Chasing yield can be a dangerous game. Instead, investors must look at the underlying fundamentals of a business to uncover whether the company can afford to continue paying its dividend in the future. Many times, those stocks sporting the highest yields are those with the riskiest dividends.
So, we asked three Motley Fool investors to highlight a dividend-paying stock they liked that sported a yield north of 5% but also offered a sound business that should support the payout. They identified TerraForm Power (TERP), AT&T (T -2.30%), and Cedar Fair (FUN -1.33%) as all fitting the bill.
A dividend backed by wind and solar energy
Travis Hoium (TerraForm Power): Wind and solar farms can be some of the most stable investments in energy because they have a fixed cost up front and are backed by long-term contracts to sell energy to customers like utilities and businesses, known as power purchase agreements. For investors, the projects look more like bonds than traditional energy assets, with very little volatility in cash flows and very predictable returns long term.
TerraForm Power is one of the biggest renewable energy owners in the country with 2,606 MW of wind and solar projects. The average power purchase agreement has 15 years remaining, giving the company predictable cash flows well into the 2030s.
It's also likely that TerraForm Power will keep growing its dividend long term. About 15% to 20% of the free cash flow, known as cash available for distribution, will be retained by TerraForm Power and used to fund acquisitions that will drive long-term growth. The combination of predictable cash flows and organic growth is a great combination for any stock.
Management targets a 5% to 8% dividend increase each year on top of the $0.76 per share dividend today, a current yield of 6.9%. With wind and solar installations growing worldwide and more projects in need of financing from entities like yieldcos, TerraForm Power is in a great position to buy projects opportunistically and rely on stable cash flows to fund the dividend. It may not be the most exciting stock, but TerraForm Power is a great stock for investors looking for a stable dividend for their portfolio.
Sometimes an obvious choice is the right choice
Rich Smith (AT&T): I don't know about you, but I can't boot up my Roku these days without being bombarded with ads from AT&T and its DirecTV subsidiary -- usually one after the other. So when you ask me to name a top dividend stock yielding over 5%, AT&T is naturally the first name that comes to mind.
Priced at just 6.6 times earnings, AT&T is an undeniably cheap stock. (The average stock on the S&P 500 costs something more like 24 times earnings.) Its dividend yield of 5.7% is nearly three times richer than the average 2% payout on the S&P -- and with a payout ratio of only 41%, it's a dividend AT&T can easily afford to pay.
What I like best about AT&T, though, isn't just its cheap price and its generous dividend yield -- it's the company's business smarts. Think about it: The biggest challenge for any telecommunications provider is amassing enough bandwidth to keep its customers supplied with TV, internet, and phone service, and doing so at an affordable cost. AT&T regularly spends more than $20 billion a year on capital investment for just this purpose.
By buying DirecTV in 2014, though, AT&T made a lot of its bandwidth problems go away, opening an avenue to shunt TV consumers over to satellite TV consumption, thereby freeing up bandwidth in its cable pipes to carry more internet service via U-verse, obviating the need to lay as much "pipe" to keep up with bandwidth demand. (Phone service is primarily provided by cell tower.)
How is that working out for AT&T? Here's a hint: Last quarter, profits surged 681%.
A roller-coaster ride that's a winner
Rich Duprey (Cedar Fair): Few investments offer as much fun when using their product or service as does amusement park operator Cedar Fair, which also offers a healthy dose of growth and profit.
We're approaching the months that serve as the wheelhouse for Cedar Fair, which just opened its Twisted Timbers hybrid coaster at its Kings Dominion park, the first new coaster there in eight years, while the flagship Cedar Point park has upgraded its Mean Streak wooden coaster. Such attractions serve to bring in more guests, and Cedar Fair drew 25.7 million guests across all of its parks in 2017, up 2% year over year and a record high, despite battling extreme weather patterns earlier in the year. Annual pass sales for the current year are running 10% ahead of last year.
Yet the theme park operator presents a great investment opportunity. With a dividend that currently yields 5.4%, Cedar Fair's stock is down 8% from the year-ago period and is essentially flat year to date. Shares trade at a reasonable 23 times earnings and 17 times next year's estimates, and management has said it remains "committed to a steady 4% increase in our annual distribution rate going forward."
Income-seeking investors who are looking for growth from their stocks, not to mention a bit of fun, too, can't go wrong with Cedar Fair.