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Author: BruceCM Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 8754  
Subject: Re: Van Knapp on Diversification Date: 2/12/2013 3:29 AM
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I have been conversing with and commenting on DVK's articles on SA over the years, and I find him to be one of the few who truly 'get' income investing. But this isn't to say I don't, on occasion, disagree with him...and this is one point upon which I do disagree with him.

When one moves from one dividend stock to another, it is likely that person will be taking greater or less income risk with the replacement stock. What's tough to measure here is income risk...or the chance that the company will either cut or fail to raise its dividend at the rate you expect. Unfortunately, there is not a Standard Deviation, covariance, coefficient of determination or Beta for income investors, so most of us use such factors as
1. 10 year dividend CAGR
2. trend of quarterly net free cash flow payout ratio
3. debt/equity and
4. some qualitative assessment of the company's future revenue prospects.

A failure to take one or more of these into account when moving from income stock A to income stock B will most likely result in adopting higher risk without knowing it.

Case in point with DVK's article is OHI. I hold 6 of the 12 HC REITs for their reliable...albeit slow growing, annual dividends and sound cash flow fundamentals....but mostly for the diversity they have of Medical facilities and revenue sources to operators. OHI is not on my list primarily due to #4 above. Per one of their recent 10Qs, if I recall correctly, most of OHI's facilities are Skilled Nursing Facilities (SNFs) and all of the SNF's are funded through Medicare or Medicaid Reimbursements. To me, this is simply too much risk to their future cash flows. It reminds me a bit of MT and KIND back in the late 90s when Medicare suddenly put a cap on outpatient therapy reimbursements which effectively put the operators of these two REITs into bankruptcy.

Income diversification matters.

BruceM
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