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Forget GameStop: Buy These Red-Hot Dividend Stocks Instead

By Daniel Foelber, Scott Levine, and Lee Samaha - Jan 30, 2021 at 9:25AM

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Ignore the meme stock noise and focus on fundamentally strong companies.

In one week, shares of GameStop have gone from $35 to $350 as Reddit users bid up its stock price in an effort to crush hedge funds that were short the stock. A similar theme has persisted in other companies with high short interest like AMC Entertainment Holdings -- spiking volatility and disrupting investor confidence. This effect, paired with the Federal Reserve's updated January policy statement, led to the biggest decline in the S&P 500 in three months.

Long-term investors are better off ignoring the noise and focusing on fundamentally strong companies. We asked some of our contributors which red-hot dividend stocks they think are good buys right now. They came up with Raytheon Technologies (RTX -1.09%), Atlantica Sustainable Infrastructure (AY -0.67%), and United Parcel Service (UPS -1.04%).

Bull and bear figurines on top of ascending stacks of coins.

Image source: Getty Images.

Learning to fly

Lee Samaha (Raytheon Technologies): It's no secret that the commercial aviation market faces a multi-year recovery and there's no definite flight path laid out as of yet. That said, it shouldn't deter you from investing in the industry, and specifically in Raytheon Technologies.

While the exact timing of a recovery in passenger traffic and flights is subject to change, few people will argue that it won't happen over time. Raytheon's management believes it won't be until 2023 that commercial traffic returns to 2019 levels. That's a concern for a company that manufactures aircraft engines, commercial aerospace original equipment, and aftermarket components and structures.

However, before you give up on the stock, consider that Raytheon also has a substantive defense business. In addition, management just forecast it would generate bundles of free cash flow, which will easily cover its dividend (current yield 2.9%) and also allow for share buybacks.

In fact, the two defense-focused businesses, Raytheon Intelligence and Space and Raytheon Missiles and Defense, contributed 48% of sales and 83% of adjusted segment profit in the recent fourth quarter. This defense revenue will provide valuable earnings and free cash flow support as the commercial aerospace market comes back.

Meanwhile, management's guidance is for $4.5 billion in free cash flow in 2021, a figure which easily covers the $3 billion needed for the dividend. Moreover, CEO Greg Hayes plans to use the remaining $1.5 billion for share buybacks. All told, Raytheon's dividend is very well covered and with a multi-year recovery in aviation in progress investors can look forward to dividend increases down the line.

Strong cash flow powers this clean energy dividend

Scott Levine (Atlantica Sustainable Infrastructure): While Atlantica Sustainable Infrastructure (Atlantica Yield) is hardly the desire of Reddit investors, the stock has powered considerably higher of late. Outperforming the market over the past three months, shares of Atlantica Yield have soared 29% while the S&P 500 has risen about 10%. With the election of President Joe Biden -- a renewable energy advocate -- in November, it's unsurprising that investors have given the green light to this green energy stock. But it's not only investors keen on clean energy that are likely attracted to Atlantica Yield. Offering investors a 3.9% yield, Atlantica Yield's stock is surely attracting the attention of dividend-hungry investors as well.

Savvy investors know that chasing high-yield dividend stocks is hardly a wise strategy. It's not uncommon for investors lured in by an attractive distribution to be quickly dismayed to find that the company's finances can't sustain the high payout. But Atlantica Yield's business model should comfort skeptical investors. As a yieldco, Atlantica Yield enters into long-term power purchase agreements -- relating to natural gas and water assets as well as solar and wind power projects -- that generate strong, consistent cash flows, so it has good foresight into its future finances. For example, over the past 12 months, Atlantica Yield generated $345 million in free cash flow, representing about 35% of its revenue. And that's far from an outlier in terms of the company's recent performance. Over the past three years, Atlantica has generated annual free cash flow that represents 37.5% of its sales, according to Morningstar. And that's to say nothing of the money the company has returned to investors by way of the dividend. 

President Biden's immediate rejoining of the Paris Agreement is hardly the only signal that he's committed to renewable energy. He recently expressed interest in converting the federal government's fleet of vehicles to electric vehicles, and -- to the chagrin of the oil industry -- he announced a moratorium on new oil and gas drilling on federal land. These actions, in conjunction with the extension of solar and wind power tax credits included in the recent stimulus bill -- suggest that renewable energy stocks like Atlantica Yield are poised to prosper.

An e-commerce play that's just getting started

Daniel Foelber (UPS): Shares of UPS had a hot 2020, producing a total return of around 50%. And for good reason. It recorded a record rise in U.S. average daily package volume in the second quarter. It then followed up that performance by posting stellar third-quarter results as revenue and earnings per share (EPS) grew double digits year over year. Like other package delivery stocks, UPS is benefiting from increased consumer spending, especially from e-commerce. However, the company isn't just riding a short-term tailwind. It has made key investments in its e-commerce, healthcare, and automotive segments because it believes there will be growing demand for these services for years to come.

UPS Total Return Level Chart

UPS Total Return Level data by YCharts

In addition to expanding its domestic presence, UPS CEO Carol Tome noted that the company's third-quarter international and supply chain and freight revenue "was the highest quarterly growth we've seen in nearly three years." However, supply chain and freight has been the company's weakest segment as operating profit and margins have been strained. Unsurprisingly, the company announced on Monday its decision to sell UPS Freight for $800 million. The sale will help UPS focus on growing its U.S. domestic and international presence.

UPS' strong revenue and profit growth support its stable dividend. The company has consistently grown its dividend since 2001 and now pays a $1.01 per share quarterly dividend -- a yield of 2.5%. That's above the S&P 500's average yield of 1.55%. Given the strength of its underlying business, UPS is well positioned to grow its dividend further.

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Stocks Mentioned

Raytheon Technologies Corporation Stock Quote
Raytheon Technologies Corporation
$93.78 (-1.09%) $-1.03
United Parcel Service, Inc. Stock Quote
United Parcel Service, Inc.
$179.92 (-1.04%) $-1.89
GameStop Corp. Stock Quote
GameStop Corp.
$124.38 (-4.09%) $-5.31
AMC Entertainment Holdings, Inc. Stock Quote
AMC Entertainment Holdings, Inc.
$13.38 (-5.31%) $0.75
Atlantica Sustainable Infrastructure plc Stock Quote
Atlantica Sustainable Infrastructure plc
$32.49 (-0.67%) $0.22

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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