Historically speaking, one of the smartest wealth-building strategies on Wall Street is to trust in dividend stocks. Companies that offer a regular payout to their shareholders are usually profitable on a recurring basis and time-tested.
Even more important, income stocks have demonstrated their ability to outperform over long stretches. Roughly 10 years ago, J.P. Morgan Asset Management, a division of money-center bank JPMorgan Chase, released a report that compared the performance of publicly traded companies that didn’t pay a dividend to those that initiated and grew their payouts between 1972 and 2012. The result of this 40-year look back was a 9.5% annualized return for the dividend-paying companies and a paltry 1.6% annualized return for the non-payers.
However, investors should recognize that not all dividend stocks are alike. While some offer exceptionally stable income for investors, others might be nothing more than a yield trap. Ideally, investors want the highest yield possible with the least amount of risk. Unfortunately, risk and yield tend to go hand-in-hand above a 4% yield.
The good news is that safe, high-yielding stocks do exist. If you want to generate $500 in super safe annual dividend income, all you have to do is invest $5,750 (split equally, three ways) in the following three ultra-high-yield stocks, which average an 8.74% yield.
Enterprise Products Partners: 7.41% yield
The first ultra-high-yield dividend stock that provides exceptionally safe income is energy stock Enterprise Products Partners (EPD).
Considering what happened with demand for crude oil and natural gas during the initial stages of the COVID-19 pandemic, some investors might be leery about trusting energy stocks with their money. However, Enterprise Products Partners is a midstream operator that’s well-protected from spot-price volatility.
Midstream energy companies are effectively energy middlemen. They’re responsible for moving recovered and refined products from point A to point B, as well as store and/or process recovered or refined gases and liquids. Enterprise oversees more than 50,000 miles of transmission pipeline and can store more than 260 million barrels of liquids.
The secret to Enterprise’s success is the structure of its contracts with drilling companies. The company primarily relies on fixed-fee contracts, which produce highly predictable cash flow no matter how volatile the spot price of crude oil and natural gas are.
Macroeconomic factors represent another reason Enterprise Products Partners finds itself in a favorable position. The uncertainty of the pandemic coerced global energy majors to reduce their capital expenditures (capex). After more than three years of lowered capex, it’s going to be difficult to rapidly increase the supply of crude oil.
To boot, Russia’s war with Ukraine has no defined end date. When oil supply is constrained, it tends to lift the spot price of crude oil and encourage domestic drilling. In other words, it’s a red carpet rolled out for Enterprise Products Partners to sign new long-term contracts with drillers.
Enterprise has increased its base annual distribution for 25 consecutive years, which makes its 7.4% yield about as rock-solid as they come for ultra-high-yield companies.
PennantPark Floating Rate Capital: 11.37% yield
A second ultra-high-yield dividend stock that can collectively generate $500 in super safe annual dividend income from an initial investment of $5,750 (split equally, three ways) is business development company (BDC) PennantPark Floating Rate Capital (PFLT). PennantPark has the highest yield among the three companies listed here (11.4%) and doles out its payout on a monthly basis.
BDCs are businesses that primarily invest in small-cap and microcap companies. Although PennantPark holds $157.2 million in common and preferred stock, it’s predominantly a debt-focused BDC, with $1.01 billion tied up in first-lien secured debt of middle-market companies.
Being a debt-focused BDC that targets smaller businesses comes with several advantages for PennantPark. For one, smaller businesses are generally unproven and therefore have limited access to debt and credit markets. This means the debt PennantPark does hold is at a higher yield than typical market rates.
Another important aspect of PennantPark’s operating model is that its entire $1.01 billion debt investment portfolio is of the variable-rate variety. Since March 2022, the Federal Reserve has undertaken the most aggressive rate-hiking cycle in decades. Every rate hike is putting more money in PennantPark’s pockets and increasing its interest-income earning potential. Between September 2021 and March 2023, its weighted average yield on debt investments jumped 440 basis points to 11.8%.
Don’t overlook PennantPark’s investment diversification, either. Including its common/preferred stock investments, the company holds stakes in 126 businesses — about a $9 million average per investment.
Further, all but $0.1 million of its $1.01 billion in debt investments are first-lien secured. Debtholders who are first-lien secured are first in line for repayment if a company seeks bankruptcy protection. In short, PennantPark has done a phenomenal job of protecting the capital it’s put to work.
Verizon Communications: 7.43% yield
The third supercharged income stock that can help you collect $500 in super safe annual dividend income with a starting investment of $5,750 (split three ways) is telecom stock Verizon Communications (VZ).
For years, the biggest knock against Verizon has been its lack of growth. With interest rates hovering at or near historic lows for much of the past 14 years, investors opted to put their money to work in faster-growing stocks. But with rates now soaring, value stocks, and the predictability of the operating cash flow they offer, are back in focus.
One reason Verizon’s dividend is incredibly safe is due to the services it provides. Although access to wireless services and the internet aren’t on the same level as, say, food and water, the vast majority of consumers are unwilling to give up their access to wireless services or the internet during economic downturns. Consistently low churn rates suggest Verizon’s operating cash flow should be relatively steady in any economic environment.
Just because Verizon is a mature business doesn’t mean the company lacks growth initiatives. For instance, the steady rollout of its 5G wireless network should encourage businesses and consumers to upgrade their wireless devices. The benefit for Verizon will be an uptick in data consumption, which is a sizable margin driver for its wireless operating segment.
Broadband is another surprising needle-mover. Verizon spared no expense purchasing 5G mid-band spectrum in 2021, which it’s now using to offer 5G broadband services to residential users and businesses. Though broadband isn’t the growth story it was 20 years ago, it still produces consistent cash flow and can be quite useful when it comes to encouraging high-margin service bundling.
With a reasonable payout ratio of 56%, Verizon is leaving itself enough room to continue doling out a 7.4% yield while also chipping away at its long-term debt.
— Sean Williams
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Source: The Motley Fool