A good rule of thumb to follow in the stock market is that if something looks too good to be true, it probably is. In today's low-interest-rate environment, stocks with big dividend payments probably look like yield traps -- businesses where the market is pricing in a very likely cut to that dividend.
Still, there are legitimate businesses out there that pay decent dividends. To figure out which ones have staying power despite the high payment, you have to understand why they pay and may be able to sustain such a generous payout to their owners. With that criteria in mind, here are three stocks to consider buying with dividends yielding more than 5%.
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1. A hard money lender with no debt of its own
Broadmark Realty (BRMK) is a hard-money lender that specializes in making secured construction loans. The company is structured as a real estate investment trust, which means it has to pay out at least 90% of its earnings in the form of dividends. As a result, as long as Broadmark Realty remains profitable, it has good reason to have a fairly high yield. Its current yield is just over 7%, which it pays via a $0.06 monthly dividend.
On the surface, it may seem crazy to consider investing in a stock that focuses on lending money to construction projects in the middle of a pandemic that hampered so much commercial activity. What Broadmark Realty has going for it, however, is that it has no debt of its own on its balance sheet. That gives it incredible flexibility in how it manages its operations and allows it to ride through rough waters that could otherwise sink lenders that themselves carry substantial debt loads.
Even though Broadmark Realty has a 7% yield, that's not near the high end of yield among mortgage-focused REITs. That relatively low yield is a testament to the company's debt-free balance sheet, as investors are willing to accept a lower spot on the risk/reward trade-off curve.
2. An energy company not strictly tethered to the price of oil
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Phillips 66 (PSX -0.35%) operates as an oil refiner, transportation, and marketing company. Although its business is sensitive to the overall demand for energy, it is far less sensitive to the price of that energy. That's because it buys oil on the market and uses that oil as an input into the rest of its operations. Since the profitability of the gasoline that it refines is largely based on the crack spread between oil and its refined products, the raw price of oil doesn't matter to Phillips 66 as much as it does to oil producers.
That's a key reason why it was able to maintain its $0.90 per share per quarter dividend throughout 2020, despite a period of negative oil prices. Indeed, Phillips 66's dividends have been well-covered by its operating cash flows over the past twelve months, giving good reason to believe that they can be sustained in the future. At a recent share price of $65.23, that gives Phillips 66 a yield of around 5.5%.
Energy transportation and refining are vital industries that are also ones that people don't necessarily want in their back yards. That makes it tough for new competitors to enter the space and helps improve the chances that existing companies like Phillips 66 can keep sufficient cash flows to continue to pay out those generous dividends.
3. An insurance titan that prides itself on being "rock solid"
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Prudential Financial (PRU -1.40%) cares deeply about its financial strength. It cares so much that it uses an actual rock -- the Rock of Gibraltar -- as its corporate symbol to showcase how rock solid its balance sheet is. That strength translates to a conservative balance sheet with over $400 billion in bonds backing up better than $60 billion in net equity.
Insurance is the business of pricing risk. In that business, an insurance company's balance sheet equity is what it uses to pays for risks it didn't adequately price for with its premiums. That means that a lot can go wrong with Prudential Financial's operations, above and beyond what it's already planning for, before it runs into serious troubles. In the middle of a global pandemic, that should provide tremendous comfort for potential shareholders.
Adding to that sense of comfort, Prudential Financial generated over $12 billion in cash from operations in the first nine months of 2020. That suggests that it is doing an adequate job of pricing in its risks, even amid all the unknowns we're facing. It also suggests that the company's dividend -- which currently sits at $1.10 per share per quarter -- can likely continue. At a recent share price of $78.09, that means shareholders are receiving around a 5.6% yield to hold on to that financial behemoth.
Decent dividends are still available if you know how to look
Even in these low interest rate times, dividend stocks with decent and likely sustainable payments are still available. To find them, you have to look beneath the headline payment amount and seek to understand how they make their money. With that understanding, you can better gauge the likelihood that they'll be able to continue to provide such generous payments, and thus make a more intelligent investing decision for yourself.
