Dividend yield is often the first -- and sometimes the only -- criterion income investors look at when buying dividend stocks. Yield is important, but you must weigh whether it's safe and sustainable. Otherwise, you could end up in the high-yield trap and lose money, which is exactly the opposite of what a dividend stock is meant to do.
So how do you know a high-yield dividend stock is worth your money? If the underlying business is fundamentally strong and the company has a strong dividend track record, you're on the right track. The two stocks discussed below, yielding 6% and 8%, are fine examples. And the best part? Both stocks could rally as their industries recover.
An underappreciated dividend stock
W.P. Carey (WPC 0.27%) displayed solid resilience during the COVID-19 pandemic, but the stock is still down about 21% in the past 12 months and yields a big 6% today, making it a compelling buy.
With the pandemic nearly shutting down the economy, investors in real estate investment trusts (REIT) feared a slump in rent collection, especially from commercial-property focused REITs like W.P. Carey. But even during peak lockdown months of March and April 2020, the company collected at least 95% of its contractual base rent.
Its collections started to climb as the year progressed, hitting 98% and 99% in the third and fourth quarters, respectively. Credit largely goes to W.P. Carey's diversification.
Image source: Getty Images.
The company has nearly 1,240 properties leased out to more than 350 tenants, with industrial and warehouse properties bringing in nearly 47% of its annual base rent. The remaining properties are spread across office, retail, self-storage, and others such as educational facilities and hotels. Moreover, nearly 37% of its rent comes from Europe.
That diversification compounds the benefits of W.P. Carey's net-lease REIT structure, under which it can pass on most property-related costs to tenants and avail annual rent escalators built into its lease agreements. With these two factors at play, W.P. Carey could limit the fall in its adjusted funds from operations (FFO) to only 5.2% in 2020.
More importantly, W.P. Carey hiked its dividend in each of the four quarters of 2020. The company has a solid dividend track record, having increased dividends every year for more than two decades.
The trend should continue this year, as management is projecting 1%-4% growth in adjusted FFO in 2021. With management also targeting "significantly" higher spending -- to the tune of at least $1 billion -- on acquisitions this year, W.P. Carey is poised for growth, and so is its dividend.
Three reasons this 8%-yielding stock could surge
With oil prices taking off this year, the focus is back on oil stocks. Among the many companies poised to benefit from the rally, you might want to pay attention to Enterprise Products Partners (EPD 0.48%), which is still down about 12% in the past year and yields a hefty 8%. If the company could come out of an exceptionally challenging 2020 almost unscathed, there's no reason to believe it won't thrive as energy markets recover.
That sky-high dividend yield looks safe. Enterprise Products Partners generated $6.4 billion in distributable cash flow (DCF) in 2020, down barely 3% from its record 2019 DCF. That not only comfortably covered its dividends for the year 1.6 times over, but also left the company with nearly $2.5 billion to improve its balance sheet and reinvest in business.
Again, diversification has been the key to Enterprise Products Partners' resilience and growth. The company operates in the midstream oil and gas sector, owning and operating infrastructure to transport, process, and store oil and natural gas -- a business that's largely fee-based and somewhat insulated from fluctuations in oil prices. And within the midstream space, Enterprise Products Partners has a hugely diversified asset base.
Here's why I think Enterprise Products Partners stock is a buy now. First, I expect the company to announce a dividend hike in March, which should support its high yield. Second, it has stepped into 2021 with strong cash flows, a sturdier balance sheet, and plans to invest $1.6 billion in growth projects this year. Third, three of the company's projects are on track to start operations this year and contribute to its cash flows.
That should get the ball rolling for Enterprise Products Partners as the energy markets revive, and ensure regular and steadily rising dividends for shareholders.
