More often than not, dividend stocks are the foundation of successful investment portfolios. Aside from the fact that dividend-paying companies have handily outperformed non-dividend-paying stocks over the long run, dividend stocks bring a number of other advantages to the table that investors can appreciate.
For starters, dividend-paying companies often have a time-tested and profitable business model. In other words, a company wouldn't be consistently sharing a percentage of its earnings with shareholders if its management team and board didn't foresee continued growth and profitability in the future. Thus, when you're buying into a dividend stock, you're usually purchasing a company with a stable business and a relatively clear long-term outlook.
Secondly, dividend stocks can really help take the sting off of inevitable stock market corrections. During the fourth quarter of last year, the stock market underwent its steepest correction in a decade. Considering that it's impossible to predict when a correction will occur, what will cause it, how steep the drop will be, or how long it'll last, regularly paid dividends can help calm the nerves of skittish investors and hedge against some of the potential short-term downside.
Arguably most important of all, dividend payouts can be reinvested back into more shares of a dividend-paying stock through a dividend reinvestment plan, or DRIP. A DRIP is a commonly used strategy by money managers to compound wealth. It allows investors to increase their ownership in dividend-paying companies, which in turn leads to larger payouts in a repeating pattern.
Two dividend stocks yielding over 10% to consider buying right now
But there's a catch with dividend stocks -- namely, that yield and risk tend to be correlated. We, as investors, want the highest yield imaginable with the least risk possible, but things don't actually work this way. Instead, extremely high-yield dividend stocks (i.e., yields of over 10%) tend to be the riskiest of all. That's because yield is a function of share price, so a struggling business model might look like an income bargain when it's actually a value trap.
However, there are two ultra-high-yield dividend stocks that appear reasonably safe and offer intriguing value for patient investors with a low-to-moderate appetite for risk.
Alliance Resource Partners: 10.9% yield
Generally speaking, the idea of investing in coal probably makes most people's stomachs churn. Coal has been supplanted as the primary source of electricity generation in the U.S. by natural gas, and most coal producers were mired in debt this decade, leading to a wave of bankruptcies throughout the industry. But Alliance Resource Partners (ARLP -2.18%) isn't your average coal producer.
The first thing that makes this company so unique is its push to lock up volume and price commitments years in advance. Even though this could leave the company at a bit of a disadvantage if coal prices were to significantly rise in the short term, what's far more important is that doing so protects Alliance Resource Partners from having its production exposed to potentially volatile wholesale-price fluctuations. As of its fourth-quarter report, the company had 36.8 million tons of volume locked in for 2019 and another 18 million tons committed for 2020. For context, the company usually produces 40 million tons a year but should see a roughly 10% increase in demand at the midpoint in 2019, to 44 million tons.
Alliance Resource Partners has also been more than willing to look overseas in lieu of weaker domestic demand. Having hardly exported any coal as recently as 2016, the company now has 8 million tons locked in for export in 2019. Emerging-market economies like China and India that have rapidly expanding industrial centers and suburbs are hungry for electricity-producing coal, which is providing a nice channel for Alliance Resource to offload its production.
This is also a fiscally prudent company, making acquisitions that don't strain its balance sheet. With less than $470 million in net debt, Alliance Resource has none of the insolvency concerns that plagued its peers. Needless to say, at seven times next year's earnings per share and a nearly 11% yield, it's possibly the most attractive ultra-high-yield dividend stock.
Check out the latest earnings call transcripts for Alliance Resource Partners and Annaly Capital Management.
Annaly Capital Management: 11.9% yield
Call me a contrarian, but mortgage real estate investment (REIT) Annaly Capital Management (NLY 0.55%) still has a lot to offer investors, even in a non-optimal economic environment.
A mortgage REIT like Annaly is a company that makes money by purchasing mortgage-backed securities (MBS) that bear a certain interest rate. Mortgage REITs borrow at short-term rates but purchase these long-term (and higher-yielding) mortgage-backed securities with the intent of pocketing the difference in long- and short-term interest rates as their net interest margin.
One thing you should know about Annaly is that it almost exclusively buys agency-only MBS. By "agency-only," I mean mortgage-backed securities that are protected by the federal government in case of default. As you can imagine, this added protection means the yields on agency loans are much lower than unprotected non-agency loans. This is why Annaly often turns to leverage in order to magnify its returns.
In general, a market where interest rates are falling tends to be optimal for Annaly Capital Management's strategy, while a rising interest-rate environment (like we're in now) is less than optimal. But there's more to it than this. Monetary action from the Federal Reserve that features slow, deliberate interest-rate hikes gives Annaly the time it needs to adjust its portfolio to maximize profits. In other words, the Fed's eggshell approach to interest-rate hikes has allowed Annaly ample time to adjust its holdings and not get ravaged by shrinking net interest margin.
For nearly a decade now, Annaly's yield has surpassed 10%. I'm not entirely certain its income from operations can support its existing payout of $1.20 a year, but I do feel fairly confident that its ongoing payout won't dip much below 10%, if at all. At just 1.1 times book value, Annaly looks like a bargain for income investors.