One of the benefits of a Roth IRA is that you pay taxes on the money as it goes in so you don't have to pay taxes when you pull money out. That makes these retirement accounts the perfect place to put income-oriented investments like high-yield dividend stocks. International Business Machines Corp. (IBM 1.05%), ONEOK, Inc. (OKE 0.75%), and Royal Dutch Shell plc (RDS.B) are three great stocks for you to consider for your Roth IRA.
1. The turnaround
IBM's yield is around 4.1% today. That's a lofty number for a technology giant, but this over 100-year old company has been struggling through a business makeover. That's lead to revenues falling, quarter over quarter, for more than five years. Investors have been, understandably, worried that IBM won't be able to change with the shifting technology market.
Image source: Getty Images
IBM, however, has revamped its business before over its long history, going from scales and clocks to mainframes to computers to tech services. Right now it's moving out of lower margin businesses like building computers and into higher margin areas like cloud computing, artificial intelligence, and security. As the revenue declines show it's been a slow process.
However, if you believe, as I do, that IBM can successfully change with the times again, then you have an opportunity to add a high yielding tech name to your portfolio -- one, by the way, that has increased its dividend in each of the past 22 years. Note, too, that despite the top line declines, earnings have remained relatively strong, helped along by stock repurchases. To put a number on that, revenues are down around 20% over the past decade, but earnings per share up up by 70%. And IBM is still producing plenty of cash flow -- enough to cover that dividend and, so far, the costs of its turnaround effort.
2. Shifting the mix
ONEOK is another company that's in the middle of a business transition. This midstream oil and gas corporation recently purchased ONEOK Midstream Partners. This move will reduce ONEOK's cost of capital, which will make it easier for the company to fund its growth in the future. Note that I'm using the word company here: ONEOK is not a partnership, as partnerships can create tax complications for IRAs. ONEOK is a great way to get exposure to dividend paying midstream assets without causing yourself any tax headaches.
After the acquisition of ONEOK Midstream Partners, however, ONEOK still has a relatively high debt load. Now that the deal is done, the company plans to focus on debt reduction. The goal is to get debt to EBITDA levels below 4. That's something you'll want to watch to ensure management comes through. One pre-merger promise that ONEOK has already made good on, however, was the huge 21% dividend hike in August following the completion of the deal.
OKE Financial Debt to EBITDA (TTM) data by YCharts
ONEOK currently yields around 5.3% and has increased its dividend every year for 15 years. There are a lot of moving parts today, but with dividend coverage of around 1.5 times in the second quarter and a largely fee-based business model, there appears to be little reason to worry about the dividend.
3. Paying off those debts
Speaking of debt reduction, you might also want to look at Royal Dutch Shell. This integrated oil and natural gas giant is in the process of repairing its balance sheet following the over-$50 billion acquisition of BG group in the middle of the recent oil downturn. It currently yields around 6%, but hasn't been increasing its dividend lately because of the debt issue. One note here: you'll want to stick to the class B shares, because the A shares are subject to Dutch withholding taxes.
The BG purchase is a balance sheet concern because it increased Shell's debt by roughly 50% in 2016. Following the deal, the company announced plans to sell $30 billion worth of non-core assets so it could pay down debt. It already has roughly $25 billion worth of asset sales inked or completed. So, like ONEOK, Shell is making good on its promises.
Shell's cash flow breakdown over the past 12 months. Image source: Royal Dutch Shell plc
That said, despite the fact that oil prices are still well off their 2014 highs, over the trailing year through June Shell's cash flow was enough to cover its dividend and debt reduction efforts. So things appear to be going pretty well for Shell right now. Be prepared for some bumps if you decide to step in here, though: the top- and bottom-lines are driven by commodity prices, and, well, selling $30 billion worth of any business isn't exactly a simple process.
Take advantage of the Roth
IBM, ONEOK, and Shell offer relatively high income streams that you can pull out of your Roth tax-free. That's a huge benefit to you and your financial future. IBM is probably the highest risk option here, since it's still working through a difficult turnaround. ONOEK's acquisition should help it grow in the future, but watch the debt to EBITDA level to make sure management comes through on the promised reductions. Shell, meanwhile, appears well along the way toward repairing its balance sheet after a giant deal, and its high yield seems worth the risk.
