All too often when a cheap stock offers a high dividend yield, it's too good to be true. Perhaps the stock has plunged with good reason, for example, and the company simply hasn't suspended or reduced its payout yet.
But make no mistake, not all high-yielding bargain stocks are value traps. We asked three top Motley Fool investors to each pick a high-yield stock that they believe is trading at a rock-bottom price. Here's why they chose Retail Opportunity Investments (NASDAQ:ROIC), Teleffonica S.A. (NYSE:TEF), and Ford (NYSE:F).
A unique way to bet on real estate
Steve Symington (Retail Opportunity Investments): Given today's increasingly competitive retail environment, the brick-and-mortar retail industry might not seem like the best place to park your money. But Retail Opportunity Investments has found a different way to capitalize on the sector. By buying and revitalizing necessity-based retail properties -- which generally means they're anchored by large grocery chains, thereby ensuring healthy traffic to all stores in the area -- that are located in mid- to high-income areas, the company has been able to steadily increase base rents while keeping occupancy rates above 97% for the past four years straight.
Last year alone, Retail Opportunity Investments acquired nearly $360 million of grocery-anchored shopping centers, adding over 1 million square feet to its portfolio in the process. And it shows no signs of slowing down, having already made almost $24 million in acquisitions so far in 2018 as of its most recent quarterly report last month.
And as a real estate investment trust (REIT), Retail Opportunity Investments is required to pay 90% of its income to shareholders through dividends, which means a current annual yield of 4.4%. With shares trading at just 15 times this year's expected funds from operations, and for investors willing to buy and hold while the company continues to grow its portfolio in the coming years, I think Retail Opportunity Investments stock is a compelling buy.
Bad dividends? Nope, that's just a cultural difference
Anders Bylund (Telefonica): With its core operations running in Latin America and Europe and headquarters in Madrid, Spain, Telefonica is nearly invisible to American investors. That's a shame, because it's a well-run telecom with global growth ambitions -- and a solid but unfamiliar dividend policy.
In America, dividends are expected to grow on a straight line forevermore. Warren Buffett often cites this expectation as one of the main reasons why Berkshire Hathaway does not and will not pay a dividend -- the backlash if and when the annual payout increases come to an end is just too brutal for the Oracle of Omaha.
It's different in Europe.
Sure, every dividend investor loves a predictable streak of dividend increases. But dividend policies are seen as a more malleable thing over there. Payouts are expected to rise and fall as appropriate when management can find better uses for incoming cash. It's a lot like share buybacks for American companies -- a highly adjustable way to return cash to shareholders without set-in-stone expectations of an eternal commitment to the policy.
So Telefonica's dividend payouts have moved 61% lower over the last decade with many swings both upward and downward. For the most part, the telecom's yield has hovered between 4% and 10% in recent years. Today, the yield stands at 4.6% -- low for Telefonica but generous compared to other dividend payers.
Share prices have fallen 10% lower over the last 52 weeks. Today, Telefonica's stock is trading at just 2.6 times trailing EBITDA profits. It isn't hard to find deep-discount value stocks where that ratio sits at six or 10 times trailing EBITDA.
Telefonica is revamping its operations around cloud computing and digital telephony, which will limit costs and drive profit margins higher over the long run. In the meantime, you can hold your nose over those unpredictable (but generous) dividend payouts and stow away some Telefonica shares at a fantastic valuation.
Time to add this auto stock on the cheap
Todd Campbell (Ford): The auto business is Uber-competitive (see what I did there?), but investors have punished Ford significantly lately and with plenty of cash flowing in and a 5.4% plus dividend yield, I'm warming up to including it in income portfolios.
Sure, Ford isn't as sexy of a story as Tesla, but Tesla isn't the only company working on next-generation driverless electric cars. In January, Ford announced that it will invest $11 billion and have 40 hybrid or fully electric vehicles in its lineup by 2022, including a hybrid F-150 pickup that could roll out as early as 2020. This plan should keep it neck and neck in the EV race since all the major automakers have announced similar strategies.
Of course, Ford's investments won't come cheap and perhaps that, along with a dip in operating margin due to rising costs, is why Ford's shares have declined by double-digit percentages this year.
Nevertheless, Ford's still making money and it's kicking off plenty of free cash to support its dividend. Yes, its earnings per share is expected to slip this year, but it'll still be about $1.70, and its cash dividend payout ratio, a measure of how much free cash is being spent on dividends, is only 23%. That suggests plenty of financial flexibility here. With price-to-book and price-to-sales ratios at five-year lows, I think there's good reason to become a Ford investor.
The bottom line
We can't guarantee that these three stocks will beat the market from here. But whether we're talking about Retail Opportunity Investments' unique approach to investing in retail, the lack of appreciation surrounding Telefonica's unpredictable payouts, or Ford's ambitious plans to win over the electric-vehicle market -- and combined with their attractive valuations today -- we like their chances of doing just that for patient, long-term investors.