High yields and low earnings multiples tend to go hand in hand, but big dividends can be a sign that a company is no longer in a position to deliver solid growth and needs to attract investors through payouts. That means that simply chasing yield can be a dangerous pursuit so we asked a panel of top Motley Fool investors to help readers identify stocks that offer the right combination of sound business fundamentals, sustainable income generation, and attractive valuations.
Picking up the pieces
Dan Caplinger (Fred's): The retail sector has gotten hit hard in recent years, and one of the most volatile areas has been the drugstore retail niche. Fred's sought to become a major player in the industry by offering to purchase 865 drugstore locations from Rite Aid (NYSE:RAD) as part of its then-proposed merger with Walgreens Boots Alliance (NASDAQ:WBA). When the Rite Aid-Walgreens merger fell apart, Fred's was left out in the cold, and Rite Aid appears to be ready to operate its remaining stores after selling more than 1,900 locations to Walgreens.
Without the opportunity to expand aggressively through the purchase of hundreds of pharmacy locations, Fred's has been left in a difficult spot. The stock price has plunged to its lowest levels in nearly 20 years, and the company is looking hard at its efforts to implement a viable turnaround strategy. For now, Fred's hasn't made any changes to its dividend policy, which includes a $0.06-per-share quarterly payout that works out to a 5% yield. Although the company didn't discuss dividends explicitly in its most recent conference call, Fred's might well have to consider a future cut if its strategy requires considerable capital investment. Investors should be fully aware of the risks involved before seeing Fred's simply as a high-yield value play.
Nothing rock bottom about a steadily rising payout
Sean O'Reilly (Enterprise Products Partners): My pick for a high-yield stock at a rock-bottom price, Enterprise Products Partners, is one of the biggest midstream energy infrastructure owners in the United States. Shares have slid 9.8% year to date, but don't let its share price performance turn you off. Enterprise Products Partners recently announced its 62nd distribution increase since its IPO in 1998, and currently sports a yield of around 6.9%. This 4.3% increase brings its annual distribution to t $1.69. Primarily servicing the natural gas industry, it owns approximately 50,000 miles of natural gas, NGL, crude oil and other petrochemical products pipelines. In addition, it owns 260 million barrels of natural gas liquids (NGLs), 260 million barrels (MMBbls) of NGL, refined products, and crude oil storage capacity.
As a master limited partnership, Enterprise Products Partners is required to pay out 90% of its taxable income as dividends to its unit owners. In exchange, it doesn't pay corporate income tax. For this reason, traditional dividend safety measures like payout ratios aren't useful. However, its distribution-to-distributable cash flow (DCF) ratio currently stands at 0.83 for the nine months ended Sept. 30, 2017 -- more than reasonable for an MLP as diversified as Enterprise. Looking ahead, it has plenty of projects in the pipeline (see what I did there?) to keep its payout growing for years to come. Management recently noted at the RBC Capital Markets MLP Conference that it had $9.1 billion in planned capital projects through FY 2019 -- new assets that will drive its cash flow ever higher. With shares languishing at 52-week lows and a yield pushing 7%, Enterprise Products Partners is a great high-yield stock at a rock-bottom price.
A discounted income play in telecom
Keith Noonan (AT&T): Shares of AT&T have dipped roughly 12% since October following lackluster third-quarter results, disappointing projections for the company's wireless and satellite television businesses, and challenges to its merger with Time Warner from the Department of Justice. Shares are now down more than 19% year to date and trade at roughly 12 times forward earnings estimates. The big price drops have also had the effect of lifting the company's dividend yield, which now sits at a hefty 5.7% and gives income-focused investors added reason to narrow in on the stock.
While AT&T is currently seeing some weakness in demand for its postpaid wireless service, the long-term trends points to more devices heading online and requiring connectivity and the company benefiting from a range of service bundling opportunities. To be sure, closing the Time Warner deal is important for the company on that latter front. As it stands, AT&T could have to make additional concessions in order to get the deal approved or successfully defend the merger in court, but I think there's a good chance that it will eventually go through and that the related stock declines present a buying opportunity.
There's no doubt that the last couple of months have seen some unfavorable developments for AT&T, but its stock looks like a bargain for income investors with its dividend yield near its highest point in the last five years and a 33-year history of payout growth.
Dan Caplinger has no position in any of the stocks mentioned. Keith Noonan has no position in any of the stocks mentioned. Sean O'Reilly has no position in any of the stocks mentioned. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.