Lots of stocks look overvalued right now. Even the valuation of the overall S&P 500 is approaching a 15-year high, at 21.6 times earnings. If you're a value investor, that number probably makes you want to ignore the stock market altogether.
But there's another option: investing in reliable dividend stocks. Buying a stock that offers a solid quarterly payout helps your portfolio earn money as you wait for valuations to cool down.
With that in mind, we asked five Motley Fool contributors for their top picks of dividend stocks to buy now. They came back with Brookfield Infrastructure (BIP 3.35%) (BIPC 3.21%), Microsoft (MSFT -1.27%), Clearway Energy (CWEN 1.29%), American Express (AXP 6.22%), and Essential Utilities (WTRG 0.80%). Here's why.
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What we can't do without
John Bromels (Brookfield Infrastructure): Some things are nearly impossible to live without. Home heating in the wintertime, for example, or phone and internet service. Companies that provide such services are more resilient to the economy's ups and downs than companies whose services aren't essential.
Brookfield Infrastructure's $77 billion worth of assets primarily provide such indispensable services. The company owns more than 1,300 miles of electrical transmission lines, 11,000 miles of gas pipelines, 12,000 miles of fiber data lines, and 20,000 miles of rail lines strategically located around the globe. It relies on those assets to churn out a 12%-15% long-term return on equity, which it uses to fund a 4.7% payout.
Management expects that payout to grow between 5% and 9% annually. The company's share price also seems likely to increase. Even in the current climate, Brookfield sports a reasonable valuation, with an enterprise value of just 14.4 times EBITDA, which is near the low end of its historic range. Brookfield Infrastructure looks like a solid pick in an uncertain economy.
Big tech's growing dividends
Travis Hoium (Microsoft): Technology companies that have started paying dividends aren't typically high-yield stocks, and Microsoft is no different. But what they have going for them is long-term growth and the opportunity to grow the dividend at a strong rate for the long term.
Microsoft's free cash flow is growing at a rapid clip as cloud services grow and business services like Office and LinkedIn continue to improve steadily. You can also see below that the dividend payment is still only about one-third of what the company makes in free cash flow each year.
MSFT Free Cash Flow data by YCharts
What I like about Microsoft's dividend is that I don't see any big disruptions to the business taking place anytime soon. Cloud growth shows no end in sight, business productivity tools haven't lost much ground even as companies become more mobile, and few tech companies have the scale to compete with Microsoft as new opportunities arise.
Microsoft is already one of the biggest companies in the world, so the appreciation of the stock may slow in the coming years. But the dividend still has a lot of room for growth and that's why I like the stock, even if the yield is just 1.1% today.
Growth catalysts galore
Matt DiLallo (Clearway Energy): Clearway Energy is an excellent option for income investors. The renewable energy producer currently yields an above-average 3.5%. That payout is on solid ground since it only consumes about 54% of the company's stable cash flow, most of which has the backing of long-term contracts.
As good at that current income stream might be, the real attraction in Clearway Energy's dividend lies in its upside potential. It's artificially low at the moment because one of its largest customers -- California utility PG&E (PCG 1.87%) -- is in bankruptcy. Given the uncertainty of those proceedings, Clearway's lenders have restricted its access to the cash flow generated by PG&E's contracts. However, that company is close to exiting bankruptcy, which will enable lenders to lift those restrictions, freeing up the retained cash as well as future cash flows generated by PG&E. When that happens, Clearway expects to normalize its dividend.
Meanwhile, there's plenty more upside to the payout in the coming years. Clearway recently signed agreements to invest in three wind projects, which should close by early next year. Those deals will boost its cash flow per share by another 10%. On top of that, it has an extensive pipeline of potential acquisition opportunities thanks to its relationships with a renewable energy project developer and a leading private equity firm.
Given all those tailwinds, Clearway Energy appears poised to grow its payout rapidly in the coming years. That high-powered income stream makes it look like a great dividend option, especially for investors seeking exposure to renewable energy's bright future.
A timeless business
Jason Hall (American Express): Frankly it's understandable that American Express shares are down this year. At its core, the company's a bank, lending the money to cardholders when they make a purchase (not to mention a pretty large business lending operation). This makes it subject to a kind of risk the other big credit card names that just operate the payment networks simply aren't exposed to.
But while I get it that some investors have exited their stake on the potential risks of more borrowers not being able to meet their obligations, I think it's also created a wonderful opportunity for investors looking at the bigger picture to buy. At recent prices, AmEx shares are down 29% from the pre-crash high. Moreover, the dividend yield near 1.7% at recent prices, is substantially above the average yield over the past decade. That indicates the shares are undervalued:
AXP Dividend Yield data by YCharts
Not to ignore the risks. American Express will almost surely see more defaults in 2020 as the recession catches up to some of its cardholders. But historically, the company has been incredibly good at managing the risks of default across the economic cycles, and I expect the 2020 recession will be no different.
Lastly, the future looks incredibly bright for every company involved in the shift to a cashless economy, even century-plus-old American Express. So while some investors have sold to avoid the short-term risks, long-term investors should take the opportunity to invest in this dividend-growth dynamo while it's on sale.
An essential business selling at a reasonable price
Tyler Crowe (Essential Utilities): If you're looking for an investment that can handle the ups and downs of the market well, then water and gas utility Essential Utilities is a stock that should be on your radar. Like electric utilities, the company's business is predicated on a few things: spending on capital improvements to its system, getting approval from state regulators to raise rates, and growing the business through acquisitions. The first two are intertwined because state regulators typically permit rate increases if a company can show it is spending money to improve service to its customers. According to management, the company has approval from regulatory bodies to invest $2.8 billion to upgrade its water and gas services through 2022, which should result in annual rate increases of 7%-9% for its water business and 8% to 10% for its gas distribution.
One of the unique opportunities for water utilities is that unlike electric utilities where most service is already handled by companies, there are still several municipalities that handle their own water and wastewater treatment. Essential Utilities and other water utilities have been growing over the past decade by negotiating with municipalities to acquire their water treatment facilities in exchange for service contracts. One example of this was Essential Utilities' recent acquisition of Delaware County Regional Water Quality Control Authority's municipal wastewater system. The deal will add 500,000 new customers and is expected provide other opportunities to acquire smaller water and wastewater systems in the Philadelphia area.
Because water utilities are such a stable business, they rarely go on sale. The integration of People's gas utility and the recent market sell-off, though, has Essential Utilities' stock has a 2.1% dividend yield. That doesn't sound like much, but one of the highest yields you can get with this stock over the past year. Essential Utilities is one of those stocks that is well suited for someone looking for a slow but steady income generator that won't be affected much by the ups and downs of the economic cycle.
