More often than not, dividend stocks are the glue that holds great portfolios together. Back in 2013, J.P. Morgan Asset Management released an analysis that compared the annualized return of publicly traded companies that initiated and grew their payouts between 1972 and 2012 with publicly traded non-dividend companies over the same period. The report revealed that dividend-paying stocks ran circles around non-dividend-paying stocks by a wide margin (9.5% annualized vs. 1.6%).
These figures shouldn't surprise anyone. Businesses that pay a dividend are often profitable, time-tested, and have trustworthy management teams.
Unfortunately, dividend yield and risk are often correlated, and generally, the higher the yield, the greater the risk. Since yield is simply a function of payout relative to share price, a company with a struggling or failing business model can offer an exceptionally high yield. This means ultra-high-yield stocks -- i.e., yields that I'm arbitrarily defining as 8% or higher -- can be more trouble than they're worth.
But not all ultra-high-yield dividend stocks are bad news. I've perused the minefield of double-digit and high-single-digit yielding companies, and three stand out as being particularly attractive, given their long-term track records of profitability.
If you want big income without big risk, the following three ultra-high-yield dividend stocks are begging to be bought.
Annaly Capital Management: 10.8% yield
Few industries have been more universally disliked in recent years than mortgage real estate investment trusts (REITs) -- but that's about to change.
The operating model behind mortgage-REITs is pretty simple to understand. These are companies that borrow money at a short-term rate and typically use leverage to acquire higher-yielding assets that have a long-term payout. In the case of Annaly Capital Management (NLY 3.65%), we're talking about a company that buys mortgage-backed securities (MBS). The difference between the yield that Annaly generates from these mortgage-backed securities and the short-term rate it pays on its borrowing is its net interest margin. The wider this margin, the more profitable Annaly Capital can be.
Last year, we witnessed the yield curve briefly invert, when short-term bond yields were higher than long-term bond yields. That's awful news for Annaly's net interest margin. However, economic recoveries typically produce a steepening yield curve. This is where long-term yields rise significantly, thereby widening the gap between short-and-long-term yields. In other words, we're right in the sweet spot where Annaly starts to see its earning potential go through the roof.
Furthermore, Annaly Capital Management almost exclusively purchases agency-only assets -- i.e., mortgage-backed securities that are backed by the federal government in the event of a default. Although agency-only assets have lower yields than non-agency assets, the safety provided by these agency assets is what allows Annaly to use leverage to its advantage.
With the Federal Reserve intent on keeping interest rates at or near historic lows through 2023, the table is set for Annaly Capital Management to deliver serious income to its shareholders.
Altria Group: 8.5% yield
Another ultra-high-yield dividend stock just begging to be bought is U.S. tobacco giant Altria Group (MO -0.13%).
It's no secret that tobacco stocks are facing an uphill battle. U.S. regulators are fully aware of the dangers of smoking tobacco products and have been hammering home these concerns to the public for a long time. It's resulted in the U.S. adult smoking rate falling from around 42% in the mid-1960s to just 14% in 2019. That's great news from a healthcare standpoint, but not such great news for Altria, the company behind the popular Marlboro brand.
However, one thing Altria still has working in its favor is its exceptional pricing power. Since nicotine is an addictive chemical, Altria has never had an issue passing along price hikes to consumers. Despite persistent declines in cigarette shipment volume, Altria's revenue continues to motor higher, primarily because of higher prices.
Altria also has smokeless-product options that could become long-term growth drivers. For instance, the company plans to introduce the IQOS heated tobacco system to a handful of new markets. It's also seen its distribution of oral tobacco-leaf free nicotine product on! gobble up a 2.1% share of the oral tobacco category.
Altria even has exposure to the North American cannabis industry. In March 2019, it completed a $1.8 billion equity investment in Canada's Cronos Group, netting a 45% stake in return. Given Altria's keen knowledge of developing products and marketing to smokers, the duo is expected to work on cannabis vape products that can eventually be marketed throughout North America.
Altria has ample avenues to grow -- along with a rock-solid 8.5% annual yield.
ExxonMobil: 8.5% yield
Income seekers would also be wise to consider the mother of all oil stocks, ExxonMobil (XOM -0.65%), which, like Altria, is also parsing out a delectable 8.5% yield.
Not to sound like a broken record, but the oil industry is going through plenty of struggles of its own. The coronavirus disease 2019 (COVID-19) pandemic caused a historic short-term plunge in crude oil demand, and even briefly sent West Texas Intermediate crude futures into negative territory. For ExxonMobil, weaker crude prices have meant sizable quarterly losses.
But amid the rash of U.S. shale bankruptcies, Wall Street and investors seem to be overlooking the "integrated" component of ExxonMobil's oil and gas operations. While there's no question that the company's upstream drilling operations yield the best margins, the company has downstream refining and petrochemical assets specifically to offset weaker crude prices. If per-barrel pricing were to remain below its recent four-year average, we would expect consumer and enterprise demand for petroleum products to pick up, ultimately boosting cash flow for ExxonMobil's downstream assets.
The company also has ample levers it can pull as an integrated oil and gas giant. For instance, ExxonMobil reduced its capital expenditure budget by $10 billion in 2020 to $23 billion, and has planned to further cut its capital expenditures (capex) in 2021 to a range of $16 billion to $19 billion. The company has also halted retirement contributions and reduced headcount to offset reduced short-term demand.
Yet even with a potentially halved capex budget, ExxonMobil's plans for the Payara project offshore of Guyana remain on track. When complete in 2024, this expansion should add roughly 220,000 barrels of oil production per day.
Oil stocks may have struggled in 2020, but they're not going anywhere. That makes ExxonMobil and its juicy dividend an intriguing buy.