Income investors always face a dilemma when looking for the perfect dividend stock: They want the most possible income with the least possible risk. Usually this means hovering in the middle or caving in to the safety of a smaller yield.
However, the most daring investors stare risk square in the eye and go after high-yielding dividend stocks. There's no question that weeding out the potential bad apples among high-yield stocks (those typically yielding over 4%) is tedious, but the income rewards can be well worth it.
We asked three of our Foolish investors to name a high-yield dividend stock that the most daring of income investors should consider. They chose mortgage real estate investment trust Annaly Capital Management (NYSE:NLY), retail giant Target (NYSE:TGT), and domestic automaker General Motors (NYSE:GM).
Psst! How does a 10% yield sound?
Sean Williams (Annaly Capital Management): If income investors really want to be daring, they should take a good look at mortgage real estate investment trust (mREIT) Annaly Capital Management, which is yielding an eye-popping 10.1% at present.
Why haven't dividend investors pounced on a company with a 10% yield? The simple answer is that mREITs like Annaly tend to be very sensitive to interest rate hikes. The Federal Reserve is currently in the process of tightening monetary policy, which has meant an increase in lending rates. Mortgage REITs make their money on the difference between the rate at which they borrow and the rate at which they lend, which is known as net interest margin. If interest rates rise quickly, it becomes more expensive to borrow money; the net interest margin shrinks, and so does Annaly's ability to pay out delectable dividends in the process. In other words, Wall Street is anticipating a future payout cut from Annaly.
Could this happen? Absolutely. But is Annaly Capital Management going to see a major haircut to its dividend? That I don't believe.
First, take a look at U.S. economic growth. Yes, low unemployment levels are conducive to future rate hikes and monetary tightening, but inflation has moved lower in four straight months, suggesting that the Fed may move slowly with future rate hikes. The longer it takes for the Fed to reach its 3% fed funds target, the more a company like Annaly will be able to use leverage to its advantage.
Additionally, investors should understand that Annaly's portfolio of assets, such as mortgage-backed securities, is almost entirely agency-backed. In plainer terms, it means that Annaly's assets are backed by the government in case of default. It does mean it pays out lower yields than its peers that focus on non-agency assets, but it gives investors more cash flow predictability and the chance to sleep well at night.
Annaly has been generating about a 10% yield for a decade. There's no guarantee it'll be able to maintain a yield this high if interest rates keep nosing higher, but I'd suggest that Annaly's yield will continue to crush that of the S&P 500. So income investors who want to double their money within a decade on payouts alone would be wise to give Annaly a look.
Aim for a 4.5% yield
Demitri Kalogeropoulos (Target): With over 1,800 stores spread across the country, Target is heavily exposed to the growth slowdown that's harming the broader retailing industry. Its weak results over the past year illustrate that sensitivity. Comparable-store sales ticked down in the first quarter as customer traffic declined by 0.8%. Solid growth on the digital side of the business, meanwhile, only blunted the damage as a 22% gain in the e-commerce sales channel turned what would have been a 2.2% comps decline into a 1.3% dip. Earnings were down 6% for the quarter.
The punishment the stock has taken in response to these results has made Target one of the highest-yielding stocks on the S&P 500 at over 4.5%. There's little danger that this retailing giant will be slicing its dividend any time soon, though. After all, it has boosted its payout each year since going public in 1967, and the dividend amounted to just under half of its operating cash flow in 2016 .
That said, a Target purchase today only makes sense for long-term investors who believe management will engineer an operating rebound with e-commerce growth and a new focus on price-based competition in stores. The early results of that shift are encouraging, as comps are set to tick higher in the second quarter. Yet the ride won't be a smooth one for investors, given that management has warned shareholders to expect a multiyear transition period.
Prepared for the road ahead
Daniel Miller (General Motors): You'd have to be a daring investor indeed to buy into automakers such as General Motors currently. The truth is, the auto industry is cyclical in nature and the stocks are often heavily sold off as the industry peaks or economic concerns grow, even if the bottom line remains healthy and attractive. Further complicating things is the fact that the industry is poised to evolve more over the next two decades than it has over the past century, which leaves a hefty amount of uncertainty for investors to digest.
Despite the high level of uncertainty facing the industry and daring investors willing to buy in, General Motors trades at a cheap six times its trailing-12-month earnings, and boasts a dividend yield of 4.25%. And if investors are daring enough to buy into GM, they'll find that the automaker has changed its ways since the Great Recession, when it was caught in a unique bailout.
For instance, while its crosstown competitor Ford Motor Company is sticking in markets for the long term -- which has sadly been unrewarded by Wall Street's short-term thinking -- GM has taken a near-term approach and sold its problematic European operations. That could be a move that hurts GM in the long term, but considering it had lost over $20 billion since 1999, it's a move that shows GM is trying to focus on its most profitable products and markets to the benefit of its bottom line and shareholders.
General Motors has invested substantially in its future, with the electric Bolt recently going into production, its Maven smart-mobility brand continually expanding, and its Cruise Automation acquisition having the potential to bolster the development of its autonomous-vehicle technology. It also has cut costs, improved its scale, improved its return on invested capital in recent years, and recently posted a strong quarter. While the uncertain auto-industry future is fast on its way, GM is more equipped than ever to adapt and evolve -- and for daring investors, its 4.25% dividend yield is enticing.
Daniel Miller owns shares of Ford and General Motors. Demitrios Kalogeropoulos has no position in any stocks mentioned. Sean Williams has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Ford. The Motley Fool has a disclosure policy.