The 7 monthly dividend stocks that pay the highest returns and the basic rules to protect you from that high yield trap
Hey Bow Tie Nation, I'm helping you solve one of the biggest problems in monthly dividend stocks, that tradeoff between high dividend yield and stock prices that go nowhere!
Investors rush into stocks like the San Juan Basin Royalty Trust, ticker SJT, and its eye-popping 8% dividend yield. That’s more than six-times the dividend you get from the broader stock market!
But then this happens…those shares of the high-yield dividend stock go nowhere and even fall as the market runs higher. Including the price return, investors in SJT earned just 5.4% a year over the last five. That’s less than a third the 17.8% annual return on the S&P 500.
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And I’m not just cherry-picking a dividend stock to prove the point. Of the 46 monthly dividend stocks I follow, four of them earned less than their dividend yield over the last five years. That means the stock price fell so much, it completely wiped out the dividend and then some!
I found the total annual return on each dividend stock including yield and price return and you can see here, four stocks actually lost money, and 16 of them underperformed that return on the market.
This high dividend stock trap is something 90% of dividend investors fall into, that tradeoff between yield and actual return.
But the good news is, you CAN have both. You don’t need to sacrifice stock returns for dividends. You CAN have your cash flow and price returns.
In this video, I’ll show you how to find the best monthly dividend stocks for both cash flow and return. I’ll share three simple rules to protect you from that high yield trap and then reveal the five monthly dividend stocks with the highest returns. Stick around and I’ll also show you two monthly dividend stocks that have struggled lately but could be your best investments this year.
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Monthly Dividend Stocks for the Highest Returns
I’m excited to get into that list because these five monthly dividend stocks have averaged a 124% return over the last five years, double your money plus pay you an average 7% dividend yield. We’ll start with the list and I’ll show you how I found these.
I’ll be counting up to the stock with the highest return and first on our list, Prospect Capital Corporation, ticker PSEC.
Prospect is a business development corporation, a BDC founded in 2004 with over 16 years of dividends and performance. The company manages a $5.7 billion portfolio of 122 investments in companies across 39 industries and earns a 9.9% yield on its portfolio. That’s more than enough to cover the stock’s dividend yield and has helped it produce a 13.3% annual return over the last five years.
BDCs make loans to small- and mid-size companies, those too big for your regional banks but still too small to get money from the capital markets. And that portfolio yield is the most important thing you want to watch for here. You’ll find this in any BDC’s financial statements called the Weighted Average Portfolio Yield, and it’s the average interest rate the company makes on its loans. You want to make sure that’s above the dividend yield. A portfolio yield above the dividend is not only a sign the company can keep paying that dividend but it’s also making enough that you’ll see the stock price grow as well.
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Prospect’s portfolio yield is more than two percent above the stock’s 8% dividend yield so some room there to increase the dividend and reinvest in the business.
In fact, Prospect has returned a cumulative $18.60 per share in dividends for more than $3.3 billion since the 2004 IPO and that payout keeps climbing. That’s the purpose of these BDCs is to act as a bank and investor to mid-size companies, manage those assets and then return 90% of earnings as cash flow to you the investor.
Next on our monthly dividends list is a fan favorite, Gladstone Investment Corporation, ticker GAIN, for a 5.5% yield and 113% total return.
And why I like GAIN here is because it takes a higher equity share than most other BDCs. Remember, those business development corporations are mostly making loans so the upside is capped at the interest rate. But Gladstone’s target investment is 25% equity and 75% debt versus a traditional BDC that will look for less than 10% equity in the companies it works with. That higher equity ownership might mean higher risk but it’s also going to mean higher returns on these investments.
And we see that in GAIN’s history of return on equity which is well above the industry average. The five-year average ROE of 17% is over three-times the median ROE for the BDC group and even though near-term return has come down, it’s still well above the average for the group.
Gladstone’s current portfolio is spread across 28 companies in 14 industries so a level of diversification there that should help it continue those returns even in a sluggish economy. The shares have done so well in fact that it’s been able to pay out multiple special dividends, boosting that cash return.
How to Find Stocks That Won't Lose Your Money
We’ll get back to that list of stocks but I want to show you how to find these and more importantly, how to find the dividend stocks that won’t lose your money.
Because finding a list of monthly dividend stocks is easy. Any Google search will find you dozens of lists. Finding those monthly payers and the highest yielding ones is easy but then it’s the research and analysis that helps you make the higher returns.
That means looking at each individual stock to see which have produced positive price returns in the past, that higher stock price. To do that, go to Yahoo Finance and click this Historical Data tab. This will show you the stock price history and dividends of any stock. Change the timeframe here to five years and you can change the frequency to Monthly.
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And you want to use this column for the Adjusted Price, that’s the stock price adjusted for any splits and dividends. It’s going to give you a true measure of the total return.
So if we scroll down, we can see that Apple was trading for $27.25 a share five years ago. If we take today’s price divided by that, we see that shares have produced 5.5-times over the period or a 450% return. And if you want to see how much that is per year, you just click this X to the Y button and 0.2 to see Apple has returned 40% annually over the last five years.
Of course, the first thing is to make sure that total return is more than one or that the annual return is at least higher than the dividend yield. That tells you the company is producing a stock price return besides just the dividend.
You can also use some of the fundamental analysis we talk about here on the channel to find stocks that are going to produce that positive return. Remember, you’re not just finding a good dividend stock, you’re trying to find a good company and a good investment.
This next monthly dividend stock, AGNC Investment, ticker AGNC, isn’t as high a return as the others but still posts a 9% yield and a 50% return in five years.
AGNC holds a $103 billion investment portfolio with $99 billion of that in Agency mortgage backed securities. It’s basically borrowing on extremely low short-term rates, leveraging that money up and then investing in longer-term mortgages. That’s how it’s able to turn a spread of 2%, the difference between its borrowing and investments, into a nine- or ten-percent return.
Besides that strong dividend yield, I wanted to include this one for a little diversification. You’ll notice a lot of high yield dividend stocks are in those business development corporations. So adding other types of companies like real estate stocks and mREITs is going to help protect your returns if something happens in the BDC industry.
Book value is really the measure you want to use to value mortgage REITs and it hasn’t been pretty for AGNC, now at $16.41 per share. That means the shares are trading under their book value which is a pretty good place in terms of value.
One bright spot is that the net interest spread, that’s the difference between the interest rates on investments minus those short-term rates on which the company borrows, that spread has increased over the last year and the company is hedged on many of its products so should be able to continue that profitability ahead.
Horizon Technology Finance, ticker HRZN, is a unique case in BDCs along with its 6.8% dividend and 130% return over the last five years.
Horizon makes secured loans to venture and private-equity backed companies in the life sciences and technology industries…and honestly is there any better place to be for investing right now?
The portfolio of loans is well diversified by sector, geography and company stage. All these are going to be those fast-growing startups backed by venture capital and again, a great niche in healthcare and technology.
So besides that high yield you get from the typical business development corporation, here you get a little bit of growth stock as well.
The average yield on portfolio debt is 16.3%, well above the 7% dividend yield, in fact I think the biggest yield spread I’ve seen in a BDC stock. That keeps the dividend safe and will mean the stock price should continue to rise.
Horizon has all the funding it needs near-term with a $45 million share offer earlier this year and a $100 million debt facility. Shares are paying the 9% dividend yield and paid a special dividend of half a percent last April.
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Gladstone Capital, ticker GLAD, pays a 6.6% dividend yield and has rewarded investors with a 147% return over the last five years.
And normally I wouldn’t load a portfolio up with so many business development corporations, instead trying to diversify it with more mREITs, real estate and MLPs but this chart shows an interesting idea for the group. This is the average portfolio yield for Gladstone since 2012 and notice rates were much higher before 2019. The average yield on loans was over 11.6% in the five years through 2019 versus just 10.5% this year.
As interest rates rise over the next couple of years, you’ll see that average portfolio yield rise as well. As long as the economy doesn’t fall apart and loan defaults don’t jump, these BDCs are primed to book higher cash flow and pay out higher yields to investors.
But if you are over-exposing a portfolio to one type of company, especially BDCs, then you want to pay special attention to each company’s sources of capital and business. For example, every BDC will show you the industries in which it loans and the type of loans it’s making. You see here that Gladstone is well diversified across 17 industries so a major event in any one group isn’t going to materially affect the company.
3 Rules to Protect Your Portfolio From the High Yield Trap
Before I reveal those last two dividend stocks, two stocks with an average yield over 6% and potentially the highest returns of the group, I want to show you those three rules to protect your portfolio from that high yield trap, three simple steps to make sure you book positive returns along with your dividend cash flow!
Rule #1…just look at the stock chart. It’s not a fool-proof way of avoiding that yield trap but it’s a good start when the stock price has gone up in the past. You can calculate the actual return like we looked at earlier or just look at the chart over the past five years. I wouldn’t rule out a stock just based on the chart but if it doesn’t check the next two rules, better to just find another stock.
Rule #2 here, use relevant cash flow coverage measures and this is something a lot of investors misunderstand.
You see, the problem is, a lot of these high dividend stocks are in different types of company structures and you’ll need to use different measures for dividend safety and cash flow.
For example, for real estate stocks, these companies have very high depreciation taken off the income statement so earnings are skewed and not a good measure of actual cash flow. That means you need to use a different measure, the funds from operations or FFO, to compare how much cash is being generated and how much goes to paying the dividend.
For BDCs, we already talked about using that average portfolio yield to make sure a company is earning a higher yield than it’s paying out. And for regular types of companies, you can use the payout ratio which is the annual dividend per share divided by the company’s earnings per share. This is going to show you how much of a company’s profits go to paying the dividend. Too high and it isn’t saving enough back for growth…too low and it’s not much of a dividend stock.
The third rule for creating your monthly dividend portfolio is to diversify into different types of dividend stocks.
These different types of companies; from BDCs to REITs and MLPs, they all have different ways the economy and other factors affect the stocks. Higher interest rates might be great for BDCs but not so much for MLPs or other stocks. Your first goal is to invest in good companies but you also want to make sure you spread your risk out over different sectors and types of companies.
Now on to those two high-dividend stocks that haven’t blown the doors off returns lately but could be about to jump higher and our first is Pembina Pipeline, ticker PBA, with its 6.1% dividend yield.
Pembina is a midstream oil company which means it makes money on transporting oil and gas through pipelines as well as gas processing and some marketing services so overall a diversified business model in the energy space.
The company had to put some projects on hold last year to protect cash flow but maintained its BBB-credit rating and has $2.5 billion in available liquidity. Now that the price of oil has rebounded, the company is a cash flow machine.
The company has maintained earnings growth through prior crises and has actually been able to make some opportunistic acquisitions like the recent purchase of Kinder Morgan assets.
Even after a strong run in energy stocks this year, next year could be just as good. The economic recovery should support the price of oil and demand for pipeline transportation will mean good cash flows for the stock.
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Adding more diversification to the portfolio is LTC Properties, ticker LTC and its 6.6% dividend yield.
The real estate trust owns 180 properties in 27 states with skilled nursing accounting for 56% of revenue and assisted living centers bringing in the rest.
Now shares are down 21% this year for obvious reasons related to the pandemic but I was surprised researching this one that occupancy is still flat from last year at 85% in assisted living and 80% in skilled nursing. The company has been able to collect 92% of the rent due from property managers through the second quarter so it doesn’t look like the virus has affected operations to the extent feared.
Even if vacancies tick up or the economic recovery stumbles, LTC has over $503 million in an available credit line and $50 million in balance sheet cash. The company has long-term debt of $689 million but only $185 of that is maturing through the next two years so it’s got all the liquidity it needs to make it through this.
Long-term, this is a great play on America’s aging population and the demand for senior living facilities and the stock is selling at a discount. That dividend yield of nearly 7% is safe and I think you book another five- to 10% a year in appreciation over the next decade.
Read the Entire Dividend Investing Series