Stocks that pay dividends are becoming rarer and rarer. Corporate management teams often opt to retain earnings for the sake of growth instead of returning it to shareholders. This is problematic for investors who want to see steady streams of cash flowing into their portfolios every once in a while.
What's more, the S&P 500's dividend yield has fallen to a meager 1.53% per year. Luckily, individual stocks such as Automatic Data Processing (ADP 2.92%), Innovative Industrial Properties (IIPR 2.37%), and Merck & Co (MRK 0.83%) all have substantial yields, especially compared to that of the index. Let's look at why they are ideal choices for dividend investors.
1. Automatic Data Processing
For six years in a row, Automatic Data Processing (ADP) has been the top human resource (HR) product winner in Human Resource Executive. The company has over 860,000 clients worldwide in every industry, managing payroll, HR, and employer tax deductions.
This year, ADP expects to increase its revenue by 1% to 3% to $14.59 billion, and leave its earnings per share (EPS) unchanged. At the moment, the company generates close to $1.2 billion each year in cash flow from operations, which is more than enough to pay for its $81 million in capital expenditures and $781.7 million in dividends. Its stock's price-to-earnings (P/E) ratio of 32 is lower than the S&P 500's 40.3, and it offers a higher yield of 1.94%.
2. Innovative Industrial Properties
Innovative Industrial Properties has become a mega landlord in the rising cannabis industry. Aside from leasing out dispensaries/cultivation/distribution facilities to growers, it has an innovative business model that utilizes sale-leaseback programs. Basically, the company acquires stores from reputable marijuana growers like Harvest Health & Recreation Inc (HRVSF), and then rents them back to the sellers. This way pot growers get lump sums of cash to expand their businesses, while Innovative Industrial receives a steady stream of rent checks, creating a win-win situation.
It typically pays $5 million to $30 million for each dispensary, with an average lease period of 10 to 20 years, and receives 10% to 16% of the transaction value each year in rental income. Today, Innovative Industrial manages 67 properties across 17 states, with an average lease length of 16.7 years. Its facilities are 100% leased, with 100% of rent paid on time. The company is also well-capitalized, with a debt-to-asset ratio of just 7.9%.
Innovative Industrial generates about $148.4 million per year in sales, and pays a dividend of $4.96 per share based on Q4 2020 annualized rates. Last year it more than tripled its adjusted funds from operations (AFFO) to $97.8 million, which amounts to about $4.08 per share.
If the difference between its dividend payout and its AFFO looks sketchy, it really isn't. At this growth rate, the company should be more than capable of meeting its long-term payout ratio of 75% to 85% dividends/AFFO. With a dividend yield of 2.57% and a P/E ratio of 57, Innovative is simultaneously the most expensive stock on our list and the one with the most growth potential.
3. Merck & Co
Last year, Merck's business took a hit as patients took a step back from discretional health products due to the effects of the COVID-19 pandemic. Its revenue increased by 2% year over year to $48 billion, while its earnings fell sharply by 28% compared to 2019 levels, to $7.082 billion.
What saved Merck was a strong sales performance by its miracle immunotherapy cancer treatment, Keytruda. In the past two years, Keytruda's revenue doubled to $14.38 billion. The popular cancer treatment has seven years' room to grow further before its patents expire in 2028.
In addition, the company has over 20 therapeutic candidates in phase 3 trials to offset Keytruda's lost cash flows after it goes off-patent. The most promising is a potential multi-billion dollar HIV collaboration program with Gilead Sciences (GILD 0.51%).
Right now, Merck generates $2.77 in EPS, which is more than enough to cover the $2.48 per share it pays out in dividends. Trading at 27 times P/E with a solid dividend yield of 3.27%, this is an income-generating pharma stock trading at a bargain price.