When looking for dividend stocks, it's important to find a balance between yield and fundamentals. Very often the highest yields are paid by stocks that either can't support the payouts being made or have particularly risky outlooks. But frequently, the best time to buy a dividend stock is when it is temporarily out of favor on Wall Street. Here are three names that appear to be out of favor, but that still have solid businesses and long-term potential.
1. Moving energy
The first name up is master limited partnership Enterprise Products Partners (EPD 1.41%), which operates in the midstream area of the energy sector. Oil- and natural gas-related names are out of favor today for a number of reasons, including low energy prices, weak demand, and the rise of cleaner alternatives. These are very real issues, but they have to be looked at in a broader context. For example, it's unlikely that oil will be displaced for many years because energy transitions take a long time to work through. Meanwhile, roughly 85% of Enterprise's gross margin is generated by fees and isn't related to the actual price of the commodities it helps move. On the demand front, COVID-19 has artificially depressed energy use; as economies around the world open up again, demand will likely return.
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Investors willing to step back and consider these facts can pick up Enterprise's nearly 8% yield. That payout is backed by more than two decades of annual distribution increases. Moreover, the partnership has long been operated in a conservative manner, with a financial debt to EBITDA ratio that sits toward the bottom of its peer group. And despite the issues the energy industry is facing, the partnership covered its distribution by 1.6 times in the first quarter, providing ample leeway for further headwinds. With one of the largest midstream footprints in North America, Enterprise is well worth a deep dive for income-oriented investors today.
2. A diversified landlord
The next dividend stock to watch is real estate investment trust (REIT) W. P. Carey (WPC 2.85%). The first thing of note here is that Carey owns single-tenant net-lease properties, which means that the tenants are responsible for most of the operating costs of the properties they occupy. It's a fairly low-risk business model, with the REIT making the difference between its cost of capital and the rents it charges. Moreover, the company's leases tend to be lengthy (the average length was over 10 years at the end of the first quarter), providing material support to revenue during economic downturns.
EPD Dividend Yield data by YCharts
The one problem with the net-lease sector in general is that it tends to be heavily reliant on retail properties. But W. P. Carey bucks that trend, with only 17% of its portfolio in the retail space. The rest of the portfolio is in industrial (24% of the portfolio), office (23%), warehouse (22%), self storage (5%), and other (the rest). That's more diversification than you'll find at most REITs, but it isn't the only way in which Carey is diversified -- about a third of the company's rents are derived from Europe. With a 5.8% yield, a roughly 85% adjusted funds from operations payout ratio (a fairly reasonable number for a net-lease REIT), and more than 20 years of annual dividend increases, W. P. Carey is worth a look while investors are lumping it in with net-lease peers that are far more reliant on the retail sector.
3. Change is hard for Big Blue
The next name up is technology giant International Business Machines (IBM 0.06%), which has a 4.8% yield backed by roughly a quarter century of annual dividend increases. In fairness, IBM has been a tough stock to like for around a decade. That's because it is in the middle of a major transition in which it is jettisoning mature older businesses (like building computers) and shifting into new, growing areas like cloud computing, artificial intelligence, and quantum computing. Because the old businesses generated a lot of revenue and the new businesses are still being built up, the company's top line has been in a pretty steady decline for a long time.
However, the company has an incredible roster of customers and has been through transitions like this before. This time around, it looks like IBM is nearing a key turning point, with the recent acquisition of Red Hat positioning it to provide cloud services across competitors' products. With new businesses representing around half of the company's revenue at this point, it may not be much longer before IBM's top line starts growing again. The one problem is leverage, since the Red Hat deal was large and expensive, but even here the company is making material progress -- it has already reduced its long-term debt by over 10% since the deal closed roughly a year ago. The payout ratio, meanwhile, is around 65%, which is manageable. All in, there are reasons why Wall Street is taking a dim view of this technology stock. But if you are a long-term dividend investor, there are reasons why you might want to venture in here, too.
Time for a deep dive
If you are a dividend investor, you want to avoid overly risky stocks that can't sustain the high yields they are offering. Enterprise, W.P. Carey, and IBM don't appear to be in that group. They have solid businesses with strong futures. And if you are looking to maximize the income your portfolio generates, you might just want to add one or more of them to your portfolio today.
