Your wallet is not playing tricks on you. Over the past year, the price we pay for the goods and services we regularly buy has risen at the fastest rate in 40 years.
In February, the U.S. Bureau of Labor Statistics reported a 12-month trailing inflation rate of 7.9%. Not only is this pulling more money out of consumers' bank accounts, but it's devaluing the purchasing power of the cash investors have lying around. The good news is there's a potential fix for this second issue.
Dividend stocks have a rich history of mopping the floor with non-dividend payers. A 2013 report from J.P. Morgan Asset Management, a division of JPMorgan Chase, found that dividend stocks averaged a 9.5% annual return between 1972 and 2012, which compared to a mere 1.6% average annual gain for non-dividend payers over the same period. The hardest part for investors is simply figuring out which high-yielding stocks to buy.
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While not all ultra-high-yield dividend stocks are worth buying -- an "ultra-high-yield stock" is an arbitrary term I'm using to describe a company with at least a 7% yield -- three stand out as having all the tools necessary to help you crush historically high inflation.
Enterprise Products Partners: 7.05% yield
First up is oil and gas stock Enterprise Products Partners (EPD 1.77%), which is handing out a nearly 7.1% dividend yield.
For some investors, the idea of putting their money to work in an oil stock is unpalatable. Just two years ago, oil futures contracts briefly traded at negative values due to a historic demand drawdown tied to the COVID-19 pandemic. As you can imagine, low oil prices and futures market volatility put some upstream drilling and exploration companies in a bind.
NYSE: EPD
Key Data Points
However, Enterprise Products Partners is an entirely different breed of oil and gas stock. It's a midstream company, or as I prefer to call it, the middleman of the energy complex. This is a company that owns around 50,000 miles of transmission pipeline, operates 20 natural gas processing facilities, and can store 14 billion cubic feet of natural gas. In other words, it controls the essential infrastructure that gets oil and gas from the fields to refiners and terminals.
What investors should note about Enterprise Products Partners is how the company's contracts are structured. With specified volume commitments in place from drillers, price vacillations in oil and gas won't adversely affect the company's operating cash flow. Being able to accurately forecast its annual cash flow is what's allowed Enterprise Products Partners to undertake new projects, make acquisitions, and increase its base annual payout for 23 consecutive years, all without adversely impacting its profitability.
Enterprise Products Partners' distribution coverage ratio provides more proof of its financial stability. This ratio, which measures the amount of distributable cash flow generated by the company relative to what's actually paid out, never dipped below 1.6 in 2020. A figure below 1 would imply an unsustainable payout.
Among midstream oil stocks, this is arguably the cream of the crop.
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PennantPark Floating Rate Capital: 8.24% yield
Another ultra-high-yield dividend stock that can help you put high inflation in its place is the little-known PennantPark Floating Rate Capital (PFLT +3.12%). PennantPark sports an 8.2% yield and has been paying out a monthly dividend of $0.095 per share for the past seven years.
PennantPark is a business development company (BDC) that primarily invests in first-lien secured debt for middle-market companies, as well as owns various equity investments (e.g., preferred stock). In easier-to-understand terms, it typically buys debt backed by assets from publicly traded companies with market caps under $2 billion.
NYSE: PFLT
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Why purchase secured debt in generally smaller companies? The answer is because small businesses aren't necessarily time-tested, and therefore have fewer lending options available. This means PennantPark is able to generate high yields on the debt it holds. As of the end of 2021, the average yield on its debt investments was 7.5%.
But what's even more exciting for PennantPark and its shareholders is how historically high inflation should drive up profits. The company noted in its year-end report that 99.9% of its slightly more than $1 billion debt securities portfolio was comprised of variable-rate debt. As the nation's central bank scrambles to get inflation under control, higher lending rates will result in the company's variable-rate debt portfolio generating more income.
And while you might think PennantPark Floating Rate Capital would be exposed to a higher risk of payment delinquencies since it's dealing with smaller market-cap companies, this hasn't proved to be the case. Out of the 115 companies PennantPark has invested in, just three were non-accrual as of Dec. 31, 2021, which represented only 2.5% of the fair value of its portfolio.
With lending rates set to rise throughout 2022, this little-known BDC could be a portfolio superstar.
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Antero Midstream: 8.26% yield
The third ultra-high-yield income stock that offers inflation-crushing potential is midstream natural gas company Antero Midstream (AM +0.23%). By two-hundredths of a percent, Antero Midstream offers the highest yield on this list at 8.26%.
The bull thesis here is somewhat similar to Enterprise Products Partners. In Antero Midstream's case, it's operating gathering, compression, processing, and water-handling infrastructure for natural gas drilling company Antero Resources (AR 2.16%) in the Appalachian Basin (primarily the Marcellus shale). Since Antero Midstream is working with fixed-fee contracts, there are no surprises when it comes to the company's operating cash flow. This cash flow transparency is what allows the company to acquire additional acreage and expand its infrastructure.
NYSE: AM
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What investors might note about Antero Midstream is that it reduced its quarterly distribution in 2021 by 27% (from $0.3075 per quarter to $0.225). Generally, a dividend cut would be bad news and/or a major red flag. But not in this instance.
The reason Antero Midstream reduced its payout was so it would have more capital to invest in midstream infrastructure. With natural gas prices rebounding in a big way in 2021, parent Antero Resources is stepping up its drilling activity on Antero Midstream's owned acreage. By paring back distributions a bit in the short run, Antero is estimated to add $400 million in incremental free cash flow through 2025.
Best of all, despite a larger capital budget outlay, Antero Midstream has made significant headway in strengthening its balance sheet. Over the past two years, the company has reduced its debt by more than $1.6 billion, and its leverage ratio should be below 1 by the end of 2022, compared to 3.1 by the end of 2020. This added financial flexibility should come in handy with its free cash flow set to soar in the years ahead.
