The current dividend yield of the S&P 500 is about 2%. That's not a huge number for many retirees who rely on their portfolio for income. That fact causes many income investors to look for high-yield stocks to buy in order to beef up their cash returns.
So, which stocks might be tempting these income-seeking investors right now? We asked a team of contributors to weigh in, and they called out GameStop (GME +1.57%), Alliance Resource Partners (ARLP 0.66%), and Brookfield Infrastructure Partners (BIP 2.08%).
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Don't be tempted by GameStop's huge dividend yield
Anders Bylund (GameStop): This is not a recommendation to buy GameStop. It's an example of how extreme dividend yields often serve as big, red warning flags for a company in deep distress.
The video-game retailer offers a massive 10.2% yield today. In recent months, the yield has spiked as high as 12%. It's true that GameStop has attempted to reward investors with a steady stream of dividend increases, resulting in a 38% total boost since the first round of payouts were sent out in 2012.
However, the last payout hike arrived in the fall of 2016. GameStop's dividends aren't growing anymore because the company needs its spare cash to plug other holes in the business.
Traditional retailing is a tough industry these days as online sellers are taking over. That's especially true in the video-game sector, where both PCs and modern gaming consoles have the ability to just download their games instead of relying on DVD or Blu-ray disks. So, GameStop's revenues have stalled, and every profitability metric you can think of is plunging.
Share prices have followed suit, and GameStop investors suffered a negative return of 30% over the last year. That's what's driving the dividend yield to new highs.
I see no signs of GameStop reversing these trends anytime soon. This is not the kind of megayield that invites you to back up the truck and invest your entire nest egg. You should just back away slowly. Check out Brian's far stronger dividend idea instead.
GME Dividend Yield (TTM) data by YCharts.
High yields aren't always a buy
Maxx Chatsko (Alliance Resource Partners): It would be difficult to beat the 11% yield of the annual distribution of Alliance Resource Partners, but there's a catch: The company is a major producer of coal. That might not sound like a sustainable or future-oriented industry to be playing in, and Mr. Market tends to agree. The stock trades hands at just 9 times future earnings and boasts an enterprise value to EBITDA ratio of 5 -- both incredibly low in today's expensive market.
However, there are solid reasons to avoid the high-yield stock despite its rock-bottom valuation. Consider that Alliance Resource Partners saw annual revenue and operating income peak in 2014. Given the world's hasty retreat from coal power for both electricity and industrial heat, coupled with a general distaste for new coal-fired power plants outside of the Middle East and Africa, the consistent slide in the business' performance could be the new normal. That's especially true with the rise of cleaner-burning liquefied natural gas (LNG) exports.
While there's no denying that Alliance Resource Partners runs a profitable business and currently generates more than enough cash flow to cover the distribution, investors should consider the real possibility that the company's high-growth days are over. In fact, in the last 10 years, the stock has delivered total returns of 78%, compared to 177% for the S&P 500. What good is a high yield if the investment can't beat the index?
A winning formula
Brian Feroldi (Brookfield Infrastructure Partners): I'm a growth investor at heart, so I'm normally turned off by stocks that sport a big dividend yield. However, I'm happy to make an exception for Brookfield Infrastructure Partners. This company offers investors a monster dividend yield of 4.7% and the potential to deliver double-digit profit growth. That's a combination I can get behind.
Brookfield's business model is to buy a portfolio of one-of-a-kind infrastructure assets (think railroad, shipping ports, electricity lines, and more). Broadly speaking, the company only gets interested in purchasing a new asset when a few criteria are met:
- The asset faces little (or no) competition.
- The asset generates reliable cash flow in all economic conditions.
- The asset is trading at a low price.
Brookfield has used this simple investing framework for years to consistently grow its revenue and profits. The company then passes on the bulk of its profits back to investors in the form of a rising distribution while it reinvests the rest back in the business.
Time has shown that this business model has been hugely rewarding for long-term investors:
BIP Total Return Price data by YCharts.
Looking ahead, Brookfield still has billions in capital at the ready waiting for the next top opportunity to appear. That fact should keep this rock-solid business on the upswing for the foreseeable future.
