It's been a rough start to the year for investors. After reveling in the strongest bounce ever from a bear market bottom (March 2020), all three of the major U.S. indexes have pushed into correction territory. Both the broad-based S&P 500 and iconic Dow Jones Industrial Average declined by double-digit percentages, while the growth-dependent Nasdaq Composite (^IXIC -1.11%) officially dipped into bear market territory with a peak drop of 22%.
Although stock market declines can be scary in the sense that they occur quickly and often without warning, they're also the ideal time to put your money to work. Keep in mind that every correction and bear market throughout history, including for the more volatile Nasdaq Composite, has eventually been wiped away by a bull market rally.
In other words, a bear market isn't a reason to hide. It's the perfect time to go on the offensive. The simple question is: Which stocks to buy?
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Focusing on ultra-high-yield dividend stocks can be a winning strategy
While there are a number of strategies that can make investors richer, buying dividend stocks is a tried-and-true moneymaking plan.
Back in 2013, J.P. Morgan Asset Management, a division of money-center bank JPMorgan Chase, published a report that compared the performance of companies that initiated and grew their dividends to stocks that didn't pay a dividend over a 40-year stretch (1972-2012). The dividend stocks absolutely crushed the non-dividend payers over this period, with an average annual return of 9.5%, compared to an annualized 1.6% increase for the non-dividend stocks.
Though the magnitude of the outperformance may be surprising, the ultimate result -- dividend stocks offering higher annualized returns than non-dividend stocks -- isn't the least bit shocking. Companies that pay dividends are often profitable, time-tested, and have clear long-term outlooks.
The biggest challenge for income investors is balancing yield and risk. Studies have shown that once yields hit about 4%, risk and yield tend to correlate higher. Thankfully, not all high-yield or ultra-high-yield stocks (companies I'm arbitrarily defining as having 7% or higher yields) are bad news.
The recent dip of the Nasdaq Composite into a bear market is the perfect opportunity to buy this ultra-high-yield dividend-stock trio on the dip.
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AGNC Investment Corp.: 10.92% yield
The first ultra-high-yield income stock you'll regret not buying on this pullback is mortgage real estate investment trust (REIT) AGNC Investment Corp. (AGNC 1.43%). AGNC has averaged a double-digit yield in 12 of the past 13 years and doles out its dividend on a monthly basis.
Without getting too far into the weeds, mortgage REITs like AGNC borrow money at low short-term rates and use this capital to purchase higher-yielding long-term assets, such as mortgage backed securities (MBS) -- thus "mortgage REIT." AGNC's goal, and that of its industry peers, is to maximize their net interest margin (NIM), which is the average annual yield from MBS and other investments minus the average short-term borrowing rate.
At the moment, AGNC is facing a bit of an uphill battle. A flattening yield curve, where the gap between short-term and long-term Treasury bond yields shrinks, usually means a lower NIM. However, the Federal Reserve's hawkish monetary-policy stance should also lift the yields of future MBS purchases. This means AGNC should be rewarded with significant NIM expansion in the coming years.
Something else to note is that AGNC almost exclusively buys agency securities -- $79.7 billion of its $82 billion investment portfolio is made up of agency assets. An agency security is backed by the federal government in the event of default. While this added protection weighs on the yields of the MBS AGNC buys, it also allows the company to deploy leverage to its advantage.
Since most mortgage REITs stay close to their respective book values, AGNC's 16% discount to tangible book value, along with its 21% share-price decline over the past five months, makes it a perfect buy-on-the-dip candidate.
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PennantPark Floating Rate Capital: 8.69% yield
Another ultra-high-yield dividend stock you'll regret not buying during the Nasdaq bear market dip is business-development company (BDC) PennantPark Floating Rate Capital (PFLT 0.98%). Interestingly, PennantPark, like AGNC, also pays its delectably high dividend on a monthly basis.
PennantPark's operating model is pretty simple. It predominantly acquires first-lien secured debt for middle-market companies and sprinkles in other equity investments, such as preferred stock. In this instance, middle-market companies refers to publicly traded companies with market caps of $2 billion or less.
The reason this BDC has chosen to focus on middle-market companies is the yield it can generate on first-lien secured debt. Since most small-cap and micro-cap companies are unproven, their lending options tend to be limited. This allows PennantPark to rake in an average yield on its debt investments of 7.5%.
Investors should also be excited about the type of debt investments PennantPark holds in its portfolio. According to the company's year-end report, 99.9% of its debt investments were of the variable-rate variety. With the Federal Reserve recently opining that lending rates could rise up to seven times in 2022 to curb rapidly rising inflation, PennantPark appears set for a massive income windfall.
But perhaps most important, the company isn't having much in the way of issues with delinquencies. Only 2.5% of the company's portfolio was on non-accrual (on a fair value basis) as of the end of the year, with over 98% of its other company-based investments paying on time.
PennantPark Floating Rate Capital is the perfect off-the-radar income stock to buy on any dips.
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Icahn Enterprises: 15.6% yield
The third ultra-high-yield dividend stock that you'll regret not buying on the dip is Icahn Enterprises (IEP 0.35%), the highest-yielding one on this list. Icahn Enterprises has been doling out a quarterly distribution for close to 17 years and is yielding a jaw-dropping 15.6% at the moment.
The "why buy Icahn Enterprises?" argument can be broken down to two core catalysts. The first can be found in the company's name. Carl "Icahn" is the founder of this diversified holding company and remains the chairman of its board of directors.
Icahn is one of the investing world's best-known activist investors. An activist investor usually purchases a single-digit-percentage stake in a company over a short time frame with the purpose of effecting change that benefits shareholders (including the activist investor). Activist investors often angle for a seat or two on the board of directors of a struggling company and fight for specific actions, such as the sale of noncore assets, cost-cutting, or perhaps share buybacks. The point is that activist investors have a positive impact on the valuation of a company more often than not.
The other thing investors should really like about Icahn Enterprises is its cyclical ties. Even though it's a diversified holding company, a large percentage of its non-investment segment is tied up in the energy and automotive industries. Despite recessions being an inevitable part of the economic cycle, periods of expansion last substantially longer than recessions. Thus, Icahn Enterprises' portfolio is perfectly positioned to benefit from the natural expansion of the U.S. and global economy over time.
With shares of the company down 12% since early November, now is the perfect time for opportunistic income investors to pounce.
