Get cash in your pocket and total return with these high dividend stocks.
Dividend stocks beat the market. Research proves it time and again. But which dividend-paying stocks are going to you the highest yield and return on your money?
In this video, I’ll not only rank the top five dividend stocks, I’ll also reveal four dividend investing risks that will destroy your portfolio.
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Dangers of High Dividend Investing
You know I love dividend stocks and it’s a big theme here on the channel. I get a lot of comments and questions about some of the highest paying stocks, the ones with double-digit dividends. So I wanted to make a video ranking some of my favorite dividend investments.
Now those of you in the community know, I’m not about just laying out a list of stocks to invest in. I’ll reveal those five high dividend stocks but I also want to give you the tools to find your own and make better investing decisions.
That means knowing the four risks to watch out for in high yield investments. Four dangers to dividend investing that you absolutely cannot neglect.
High Payout Ratio and Stock Growth
First of these is also looking at the payout ratio for a stock. This is the percentage of profits a company pays out to cover the dividend. Pay out too little and it’s probably not much of a dividend. Pay out too much and it will seriously limit any future growth and may actually cause the company to fall behind the competition.
Finding the payout ratio is easy. You just divide the annual dividend amount by earnings per share. Now a safe ratio is going to be different for each sector. Safety sectors like utilities and telecom have higher payout ratios while growth sectors like tech tend to payout less. So make it a point to compare that payout ratio for a stock with some of the others in the same sector.
Sector Exposure in Dividend Stocks
Our next big risk, and this one is especially bad for investors reaching for the really high dividend yields like we’ll talk about, and that’s exposure risks to just a few business structures.
You see there are a few types of businesses; specifically Business Development Corporations which lend money to small and medium-sized businesses, Master Limited Partnerships which hold energy assets like pipelines and storage, and real estate investment trusts which hold commercial real estate. These three types of businesses tend to pay out almost all their profits as dividends. In fact, they get tax breaks for doing so. And these tend to be the highest dividend yields you find.
The risk is that if you’re only searching for stocks with very high dividends then you’re probably only investing across these three business structures and sectors of the economy. Now all three of these are highly sensitive to interest rates, so when rates increase it tends to hit these stocks harder. But you’ve also got risks within each like a steep drop in oil prices or credit risk in the BDCs. The point is, you need to hold more types of dividend stocks than those only in these three business types.
High Dividend Stocks and Total Return
Our third big risk to watch for is just focusing on the dividend yield. Understand that a high dividend yield is still no guarantee of a positive return. You see a lot of these really great dividend payers, yielding 12 and 15 percent, but the stock price goes nowhere and sometimes falls just as much as that yield.
This is something we’ll see in that ranked list of high dividend yield stocks. Now all five that I’ve selected have beaten the stock market over the last three years but you’ll see that the highest yield isn’t necessarily the highest return. So before you invest in a dividend stock, look into the fundamentals and make sure the company is a good investment.
The High Yield Myth
Our last dividend risk before we get to our list is to watch out for the high yield myth. I call this one the high yield myth because you find a stock with a high dividend yield, you invest in the shares and then see that the stock price has plunged over the past year.
The problem here is that a stock paying a 2% dividend only needs to see its stock price fall by 50% and suddenly its paying a 4% dividend. It’s like magic, right? Well, something’s definitely wrong with the company and when the board of directors goes to declare that next dividend, they cut it back down to 2% or maybe even cut it out completely.
So always look at what the stock price has done over the last year or two and make sure it’s not just a high dividend stock because the dividend has stayed the same while the stock price tanked.
My Favorite High Yield Stocks
Now let’s get into those five high yield stocks. I screened Morningstar for the stocks with a yield above 6% and a market cap above one billion. What I didn’t do was just pick the highest dividend stocks available. That would have left us right smack in front of the risks we just talked about.
So I went through each stock, looking through the fundamentals and prospects for growth. Picks had to produce positive total returns and have some upside potential besides just an attractive yield.
Our first high yield pick is Crestwood Equity Partners, ticker CEQP, an energy master limited partnership paying a 6.5% yield. Crestwood is the perfect example of why I say look for the total return rather than just the dividend. This is actually our lowest dividend yield in the group but has produced the highest return with an annualized 31% return over the last three years.
Crestwood is your traditional midstream MLP which means it owns oil and gas pipelines, processing stations and storage facilities. It then charges energy explorers a fee to transport through the pipelines or store in its tankers and you can see, it has assets in all the major production zones.
The company has long-term contracts with some of the biggest oil companies including ExxonMobil, Shell and ConEdison. Most of these contracts, 84%, are on fixed-fee so not subject to the volatility in energy prices.
Crestwood has some great fundamentals with 30% growth expected in distributable cash flow and an industry leading 1.5-times coverage on that DCF. This is a really important metric for MLPs that we’ve talked about on the channel. It means the company is covering its dividend by one and a half times, so the cash flow is there and it might even be able to increase the payout a little.
Our next high dividend stock is mortgage real estate investment trust Chimera Investment with a solid 10.4% dividend yield.
This is one of the oldest and most dependable mortgage REITs out there, sending investors over $4.5 billion in dividends since its founding in 2007. What I really like about Chimera is that it’s survived through that 2008 crisis, management knows the risks and it’s put together a solid portfolio of mortgage assets to keep the dividend stable even if the economy takes a hit.
The company invests in a great mix of residential mortgages, agency and non-agency mortgage-backed securities and commercial loans. And this chart showing the breakdown probably doesn’t mean a whole lot to you but it shows that diversification in the company’s assets. Total number of loans over 136,000 and spread across these different loan models. That’s what gives Chimera its stability.
One of the drawbacks to a lot of these high yield business structures, so your BDCs, REITs and MLPs is that they have to raise money frequently. They pay out almost all profits as dividends so raising money through preferred shares or stock can sometimes dilute investor ownership. Chimera has actually authorized an $85 million share buyback program so it’s acting to counteract that dilution a little.
Now one thing to remember about mortgage REITs is that the group is extremely sensitive to rising interest rates. First, real estate is just a highly-leveraged industry so anytime those borrowing rates increase, you’re bound to see a little weakness in the sector. Also though, and this has been a big weakness over the last few years for mortgage REITs specifically, is that the Federal Reserve increases short-term rates but really can’t control longer-term interest rates.
The problem here is that when the market is looking at a potential recession or at least economic weakness, those longer-term rates don’t rise as fast as the short-term rates when the Fed is hiking. Mortgage REITs borrow in those short-term rates to buy loans with longer-terms, so what you get is higher borrowing costs without much of an increase in the interest they’re collecting on those long-term assets.
Now this might not be a problem for a few quarters because the Fed has said it’s pretty much done hiking rates but just understand and be ready for a little pain in mortgage REITs every once in a while when rates are increasing.
Our third high yield pick is one of the few stocks outside MLPs, REITs or business development companies. AllianceBernstein Holdings is an asset manager with more than half a trillion in assets under management and pays a strong 6.6% dividend.
What I really like about AllianceBernstein here is that it gives us some diversification in our high yield list. AB manages stock and bond funds with 51% of assets in fixed income funds, another 38% in equity funds and the rest in alternative assets. I like that position in fixed income funds because I think it’s less prone to the trend to passive management we’ve seen with stock investing over the last few years. It’s got a strong international reach with 45% of revenue through global investment services.
The dividend payout hasn’t been as consistent on this one, so the payment has bounced around though the yield is fairly stable. The company reported a strong pipeline in institutional assets last quarter of $11.4 billion, so this is money committed to new funds that the company will be rolling out and a big opportunity for fee growth.
So with AllianceBernstein, not only do you get a solid dividend yield and good investment, but you get to diversify your portfolio a little from the REITs and MLPs that you usually find dominating a high yield list.
New York Mortgage Trust is another mREIT and pays the highest yield of the group with a 12.7% annual yield.
So this one is going to be similar to Chimera Investment in that the company invests in different types of mortgage debt. New York Mortgage focuses a little more on multi-family properties and has a larger portion of its portfolio in distressed property debt, so maybe a little risker but also a little higher yield.
Given the choice between the two, I’d have to go with Chimera but I think you can spread your investment between the two. It’s going to give you a little more diversification and take some of that company-specific risk out of your portfolio.
Our next pick here is Sunoco with a 10.7% yield and a different business model compared to a lot of the high yield MLPs you’ll see. Most master limited partnerships specialize in that midstream component, so pipelines and energy storage. Sunoco operates in the downstream segment, operating the retail and wholesale fuel stations. So not only is Sunoco a great dividend pick on its own, adding it to a portfolio of midstream MLPs will give you some diversification as well.
Sunoco books three sources for income. Fuel income through its wholesale operations selling fuel to 7-11 and other buyers. It books rental income on over 940 locations and also books other income like payment processing, franchise revenue and terminal operations.
Now let’s look at these five high dividend stocks ranked by three-year total return. Again, notice here that the highest yields didn’t translate to the highest returns with the two lowest yielding stocks producing strong annualized returns that outperformed. Notice that industry concentration we talked about in MLPs and REITs.
I’ve ranked the five here but understand these are the five best among 60-plus high dividend stocks I looked at for the video so any of these would probably make good additions to a portfolio.
If you want to see how I picked dividend stocks for our 2019 Stock Challenge. The portfolio is beating the market with almost a 20% return just this year with five stocks over 30% – don’t miss it and don’t forget to subscribe for more videos like this one.