While I'm still a couple of decades away from retirement, I don't subscribe to the notion that my entire portfolio should be in growth stocks. That's because dividend growth stocks, especially those with higher-than-average yields, have historically outperformed their stingier peers. The key, though, is finding companies that can deliver sustainable income growth over the long term.
A high yield and a high growth rate
With a dividend yield above 6.2%, Canadian pipeline giant Enbridge pays more than three times the average of stocks in the S&P 500. However, what makes that payout even more attractive is that Enbridge has all the characteristics found in the best high-yield stocks, since it generates stable cash flow, with 95% coming from long-term fee-based contracts, has a conservative payout ratio of 65%, and boasts a solid investment grade credit rating.
Pushing Enbridge even further over the top as a great income stock to buy now is that it not only offers that rock-solid high yield but also has compelling growth prospects and sells for a dirt-cheap price. On the growth side, Enbridge is in the midst of a major expansion program that should boost its cash flow and dividend at a 10% annual rate through 2020. Meanwhile, the company believes it can continue growing earnings by at least a 5% to 7% yearly pace post-2020.
Typically, fast-growing companies like that trade at a premium valuation. Enbridge, however, currently sells at a discounted price after selling off last year. That compelling combination of growth and income for a cheap price is why I recently added to my position in this pipeline stock and could do so again in the future.
Solid as an oak tree
Weyerhaeuser's dividend yield is up to an attractive 5.4% after shares of the world's largest timberland owner sold off in 2018, when lumber prices fell due to concerns that the housing market was slowing down. While Weyerhaeuser has some exposure to pricing volatility, the company generates stable cash flow overall due to its diversification across the timber industry, as it sells not only timber but also wood products and land. Those activities produce enough cash to cover its current dividend with plenty to spare, giving it money to reinvest in the business as well as repurchase stock. Finally, Weyerhaeuser has a strong investment-grade balance sheet with low leverage metrics.
Weyerhaeuser has increased its dividend in each of the last seven years, boosting it 125% overall, including 6.3% in 2018. The company aims to continue that trend in the years to come by growing cash flow as it expands its margins and its land holdings. That combination of stability in both its financial profile and growth prospects, when combined with a cheaper stock price following last year's sell-off, is why I also recently boosted my position in Weyerhaeuser.
Generating steady dividend growth
TerraForm Power offers the highest yield in this trio at 6.7%. The reason that payout is above the others is that the renewable-power company pays out between 80% and 85% of its cash flow. While that's higher than most companies, TerraForm is comfortable with that level because it sells more than 95% of the power it produces under long-term contracts or similar arrangements, which enables it to generate predictable cash flow. Meanwhile, the company's balance sheet, while not investment grade, is much improved, as its leverage metrics are now within its target range.
TerraForm Power currently anticipates that it can increase its high-yielding dividend at a 5% to 8% annual rate through at least 2022. Powering that healthy growth rate are the company's efforts to reduce costs and improve profitability. In addition to that, TerraForm plans to reinvest the 15% to 20% of cash flow that it retains to expand its portfolio so that it can further boost cash flow. That highly visible income growth is why I plan on adding to my position in TerraForm Power in the future.
The right formula for success
All three of these high-yield stocks have the characteristics found in the best dividend stocks, including solid financial profiles and visible growth prospects. So they should be able to continue increasing their dividends in the coming years. That growing income stream is a major reason why this trio sits atop my high-yield stock buy list.