Dividend stocks provide two sources of return – regular income from high dividend yields and potential capital appreciation, leading to higher total returns over time compared to the broader market. Key metrics to evaluate high dividend stocks include the dividend yield, payout ratios, earnings per share (EPS), and P/E ratio. However, a high dividend yield alone is not enough – it’s crucial to consider the sustainability of dividends based on the company’s financial health.
The average dividend yield of top high dividend paying stocks is around 12.69%, and reinvesting dividends can greatly enhance the return on investment. Investors can purchase individual high-yield dividend stocks, dividend ETFs, or dividend mutual funds that hold dividend-paying companies. When analyzing high dividend stocks to buy, key factors are the dividend yield compared to peers, payout ratio, and safety of future dividend payments.
Dividend Investing When Rates are High
Dividends are distributions made from after-tax profits by a company to its shareholders. The dividend payout ratio is the ratio of dividends per share (DPS) to earnings per share (EPS), expressed as a percentage. Payout ratios vary widely across industries, with utilities and pipelines typically having ratios over 80%, while other industries may be below 20%.
Interest Rate Sensitivity
Companies with high dividend yields are often in sectors with heavy debt loads, such as utilities, telecommunications, and REITs. These ‘interest rate sensitive’ sectors see their share prices fall when interest rates rise, as higher rates increase their debt-servicing costs. Rising interest rates can impact corporate profitability, constraining a company’s ability to pay dividends, especially for debt-laden companies. Rising rates also make other yield-producing investments like Treasuries and bonds more attractive, creating competition for dividend-paying stocks.
| Sector | Typical Payout Ratio | Interest Rate Sensitivity |
|---|---|---|
| Utilities | >80% | High |
| Pipelines | >80% | High |
| Telecommunications | High | High |
| REITs | High | High |
| Banks | Moderate | Low (benefit from higher rates) |
- Banks generally pay sizeable dividends and tend to do well when interest rates are rising, as their net interest margins improve.
- Dividend Aristocrats, S&P 500 companies that have raised dividends for at least 25 consecutive years, are also able to maintain and grow their dividends even in a rising rate environment.
- When interest rates are rising, dividend growth strategies focused on companies with long track records of consistent dividend growth tend to perform well.
The Benefits of Investing in High-Yield Dividend Stocks
The study examining the ‘Dogs of the Dow’ investment strategy found that the high dividend yield portfolio outperformed the medium and low dividend yield portfolios over the 26-year period from 1987-2012. The high dividend yield portfolio had higher average annual return, geometric mean return, Sharpe ratio, Treynor ratio, and positive and significant Jensen’s alpha compared to the medium and low dividend yield portfolios.
Historical Performance
Dividends have been a meaningful component of equity total returns historically, accounting for nearly 40% of long-term returns, and dividend income has grown in importance, now accounting for over 50% of the total income generated by a 60/40 balanced portfolio. Dividend-paying stocks have outperformed non-dividend-paying stocks with less risk over time, but a strategy focused solely on the highest dividend-yielding stocks has generated inconsistent relative performance. Historically, the Johnson Equity Income strategy has outperformed the S&P 500 and Lipper Equity Income Index on a risk-adjusted basis, with lower downside capture.
- Dividend-paying stocks in the top two quintiles by dividend yield have outperformed the S&P 500 Index the most often over the past 9 decades, but the highest-yielding stocks (top quintile) have not always outperformed due to unsustainable payout ratios.
- Companies that consistently grow their dividends have historically exhibited strong fundamentals and provided higher returns with lower volatility compared to companies that cut or eliminated dividends.
| Metric | High Dividend Stocks | S&P 500 |
|---|---|---|
| Annualized Returns | 13.02% | 10.00% |
| Volatility of Returns | 15.19% | 12.16% |
| Sharpe Ratio | 0.84 | 0.81 |
| Correlation to S&P 500 | 0.58 | – |
High dividend stocks have generated an average annual dividend yield of 6.4%. They have outperformed the S&P 500 by nearly 3.0% on an annualized basis over the long term (1960-2017). In 7 out of 10 rising interest rate periods since 1960, high dividend stocks outperformed the S&P 500, with the 3 instances of underperformance occurring during periods of unusually rapid rate increases. Interest rates are expected to continue rising, but at a gradual pace, which has historically led to high dividend stocks outperforming the broad market.
Methodology
When implementing a dividend investing strategy, it’s crucial to assess your risk tolerance and choose the right investment vehicles that align with your goals. Focus on companies with sustainable dividends, solid financials, and a history of dividend growth (https://5starsstocks.com/2024/04/10/stocks-to-invest-3/) to avoid falling into “dividend traps” and overpaying for yield.
Screening for Quality
- Look for companies with long-term profitability and earnings growth expectations between 5-15%. Avoid companies with growth over 15% as they tend to have more earnings disappointments.
- Seek companies with healthy cash flow generation to support their dividend payment programs. A minimal 5-year track record of strong dividend payouts is a good sign.
- Avoid companies with high debt-to-equity ratios over 2.00, as they will need to use cash to pay off debt rather than dividends.
The VanEck Durable High Dividend ETF (DURA) is an example of a fund that screens for companies with strong financial health and valuations, in addition to high dividend yields, to help avoid dividend traps. A more nuanced approach that considers shareholder yield (dividends plus net share repurchases minus net debt issuance) provides better risk-adjusted returns than focusing only on dividend yield.
Also read: Top Oil Stocks to Buy: June 2024 Investment Guide.
Top Ultra-High Yield Dividend Stocks
According to the article, there are two lists of top ultra-high yield dividend stocks to consider:
- Based on hedge fund sentiment, the top 12 ultra-high yield dividend stocks are:
| Stock | Dividend Yield | Hedge Fund Investors |
|---|---|---|
| Arbor Realty Trust Inc (ABR) | – | (https://finance.yahoo.com/news/top-12-ultra-high-yield-112631071.html) |
| FS KKR Capital Corp (FSK) | – | (https://finance.yahoo.com/news/top-12-ultra-high-yield-112631071.html) |
| Medical Properties Trust Inc (MPW) | – | – |
| Nextera Energy Partners LP (NEP) | – | – |
| Atlantica Sustainable Infrastructure PLC (AY) | – | – |
| Chimera Investment Corporation (CIM) | – | – |
| Starwood Property Trust Inc (STWD) | – | (https://finance.yahoo.com/news/top-12-ultra-high-yield-112631071.html) |
| Exxon Mobil Corp (XOM) | – | – |
| Johnson & Johnson (JNJ) | – | – |
| Procter & Gamble Co (PG) | – | – |
| NextEra Energy Inc (NEE) | – | – |
| Medical Properties Trust Inc (MPW) | – | – |
- A list of 10 ultra-high yield dividend stocks to consider buying in 2023, along with their dividend yields:
- Hercules Capital (HTGC) – 10.6% dividend yield
- Ares Capital (ARCC) – 9.5% dividend yield
- Horizon Technology (HRZN) – 11.1% dividend yield
- Energy Transfer (ET) – 8.4% dividend yield
- Enterprise Products Partners (EPD) – 7.2% dividend yield
- Enbridge (ENB) – 7.8% dividend yield
- Kinder Morgan (KMI) – 6.5% dividend yield
- Rithm Capital (RITM) – 9.1% dividend yield
- Altria (MO) – 9.6% dividend yield
- Verizon Communications (VZ) – 6.6% dividend yield
Dividend Aristocrats
The article also highlights the S&P 500 Dividend Aristocrats, which are companies in the S&P 500 that have raised their dividends annually for at least 25 consecutive years. Some key points about the Dividend Aristocrats:
- The index currently consists of 67 companies.
- Recent changes include the removal of Walgreens Boots Alliance and the addition of Fastenal.
- Companies with the longest streaks of consecutive dividend increases include Emerson Electric (67 years), Genuine Parts (67 years), and Procter & Gamble (68 years).
- Many of the Dividend Aristocrats are consumer staples and industrial companies, demonstrating the consistency of their businesses and cash flows.
Key Considerations
Diversification and Investment Vehicles
Investors can gain exposure to dividend-paying stocks through individual stocks, index funds/ETFs, or actively managed funds. The Fidelity Equity-Income Strategy offers a targeted stock portfolio built around income investment strategies. For a diversified approach, investors can consider indices like the S&P 500 High Dividend Index, which selects the top 80 stocks by 12-month indicated annual dividend (IAD) yield, or the S&P/ASX 200 High Dividend Index, which selects the top 50 stocks by 12-month forecast dividend yield.
Dividend Growth and Sustainability
- The S&P High Dividend Growth Indices measure the performance of companies with the highest forecasted dividend yield growth that have consistently increased or maintained dividends for a specific number of years.
- The S&P 500 High Dividend Growth Index includes the 100 companies with the highest forecasted dividend yield growth within the S&P 500, subject to constituent weight caps.
- When considering dividend stocks, investors should look at a company’s prospects for both growth and income, and how they align with their specific needs and goals.
Quality over Quantity
- Prioritize stability and sustainability of dividends over just high yield.
- Stick with established companies – Look for ‘dividend aristocrats’ – companies that have increased dividends consistently for at least 25 years.
- Be mindful of payout ratio – A high payout ratio can indicate dividends may not be sustainable if the company’s income stream declines.
- Diversify holdings – Spreading investments across multiple dividend-paying stocks can help minimize risk.
Conclusion
In summary, investing in high-yield dividend stocks can provide a steady stream of income and the potential for capital appreciation, making them an attractive option for investors seeking to generate consistent returns. However, it’s crucial to thoroughly evaluate a company’s financial health, dividend sustainability, and growth prospects before investing. A well-diversified portfolio of quality dividend-paying stocks with a track record of consistent dividend growth can help mitigate risks and enhance long-term returns.
While high dividend yields may seem enticing, it’s essential to prioritize the sustainability of dividends over just high yields. Focusing on established companies with strong cash flows, reasonable payout ratios, and a history of increasing dividends can help investors avoid dividend traps and build a resilient income-generating portfolio. By striking the right balance between income and growth, investors can utilize high-yield dividend stocks as a valuable component of their overall investment strategy.
FAQs
1. What are the top five dividend stocks to consider?
The five highest-yielding dividend stocks trading for $25 or less as of April 2024 on the NYSE or Nasdaq are Jiayin Group Inc., Petroleo Brasileiro, Frontline Plc, Hercules Capital, and Apollo Commercial Real Estate Finance, Inc.
2. Which three dividend stocks are ideal for long-term investment?
The question does not specify which stocks are best for long-term holds. However, investors typically look for stocks with stable dividends and strong business fundamentals when considering long-term investments.
3. Which company offers the highest dividend in India?
In India, the companies with the highest dividend payouts include Coal India Ltd., Oil and Natural Gas Corporation Ltd., Power Grid Corporation of India Ltd., Tech Mahindra Ltd., and ITC Ltd.
4. What is the highest yielding dividend stock that pays out monthly?
The highest-yielding monthly dividend stocks include ARMOUR Residential REIT at 15.9%, Orchid Island Capital at 17.8%, AGNC Investment at 14.8%, Oxford Square Capital at 13.7%, and Ellington Residential Mortgage REIT at 13.2%. Other notable mentions are SLR Investment, PennantPark Floating Rate Capital, and Main Street Capital with yields of 11.5%, 10%, and 7% respectively.
