The Most Outstanding Dividend Stock I Know

Today I'm going to give you some straight-talk about dividends.

High yield does not equal high return, and you could severely limit your returns if you don't heed this warning. In the next four minutes, allow me to explain what I believe is the wrong way to invest in dividends. I will also reveal the single best dividend stock I know.

You demanded it
With Treasuries and bonds paying bupkis, Fool.com readers have shown an increasing amount of interest in dividend-paying stocks over the past six months, and we are doing our best to cover them from every angle. Because of this interest, I pored through The Fool's vast databases to look for my and Fool.com readers' favorite dividend stock.

There's been especially huge interest in rural telecoms as they are among the biggest yielders in the S&P 500.

Company

Dividend Yield

Last Dividend Payment Date

Frontier Communications (NYSE: FTR  ) 8.3% 9/30/2010
CenturyLink (NYSE: CTL  ) 6.9% 9/20/2010
Windstream (Nasdaq: WIN  ) 7.7% 10/15/2010

Compared to the S&P's yield of 1.91%, it's easy to see why investors are drawn to these stocks. However, smart investors look beyond the yield and into the growth prospects of the underlying company.

Rural telecom is a declining industry, and as a result, the underlying businesses are unlikely to grow -- other than through acquisition. For example, Frontier spent $5.25 billion on Verizon's (NYSE: VZ  ) rural lines, and CenturyLink has recently agreed to merge with Qwest.

Sky-high yields of 8% may seem like a sure-fire win, but let's break it down.  This industry is not growing, which implies that your original investment will not grow.  If that holds true, it means that the maximum return you can expect is the yield itself, or around 8% per year for the companies above.

That's a decent return, but what if the industry declines? If you're taking the dividends as cash rather than reinvesting, you'll need around 12 years to double your money.  

Consider that the Internet was in its infancy 12 years ago, and you'll see that a lot can change in communication over that time period. Over the next 12 years, your original investment is at risk of declining with the industry. If it does, then those 8% returns get wiped out very quickly.

Fasten your seatbelt for REALLY high yielders
The next category of high-interest dividend stocks are real estate investment trusts or REITs. Their business model is relatively simple: Borrow low-interest short term cash and use it to purchase long-term real estate-based assets. This is highly lucrative in the current environment given that borrowing costs are essentially zero.

In order to maintain a REIT status, these companies are required to pay out 90% of their taxable income as a dividend. That requirement combined with the huge spread between borrowing costs and their return equates to some very sexy dividends for investors.

Two such companies are American Capital Agency (Nasdaq: AGNC  ) , yielding 19.7%, and Annaly Capital Management (NYSE: NLY  ) , with a current dividend of 15.3%.

This industry doesn't suffer from the same declining concerns as rural telecom, but there is something else investors should keep an eye on. As soon as the Fed begins bumping rates up -- and they will -- borrowing costs for these REITs will increase accordingly. When that happens, the spread will decrease, and ultimately their dividend yield will drop.

There will likely be some long-term outperformers in the group, as Annaly has been for more than a decade, but it's crucial that investors research the underlying company to look for operational advantages, rather than buying simply because of a high yield.

Medium yield, sky-high returns
That thinking leads to the company I believe is the greatest dividend payer in the market today. It is the leader in an industry that is essentially guaranteed to be around 100 years from now. While the industry may change, I believe this company has positioned itself to change with it. That's the kind of advantage dividend investors should demand.

I'm talking about Waste Management (NYSE: WM  ) , the $16 billion leader in waste and environmental services. Including dividends, the company has returned 34% versus the S&P 500's 7% over the past five years.

More on the dividend in a second, but here are three primary reasons I like the underlying company and its industry:

  1. Trash is an everyday reality. My apartment in Alexandria, Va., scraps 10 dumpster-loads every single day, and I'm just one in a sea of buildings. There are few catalysts that could halt this daily process repeated thousands of times across America.
  2. Waste Management is North America's largest recycler. By 2020, the company expects to manage more than 20 million tons of recyclable commodities.  I strongly believe that positions the company to benefit from a wider-spread green movement, which is almost a certainty in my opinion.
  3. They are innovators within a seemingly dirty and boring industry. From powering their trucks with liquefied landfill natural gas to creating Bagster, a heavy-duty portable "dumpster in a bag" targeted directly at consumers, the company is constantly looking for efficiencies and creating new realities in their industry.

For these reasons, even if they didn't pay a dividend, I like the company over the long-term. That's the crucial step I believe investors need to take before buying a dividend stock -- look at the company, then dig into the dividend -- not the other way around.

Combine this great business with a solid 3.6% yield and a five-year history of boosting its dividend by a compounded 9.3% per year, and you have a great addition for any portfolio.

While I truly believe Waste Management is the very best dividend stock in the market, intelligent investors demand more options for their hard-earned investing dollars.  Thousands have requested access to a special dividend report created by Motley Fool analysts, and I invite you to download it today at no cost to you. In this report, Fool analysts cover several more outstanding dividend-paying companies, including the stock Fool analyst Jim Royal calls the "dividend play of a lifetime." To get instant access to the names of these 13 high-yielders, click here – it's free.

Jeremy Phillips owns no shares of the companies mentioned in this article. Motley Fool Options has recommended writing a covered straddle position on Waste Management, which is a Motley Fool Inside Value pick and a Motley Fool Income Investor pick. The Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (24) | Recommend This Article (178)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 16, 2010, at 3:51 PM, midnightmoney wrote:

    Jeremy, can we assume you'll be buying some of this company if it's the very best dividend stock in the market? If not, could you explain why you will forgo it?

  • Report this Comment On November 16, 2010, at 4:30 PM, ayaghsizian wrote:

    I was also wondering why you don't own it? You had me convinced until i read the fine print. I can give you a loan if you're strapped for cash.

  • Report this Comment On November 16, 2010, at 5:24 PM, paul7777777 wrote:

    Sorry, but I find a dividend yield of 3,6% not interesting, also I don't see how this stock at this level can outperform. I think there are a lot of other companies with much bigger dividend yields and also likely to outperform.

  • Report this Comment On November 16, 2010, at 5:38 PM, TMFMoby wrote:

    midnightmoney & ayaghsizian - Thanks for the comments. I typically veer towards more rule-breaking type companies for my portfolio, rather than most-established dividend payers. I challenged myself to identify the very best one for this piece, and I've now added Waste Management to my watchlist so I can follow them more closely and learn more about them.

    I'll make this promise to you: I will write a followup article within two months in which I will have either bought the stock for my personal portfolio or uncovered a very good reason not to. Either way, I hope this article and my future piece will add to your thinking about Waste Management and other dividend payers.

    Foolishly,

    Jeremy

  • Report this Comment On November 16, 2010, at 5:43 PM, midnightmoney wrote:

    Fair enough, Jeremy, and thanks for the post. Food for thought is what keeps me coming back.

  • Report this Comment On November 16, 2010, at 7:31 PM, neamakri wrote:

    okay, this is the third or fourth time in the last two weeks that someone has hawked Annaly (NLY). I looked up data on Bigcharts and they pay $2.72 annual dividend.

    They earned $1.36 last year, projected $2.40 this year, and $2.58 next year. It appears that somebody is lying because you cannot continue to pay more than you earn year after year after year.

    Please either explain how this is possible year after year after year, or else stop.trying to sell NLY!

  • Report this Comment On November 16, 2010, at 8:05 PM, DDHv wrote:

    I've found that multiplying the dividend yield by the 5 year growth gives a good statistic. Taking a close look at the ones that come out at the top works well. You need to check other things also, naturally.

  • Report this Comment On November 16, 2010, at 11:25 PM, PeyDaFool wrote:

    Although I respect your opinion, Jeremey, I'll have to disagree wiu your outlook for WM. The high level of debt, relatively high payout ratio and low beta suggest to me that the stock will underperform the S&P. I'll definitely put the stock on my watchlist, however, and it will be interesting to see the future trends.

    Thanks for your article.

  • Report this Comment On November 17, 2010, at 1:29 AM, Mstinterestinman wrote:

    I think KO and MCD are also worth looking at both have been around aolong time well run and consistently increase dividends.

  • Report this Comment On November 17, 2010, at 10:36 AM, Nrgyindependance wrote:

    To @neamakri about NLY --

    You should go to the NLY stock quote page and read the many articles explaining how NLY pays out more than its earnings. In the case of NLY, earnings are misleading as they are based on GAAP accounting rules enforced to calc earnings. However, free cash flow and leverage is significant after depreciation and other "expenses" and allows them to more than cover the dividend. Plus, as a REIT they are required to pay out at least 90% of cash flow. I have owned the stock for nearly 6-7 years and dividend has always been paid, albeit with minor fluctuation. Also, at the NLY page you will see many conflicting opinions about NLY, including those by Motley Fool. The stock is worth checking out if you like dividends.

  • Report this Comment On November 18, 2010, at 3:13 PM, rainmon wrote:

    I usually just multiply the cost of 100 shares time 9%, then divide by 12, then sell a cover call option with a one month expiration date on a medium to high beta stock/etf like BIDU, EWZ, GDX, EEM, AAPL, NFLX, YUM, LVS, or you could buy T and VZ with the same approach and add in their nice dividend that is in the 6-7% ranger ever 3 months...

  • Report this Comment On November 19, 2010, at 9:04 AM, Jackeen100 wrote:

    At 8% per year, compounded annually, the rule of 72 would give you 9 years to double your money assuming you acquired additional shares via a DRIP. If, on the other hand, you took the dividends as cash, you are correct in that it would take 12.5 years to double your money. I prefer DRIP's.

  • Report this Comment On November 19, 2010, at 11:56 AM, lgaylord wrote:

    What about the big telecoms like DT or ATT, etc.?

    Do you think they're declining as well? We can't

    be without cell phones...not even for a minute!!

  • Report this Comment On November 19, 2010, at 1:02 PM, refriedbean wrote:

    NLY--I don't care how they do it. Take the money and run!

  • Report this Comment On November 19, 2010, at 1:51 PM, SonnyfromHoboken wrote:

    In response to the question about how a REIT can pay out more than it's net profits, two points. The article is not correct. REITs don't pay out 90% of their taxable income. They are required to pay 90% of thier funds from operations (FFO). In other words, essentially, the cash flow from operations. Technical accounting issues make it a bit more complicated. A non-mortgage REIT will always pay out more that it's net because of depreciation, a non-cash expense.

  • Report this Comment On November 19, 2010, at 1:54 PM, billqpgmr wrote:

    I'm a big believer in dividend stocks; with my financial advisor I am well diversified, but that includes some non-traded reits...I would much rather own reits and let them do the hard work than own real estate directly and deal with tennants, business or consumer.

    I've owned Annaly for a long time, and been happy with it. That said, my biggest learning experience in chasing high dividends was with Capital Source - CSE - which at one time was a REIT doing capital investment and doing very well. It made the mistake of buying a bank just before everything went to hell, and my 5k became 500. Made me VERY glad that I stick to a rule preventing any individual stock from becoming too large a part of my net worth.

    I own WM, and believe very much in the stock...it is one of the Buy First selections in income investor for a reason, that core set of stocks is defined for exactly the reasons provided in this article...solid companies, with long term growth prospects, and a track record of raising dividends.

  • Report this Comment On November 19, 2010, at 2:11 PM, littlemike4 wrote:

    Thanks Sonny for the clarification. I hadn't considered the condition of the requirement and appreciate the heads up.

    At the end of the day (give or take 20 yrs), when the property is all depreciated, do the REIT investors have any stake in the property, or is that the angle of the issuer?

  • Report this Comment On November 19, 2010, at 2:13 PM, shrewdshrew wrote:

    Jackeen101: Each to his or her own regardings DRIPs vs. non-DRIPS, but to suggest that it may take 12.5 years to double your money when taking the cash, surely it depends on what you do with the cash? Investing it in another stock that pays a dividend and grows exponentially can be a better strategy, particularly if it adds diversification to one's portfolio.

    For that reason, I'm not a believer in the DRIP approach. Just a thought.

  • Report this Comment On November 19, 2010, at 4:35 PM, MarkGillCPA wrote:

    littlemike4: Yes, most REITs invest in actual real estate. They record depreciation on that real estate each quarter. However, they still own the underlying real estate, even if it is fully depreciated. So, during periods of rising real estate values (let's dream a little), a REIT could have real estate on its books that is worth more than book value.

    Annaly (NLY) is different from most REITs in that they do not buy real estate. They buy real estate securities based on pools of mortgages. In this sense, they are more like a commercial bank that is trying to borrow funds at a low rate and lend it out at a higher rate - they make money on the spread. Works great so long as their borrowing cost stays low.

  • Report this Comment On November 19, 2010, at 7:06 PM, geecheegirl wrote:

    You mention it taking 12 yrs. to double your money with Frontier. And so with Waste Management's 5-year return of 34%, INCLUDING dividends, how long would it take to double your money with WM? I think I'd prefer Frontier. Even if the dividend is cut in half over time, it will still beat WM.

  • Report this Comment On November 19, 2010, at 7:41 PM, birder1500 wrote:

    I do have some problem with this analysis. Let's consider WM. It's earnings have been pretty much stagnant for the past 6 years counting this year. Seems to be stuck in a rut. Rut stocks do not make all that good of investments, I don't think. Better to buy KO, MCD, and ABT in my mind.

  • Report this Comment On November 20, 2010, at 9:51 AM, busterbuddy wrote:

    Agree with watching out of high yielder's. My high yield threshold is 8%. Anything over that should be considered speculation and you will probably lose capital over the long run. Meaning alot of the dividend is return of capital. Waste Management, well while I might add to a watch list, I'm not too sure about it. Just sort of makes me wonder too much. Pitney Bows however is something to really consider. But good article.

  • Report this Comment On November 20, 2010, at 2:15 PM, mike2153 wrote:

    On 1/20/10 I bought 200 shares of Resource Capital Corp. (RSO) at 5.33. It's now at 6.54, a 23% gain. It's a REIT. It's also paid $50. a quarter in dividends. So if it can go four more years at that rate, I'll have made my entire investment back. Then it's all gravy.

  • Report this Comment On November 23, 2010, at 2:24 AM, colibri2011 wrote:

    Looks like a good shorter term investment with a stop-loss used in case it tanks when interest rates rise again.

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