Traditionally, dividend stocks are the cornerstone of any retirement portfolio, and they tend to do most of the heavy lifting over the long run for Wall Street and retail investors alike. This is because dividend-paying stocks bring four advantages to the table.
Dividend stocks come chock-full of advantages
First, they're usually time-tested businesses that are consistently profitable. One way to look at it is this: Companies aren't going to share a percentage of their profits with investors on a regular basis if their management teams and/or boards didn't foresee ongoing profit and growth.
Second, stock market corrections are inevitable, which means that dividend payouts can help to partially offset the downside in the stock market. While your payout is unlikely to offset the entirety of a stock market correction, it can certainly help skittish investors to keep a level head.
Third -- and this is probably the best part of dividend stocks -- you can reinvest your payout into more shares of dividend-paying stock(s). In doing so, you'll compound your future ownership in dividend stocks, as well as your future dividend payout. This is a strategy that many of Wall Street's money managers use to accelerate growth for their clients.
And finally, dividend stocks have historically outperformed their non–dividend-paying counterparts, so they tend to offer a better chance at long-term appreciation.
Most very-high-yield stocks are dividend traps -- but these two look enticing
However, there is a caveat with dividend stocks. Ideally, as investors, we want the greatest amount of income with the lowest amount of risk. But according to data from Mellon Capital and FactSet Research Systems, the higher the yield, the higher the inherent risk, and therefore the lower the average return. Their data showed that S&P 500 companies with a 3% to 4% yield consistently outperformed stocks with a double-digit yield (10%+).
The issue that investors have to keep in mind is that since yield is a function of share price, a struggling or failing business model (and therefore a declining share price) could trap investors who are simply seeking a high yield. Generally speaking, high-yield stocks (especially with yields of more than 10%) require a lot of extra scrutiny before investing, and many simply won't pass muster.
There are, however, two mid-cap stocks that are currently yielding in excess of 10% that appear to be relatively safe investments for those looking to really add some income punch to their portfolios.
Alliance Resource Partners
If I had my arm twisted and was required to choose my favorite double-digit-yielding stock, it'd be coal producer Alliance Resource Partners (ARLP -1.00%). Yes, I did just say "coal," and no, I'm not entirely crazy.
In recent years, renewable energies like solar and wind have proliferated, and natural gas prices declined enough to coerce some utilities to make the switch away from coal. While this has been bad news for much of the industry, Alliance Resource Partners is a totally different breed of coal producer.
Probably the biggest differentiating factor is Alliance Resource's focus on the future. Whereas most producers are scrambling to find buyers for their product this year or in 2019, Alliance Resource is already locking up significant production and price commitments through 2021. Generally producing around 40 million tons of coal per year, the company has volume and price commitments of 24.7 million tons in 2019, 16 million tons in 2020, and 6.7 million tons in 2021. These commitments generate predictable cash flow and leave the company minimally exposed to wholesale price fluctuations.
Perhaps just as important is the fact that Alliance Resource Partners is finding plenty of demand for coal outside the United States. Through the first six months of the current year, it's booked 10.4 million tons of thermal coal for export in 2018 and 3.1 million tons for delivery in 2019. In fact, international coal markets have grown from 4.5% of total revenue in 2016 to an expected 27.2% of total sales in 2018, based on the midpoint of its revenue guidance.
And, of course, there's the company's balance sheet, which sports far less debt and leverage than those of its peers. Investors will note net debt of around $470 million (most of its peers are over $1 billion) and a debt-to-equity ratio of a reasonable 41.5%. Tack on a forward P/E of less than 9 and a yield of 10.2%, and you have what I believe is one heck of a very-high-yield deal.
AGNC Investment Corp.
Though I expect this to be an unpopular selection, I'm personally a fan of mortgage real estate investment trusts (REIT), despite investors discounting the industry as being yesterday's news. In particular, I believe AGNC Investment Corp. (AGNC 0.21%) could surprise income investors and deliver healthy returns.
The premise of mortgage REITs is simple: They borrow money at a low short-term rate then purchase mortgage-backed securities and other assets that yield a higher rate over the long term then pocket the difference as their net interest margin. Generally speaking, when interest rates are declining, net interest margin is expanding. Conversely, during a period of monetary tightening, as we're in now, net interest spreads shrink, which is bad news for AGNC's bottom line. That's why most folks have stayed away from this industry.
But there's a bigger dynamic here than simply rising interest rates. Historically, the pace at which interest rates increase matters. If the rate is relatively slow and orderly, as it's been since rates first began to rise in December 2015, it gives companies like AGNC Investment Corp. enough time to react and adjust their portfolio holdings and leverage to optimize their profitability.
Also, since AGNC invests nearly all of its assets in agency-only loans -- i.e., loans protected against default by Fannie Mae or Freddie Mac -- it's afforded the ability to lever up its portfolio to increase its potential profit. If interest rates were moving up at a quicker pace, it wouldn't be able to do so. Therefore, as long as this orderly increase in interest rates continues, AGNC should be able to safely use leverage to its advantage.
Currently paying out an $0.18 monthly dividend (good enough for an 11.2% annual yield) and forecast to bring in $2.50 in cash flow per share in 2019, even with a rising rate environment, AGNC Investment Corp. looks to have the tools necessary to maintain a double-digit yield.