If we've learned anything as investors, it's that market sentiment can shift at the drop of a dime.
After shrugging off the spread of the coronavirus disease 2019 (COVID-19) for months in China, Wall Street came to the realization in mid-February that this was an illness that had serious health and economic implications in our own backyard. Subsequently, we witnessed the S&P 500 log 10 if its 13-biggest single-day point declines (along with its seven-largest single-session point gains) in a span of 24 sessions, beginning Feb. 24, 2020. We also watched in awe as the broad-based index shed over a third of its value in less than five weeks.
The promise and peril of dividend stocks
As stock valuations have dropped, dividend yields have begun to soar, which is both a blessing and a potential curse.
Generally speaking, dividend stocks tend to handily outperform publicly traded companies that don't pay a dividend. According to a 2013 report from J.P. Morgan Asset Management, dividend stocks that initiated and grew their payout over a 40-year period between 1972 and 2012 delivered an average annual return of 9.5%. This compares to the average annual return of just 1.6% for the typical non-dividend-paying stock over this same period. These numbers alone should rightly have investors flocking to profitable, time-tested dividend stocks during the coronavirus crash.
But there's a potential problem with this dart-throw thesis. A study from Factset Reseach Systems and Mellon Capital has also shown that the higher dividend yields rise, the riskier the investment becomes for investors. Since yield is a function of price relative to payout, a plunging stock price coupled with a struggling business model could give income seekers false hope that they're landing a cash machine when, in reality, they've just fallen for a yield trap. This makes ultra-high-yield stocks – a company that I'm arbitrarily defining as paying an 8% or higher annual yield – particularly worrisome and worthy of extra scrutiny.
However, there are three ultra-high-yield stocks that, following the COVID-19 crash, look to be bargains. Not only do I believe that investors can trust these stocks, but I suspect that buying now could make income-seekers willing to reinvest their payouts rich over the long run.
Altria Group: 9.2% dividend yield
For many investors, the idea of investing in a tobacco producer probably hasn't even crossed their mind. That's because giants like Altria Group (MO -0.48%), the U.S. company behind premium brand Marlboro, have been contending with health agencies focused on getting adults to smoke less. In the U.S., adult cigarette smoking rates are now at an all-time low. This would, presumably, bode poorly for Altria. But there's more to this story than meets the eye.
One of the selling points for Altria is the addictive nature of nicotine. Even though adult smoking rates have been on a precipitous decline in the U.S., and total cigarette shipment volume fell 7.3% in 2019, companywide sales actually grew by nearly 1%, net of excise taxes. The reason? Altria has significant pricing power on its products, especially Marlboro, which accounts for over 43% of U.S. premium tobacco market share.
Altria has also done an exceptionally good job of taking care of its shareholders. This is a company that's pretty consistently repurchased its common stock throughout the years, thereby lowering its outstanding share count and providing a lift to earnings per share. Last year, Altria repurchased 16.5 million shares for a cost of $845 million, with an expected $500 million in repurchases planned for 2020.
Investors also won't want to overlook Altria's alternative tobacco options. It made a $1.8 billion equity investment into Canadian pot stock Cronos Group last March, giving a 45% stake, and has been launching IQOS, a heated tobacco device, in various markets throughout the United States. Like its peers, Altria is hedging its future bets beyond just tobacco.
Currently yielding north of 9%, there may not be a safer ultra-high-yield stock you can buy.
Mobile TeleSystems: 11.6% dividend yield
Another stock that may not exactly be on investors radars (but should be) is Russian telecom giant Mobile TeleSystems (MBT -8.64%). Russia has one of the highest wireless saturation rates in the world, and its currency, the ruble, has proven less than stable at times. Yet, neither of these concerns supersedes the many positives that MTS, as the company is also known, brings to the table.
Perhaps the single-biggest growth driver for MTS is the upcoming infrastructure upgrades to 5G. Improving infrastructure is an ongoing process that doesn't happen overnight, but for a business that relies on high-margin data, the end result should be a considerable uptick in data usage. MTS is likely to see a multiyear technology upgrade cycle both within and outside major Russian cities, and this should lead to a resurgence in the company's wireless growth rate.
Another key driver for Mobile TeleSystems is that it has expanded its operations beyond just being a wireless company. MTS offers enterprise cloud services, satellite television, and loan services through MTS Bank. As of the end of 2019, total assets for MTS Bank grew by 18%, with a nearly 44% improvement in gross loans. For the year, net profit almost doubled for MTS Bank, albeit it still remains a small contributor relative to the wireless segment. Look for these ancillary businesses to take pressure off of Mobile TeleSystems' consistently profitable, but traditionally slower-growing wireless segment.
Currently valued at 8 times next year's forecasted earnings, according to Wall Street, and sporting an almost 12% yield, this is an overseas giant that income seekers can trust.
Valero Energy: 8.6% dividend yield
A third ultra-high-yield dividend stock that could make investors rich over the long-term is Valero Energy (VLO 8.00%), the largest independent refiner in the United States.
If you've been somewhat keeping track of the oil market in 2020, you're probably well aware of why Valero and its refining peers have been beaten down. A brewing price war between Saudi Arabia and Russia has pushed West Texas Intermediate crude down to prices per barrel that haven't been seen in about 18 years. This drop-off in crude pricing, along with a serious decline in global demand for refined products as a result of mitigation measures put in place to halt the spread of COVID-19, has sacked the entire oil industry -- upstream, midstream, and downstream.
However, things may not be as bad as they appear on the surface for Valero. While there will, undoubtedly, be some short-term drawdown in refined-product demand in the U.S. with coronavirus mitigation measures still in place in a number of major cities, other data points are positive. For instance, data from the U.S. Energy Information Administration shows a continued drawdown in total gasoline barrels since the end of January. This is a typical cyclical pattern demonstrating that people are still driving and demanding gasoline.
What's more, refiners tend to benefit from lower crude prices. Since these are businesses that purchase crude to then process into usable products, a lower WTI price means reduced input costs. Conversely, low oil prices typically lead to increased consumer and enterprise demand. In other words, as soon as a few months from now we could see a resurgence in refined-product demand and explosive profit growth for Valero.
Don't let this unique and likely short-term crisis scare you away from this top-notch energy dividend stock.