3.73%|
|QTS Realty Trust Inc||NYSE||QTS||4.63%|
|Iron Mountain Inc||NYSE||IRM||7.01%|
Digital Realty Trust
Commanding over $20.0 billion of market capitalization, Digital Realty Trust Inc (NYSE:DLR) is one of the biggest players in the business. Its portfolio consists of 203 data centers located in 32 metropolitan areas. These properties total more than 32-million rentable square feet.
As one of the earliest companies to enter the data center industry, Digital Realty Trust managed to grow its business tremendously over the years. Since 2005, the company’s core funds from operations per share has increased at a compound annual growth rate (CAGR) of 13%. (Source: “Investor Presentation,” Digital Realty Trust Inc, last accessed May 14, 2018.)
Digital Realty Trust has also expanded its customer base. Today, the company serves more than 2,300 customers, including well-known names such as Facebook, Verizon Communications Inc. (NYSE:VZ), and Morgan Stanley (NYSE:MS).
Unsurprisingly, the company’s growing business has translated to increasing shareholder distributions. Digital Realty Trust has raised its annual dividend payout every year since its initial public offering (IPO) in 2004, at a CAGR of 12%. (Source: “Dividend History,” Digital Realty Trust Inc, last accessed May 14, 2018.)
Paying $1.01 per share on a quarterly basis, Digital Realty Trust stock offers an annual dividend yield of 3.73%.
QTS Realty Trust Inc
Having completed its IPO in 2013, QTS Realty Trust Inc (NYSE:QTS) is a relatively new name for income investors. But the growth it managed to deliver was nothing short of impressive.
Consider this: When QTS first went public, it had 10 data centers with 1.8-million square feet of raised floor capacity. Today, the company has 25 data centers totaling 2.7-million square feet of raised floor capacity. (Source: “Data Center Solutions in a Hybrid World,” QTS Realty Trust Inc, last accessed May 14, 2018.)
Just like Digital Realty Trust, QTS’ growing business allowed it to build an impressive track record of returning cash to shareholders. Since its IPO, QTS stock’s quarterly dividend rate has increased by more than 70%. The company currently yields 4.63%. (Source: “QTS Realty Trust, Inc. Dividend Date & History,” Nasdaq, last accessed May 14, 2018.)
Iron Mountain Inc
To round off the list is Iron Mountain Inc (NYSE:IRM), a data center REIT headquartered in Boston, Massachusetts. In an era where most companies pay less than five percent, Iron Mountain Inc stands out with its seven-percent-plus dividend yield.
Of course, a high dividend yield can turn out to be a sign of trouble. But that’s not really the case for IRM stock.
In 2017, Iron Mountain’s adjusted funds from operations grew 12% year-over-year to $752.0 million. For 2018, management expects the company’s AFFO payout ratio to be 81%, which would leave a margin of safety. Moreover, IRM is expected to lower its payout ratio to between 70% and 75% by 2020. (Source: “Q4 and Full Year 2017 Financial Results,” Iron Mountain Inc, last accessed May 24, 2018.)
And that’s not all. While management projects a more conservative payout ratio, the company’s actual payouts will likely go up. Iron Mountain is targeting a dividend growth rate of five percent for 2018, four percent in 2019, and another four percent for 2020.
Therefore, for income investors of IRM stock, the best could be yet to come.