Stocks with high dividend yields are a double-edged sword. On the one-hand, passive income streams can be significant. But the flipside is some high dividend paying stocks have serious business model challenges.
Tobacco stocks often pay high dividends but are frequently regarded as yield traps, meaning you enjoy a high dividend but potentially at the cost of a much lower future share price.
So where can you find stocks with good dividends that also have strong underlying businesses? In this article, we’ll pull back the covers to spot some interesting ideas.
You can calculate the dividend yield for a stock by taking the company’s annual dividend and dividing it by the share price.
Choosing a stock with a high dividend yield is essentially choosing an investment that is priced low relative to its dividend amount.
While share price change all the time, the dividend amount is set in advance. This means that if the price of the stock goes down, the dividend remains the same and, as a result, the dividend yield goes up.
Before pulling the trigger, you should be asking yourself why the share price is so low?
Is it because of a structural flaw in the business or simply because sentiment is negative and the “baby is being thrown out with the bath water” so to speak,
Before you invest in a dividend stock, you should do your research and look beyond dividend yield to the company’s fundamentals.
Are revenues and profits growing? Is the business suffering from competitive threats? Does the business have a stable and reliable sales pipeline?
Below, we take a look at three high dividend yield stocks in greater detail:
STORE Capital is a Real Estate Investment Trust (REIT) that specializes in commercial property.
It owns over 2,000 properties. Many of these are in retail but the company also owns fitness clubs, movie theaters, and restaurants and they boast an astonishingly high occupancy rate of 99.7%.
STORE Capital tends to use longer term leases (they average 14 years) and they include clauses that cause the rent to escalate periodically (usually annually).
With its current leases alone, STORE Capital should be able to grow its revenues at a steady pace over the next several years or at least keep pace with inflation.
In other words, it is not a very volatile stock. Warren Buffett seems to agree. His Berkshire Hathaway, invested $377 million to purchase STORE Capital stock, which represented a 9.8% stake in the commercial REIT.
At the time of our research, the STORE Capital dividend yield was over 4.7%.
AT&T is another high-dividend yield stock, sporting a 6.0% yield.
The company’s two largest segments are entertainment and wireless. It bought Time Warner, but the acquisition was hotly contested by the Justice Department.
After six weeks in court, the antitrust case was thrown out, but it is currently under appeal. This makes for an uncertain future for the mobile communications giant.
Plus, it wasn’t so long ago that the company purchased DirecTV. All those acquisitions mean that the company has extra debt on its balance sheet but that’s not to say those purchases weren’t smart.
AT&T is taking the steps it needs in order to stay at the forefront of its industry. Take 5G for example. AT&T is set to unveil its new 5G network in 12 cities before 2019 and add seven more cities to the roster within the first few months of the year.
The company is also laying the groundwork for a massive 5G rollout that will include 400 markets.
While there is fierce competition in this realm, AT&T is a strong contender. It currently has 143.8 million subscribers and is growing that list by the day.
Verizon is also a top contender in the mobile communications market. The company pays a handsome 4.5% dividend yield.
This puts it lower than AT&T but, again, that is not necessarily a bad thing. Verizon has been making its own acquisitions including Straight Path for $3.1 billion in 2017.
With that purchase, Verizon has a large percentage of wireless spectrum in the United States according to the Motley Fool, “76% of available 28 GHz spectrum in the top 50 markets and 46% of the available 39 GHz band.” AT&T actually put in a bid for Straight Path but ultimately lost.
Also, Verizon has even more subscribers than AT&T with 151.5 million under contract and it has been making some big inroads to 5G. In late 2018, Verizon’s in-home broadband its first 5G service debuts in four markets.
Mobile connections will have to come next but even this launch and getting there ahead of AT&T is an expensive endeavor. Getting in-home 5G connections out there will help the company recoup some of its investment while it lays the groundwork for the rest. It is a smart strategy and one that could pay off well.
There are some very solid reasons for investing in stocks with high dividend yields. One benefit is that a high dividend yield provides insulation from a fickle stock market.
Share prices will fluctuate, but when your stock pays a dividend, a slight buffer against headwinds is provided in addition to a minimum return on invested capital.
You can use your dividend payments as an income stream or reinvest them but you need to be aware that there are drawbacks.
If a company is paying dividends, it is spending money on attracting investors that it could be spending on developing its infrastructure, expanding, or otherwise reinvesting in the future of the company.
That might be okay for a mature corporation that has some earnings leftover, but it might not make as much sense for a young or growing company. Also, remember that a company could change its dividend policy, and that might not work to your favor.
Plus, you are taxed on dividends as though they are income which is generally at a significantly higher tax rate than cashing out a long-term investment.
In other words, tread lightly. Dividend stocks can play an important role in developing a strong investment portfolio, but all that glitters is not gold.