The Dividend Opportunity Everyone's Missing

There's one fantastic dividend play out there that no one seems to be pouncing on.

And it's probably not the one you're guessing.

It's not REITs
The cat is out of the bag on real estate investment trusts (REITs) -- particularly mortgage REITs. Every investor with eyes sees the mind-blowing 15-20% dividend yields at American Capital Agency (Nasdaq: AGNC  ) , Resource Capital (NYSE: RSO  ) , and Annaly Capital.

This play works if the Fed keeps the hammer down on rates and enables the fantastic interest rate spreads these companies are capitalizing on. That would help keep the profit train rolling and, since they're REITs that have to pay out 90% of their taxable incomes, the dividends flowing.

The way to determine the best of breed here is to compare REITs on leverage ratios (less debt is better), the frequency of share offerings (since they can't hoard cash, share offerings are an unfortunate reality), and the dividend payouts as a percentage of funds from operations (earnings plus depreciation and amortization).

But the dividend play I'm thinking of doesn't rely on government stimulus and isn't constrained by mandatory payouts that increase bankruptcy risk.

It's not the telecoms, either
Telecoms have some tasty dividends, as well. Big players like Verizon and AT&T are yielding around 6%. But the rural telecoms Frontier Communications (NYSE: FTR  ) and Windstream (Nasdaq: WIN  ) trump them by doling out 7%-8%.

For the rural players, there isn't much growth opportunity except through consolidation -- e.g. Frontier's purchase of a huge chunk of Verizon's rural assets this past summer. The bet here is basically that Frontier and Windstream can maintain their cash flows (and high dividends) longer than the market thinks.

Maybe they can. But the dividend play I'm thinking of is in a sector where consolidation is a bigger opportunity.

And it's not MLPs
Like REITs, master limited partnerships (MLPs) get special tax treatment in return for huge payouts -- 90% of their cash flows. However, rather than being real-estate-based, MLPs generally tend to be energy plays.

Because of the need for consistent cash flows, energy pipeline operators are a popular choice in this space. Think Kinder Morgan Energy Partners (NYSE: KMP  ) , Enterprise Products Partners (NYSE: EPD  ) , and Enbridge Energy Partners, which are paying out dividends in the 5%-7% range.

Pipelines get their money not from selling oil and natural gas but from charging others to transport the commodities. Buying into these types of companies on price weakness (when yields are highest) can be a great dividend play. But I like the one I'm think of more.

The dividend opportunity everyone's missing
The opportunity I'm thinking about is small banks. Depending on your mood, this may sound either (1) boring or (2) crazy to you, but that's exactly why it's such an opportunity.

In good times, no one cares about these stocks. They get no press, and they're just plain boring. But in these bad times – say, right after a financial crisis led by the banking industry -- many investors are viewing the whole sector not as boring but as toxic.

But it isn't.

In fact, there are a bunch of really quality banks out there that didn't leverage themselves up and didn't load themselves up with subprime mortgages. They continue to stick to the business model that has made banks money for years and years and years: Take deposits. Lend those deposits out to low-risk borrowers. Pocket the interest rate spread between the two.  

The trick is separating the good banks from the bad banks.

Since I started personally buying up small bank stocks a year and a half ago, no small bank has impressed me more than Community Bank System (NYSE: CBU  ) . Beyond its strong balance sheet, its strong dividend payouts, and the fact that its bad loan percentage is still the same as it was during 2005. Community Bank System is the gold standard because of management's focus on the shareholder. As a small example, management actually sends out an 8x11-inch postcard each quarter explaining the bank's results in plain English!

It's banks like Community Bank System that make buying a basket of small banks on price dips the most overlooked -- and potentially profitable -- dividend opportunity I see.

As much as I like them, though, small banks should only be part of a well-balanced dividend portfolio. So for more dividend ideas, including "one dividend stock for the rest of your life," check out the Motley Fool's free dividend report by clicking here.

Anand Chokkavelu owns shares of Community Bank System. Enterprise Products Partners LP is a Motley Fool Income Investorpick. 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 (15) | Recommend This Article (86)

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 December 07, 2010, at 3:33 PM, paul7777777 wrote:

    CBU is not interesting at all, only 3,75% dividend and after a plunge at the same level again as 3-5 years ago.

    There are a lot of banks who have much more potential, because they are still far under their normal value.

  • Report this Comment On December 07, 2010, at 4:33 PM, TMFBomb wrote:

    @paul7777777,

    For those looking to buy small banks, I think it's instructive to look at CBU as an example of a bank that does things correctly.

    I agree that it's currently on the pricey side (I bought in somewhere around $15...it currently sits around $25). This is where setting a watchlist and buying on a dip comes in.

    Dividends on the banking side won't be as eye-popping as these other high-flyers, but I think the opportunity for capital gains is greater.

    If you're looking for another promising small bank, my fellow Fool Todd Wenning recommended IberiaBank (Nasdaq: IBKC). Its dividend is just 2.5%, but its other metrics look quite strong.

    http://www.fool.com/investing/small-cap/2010/08/17/todays-bu...

    -Anand

  • Report this Comment On December 07, 2010, at 7:48 PM, vkowalczuk wrote:

    I was pleased to see how many of theses stocks I own. The way I found them is this...I went to real estate and banks for div. yields because large pay-backs from these sectors. I then gwent to E-Trade's list of hightest returns in these sectors and hence, the finds. I am getting 20% returns going in and out of these. I also found the best time to buy a stock is right after they have paid dividends.

  • Report this Comment On December 09, 2010, at 4:45 PM, mikecart1 wrote:

    CBU is about as interesting as listening to Sarah Palin's explain the theory of relativity.

  • Report this Comment On December 10, 2010, at 12:51 PM, whyaduck1128 wrote:

    I made the small bank mistake a year ago, buying some HCBK. Nice yield, but my worst performer over the last year. My other small bank stock is FFBC. The yield is no great shakes, but the stock price has done nicely, and I can keep a close eye on it because it's in my area.

  • Report this Comment On December 10, 2010, at 1:24 PM, gimponthego wrote:

    Question, please. I purchased several shares of AGNC on 12/3..I believe I missed the payout. Can anyone confirm that? Thanks! Johnny

    P.S. Either way, the stock is doing well.

    Likewise, OXPS. I added to my position today..just greedy. Originally bought on 12/3..and, again, stock is doing well. For the 1st time, there was the notation "Bought With Due Bills" above the purchase history in my account. I trade within my IRA at my bank. They were not familiar with the notation either, and I was wondering if anyone would be kind enough to explain it in layman's terms? Thanks Again!

  • Report this Comment On December 10, 2010, at 3:02 PM, marhu wrote:

    WABC & BANF are good solid little banks. There current dividend yield may not look great at first glance, but both do have a history of raising their dividends over the years. Also, their other valuation/risk ratios are great as well as WABC planned stock buy-back.

    I'm not great at math, but I hear that if dividends grow, then after a few years the effective yield for long-holders goes up, sometimes into double digits.

  • Report this Comment On December 10, 2010, at 3:14 PM, thopau wrote:

    As we all know, the dividend play is a great way to enhance cash value while watching the stock hopefully move upwards. The banks are an "ok" investment, but I've not done well with bank stocks and prefer energy trusts. As an example in 2009 started buying Baytex Energy (BTE) for around $30. I continue to buy BTE, the last purchase in Oct. of 2010. It pays a monthly dividend of 5.26% and to date I am up 53.5% on the stock. Their production is forcasted to be better in 2011 than it was in 2010. P/E is on the high-side but would like to know of other successes in similar type companies rather than banks. Have a prosperous 2011

  • Report this Comment On December 11, 2010, at 3:39 PM, uawrob wrote:

    I have UBCP it pays around 6% yeild and is going for around 8.00 a share right now. What do you think about this company

  • Report this Comment On December 12, 2010, at 12:16 PM, TMFBomb wrote:

    @uawrob,

    I haven't looked into United Bancorp (UBCP) in depth. What I'd want to look into more is its provisioning for bad loans. I usually like that figure to be 100% or above. As of June 30, it's sitting at just 43.3%. If United has to provision further in the future, that'll affect its earnings negatively and may endanger that dividend payout.

    -Anand

    P.S. I am excited that you picked a bank headquartered near where I grew up in Ohio.

  • Report this Comment On December 12, 2010, at 9:09 PM, neilvanrijn wrote:

    I've traded many of the stocks in this article at one time or another , but these days I don't collect the dividends. I have a watch list of 40 some stocks with humongous dividends and I keep track of their ex dates. All the stocks in this list have a history of significant price jumps right before their ex dates.

    I use the div as bait - dividend fishing. It works. I hit a lot of one base hits, very few strikeouts, and the occasional homer. I'm far from the only one doing this or it wouldn't work as well as it does.

  • Report this Comment On December 12, 2010, at 10:30 PM, rttellico wrote:

    Take a look at San Diego Trust (SDBK). Relatively new bank with seasoned, professional staff and a good looking growth record.

    They are picking up customers tired of dealing with the big banks after mergers and have a good looking balance sheet.

  • Report this Comment On December 13, 2010, at 4:38 PM, belcherjb wrote:

    We all know that the dividend on REITs will decline when interest rates incline - so what, if anything, does that imply regarding REITs' market price?

  • Report this Comment On December 13, 2010, at 4:42 PM, mroc237 wrote:

    Well of course if dividend's decrease then investors are going to sell off on that and also worried about decreased profits and revenues. So lower stock price when interest rates rise.

    The real dividend op everyone is missing is this, 44% yield! Not a special dividend too, a regularly declared quarterly dividend for second consecutive quarter

    http://caps.fool.com/Blogs/penny-stock-dividend-44/488913

  • Report this Comment On December 22, 2010, at 10:57 AM, johnprtl wrote:

    CBU's First Liberty banks are located in NE PA, squarely in the Marcellus shale gas region. It has historically been a depressed area, but the natural gas is changing everything. There will be a great deal more business for CBU and everyone else there for the forseeable future.

    I don't believe the NY area is actively exploiting nat gas yet, but it is sure to come.

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