Although there are a lot of ways to make money in the stock market, few investing strategies have delivered the same level of long-term success as buying dividend stocks.
Nine years ago, J.P. Morgan Asset Management, a division of banking behemoth JPMorgan Chase, released a report that compared the performance of income stocks to non-dividend payers over a four-decade stretch (1972-2012). The report showed that dividend stocks averaged an annual return of 9.5%, which equates to investors doubling their money every 7.6 years. Meanwhile, the non-dividend stocks scraped their way to an average annual return of just 1.6% over 40 years.
These results are precisely what we'd expect to see, even if the magnitude of the outperformance is a bit shocking. Companies that pay regular dividends are almost always profitable on a recurring basis, time-tested, and have clear long-term growth outlooks. In other words, they're the type of businesses we'd expect to increase in value over time.
Dividend stocks can be your ticket to a healthy amount of passive income. If you want to bring home $5,000 in annual dividend income, investing $60,300 (split equally) into the following three high-yield stocks, which combine to offer an 8.3% average yield, can make it happen.
Enterprise Products Partners: 6.88% yield
Arguably, the safest high-yield stock of the group is oil and gas company Enterprise Products Partners (EPD -0.61%). The company offers a nearly 6.9% yield and is riding a 23-year streak of increasing its base annual payout.
For some investors, the idea of putting their money to work in oil stocks might not be appealing. After all, oil demand fell off a cliff two years ago during the pandemic, with crude oil futures briefly pushing into the negative. However, this tumble in oil prices had no impact on Enterprise Products Partners' operating performance.
What makes this company so special is that it's a midstream operator. Whereas drilling and exploration companies are intricately tied to the vacillations in oil and natural gas prices, midstream companies often lock in volume commitments to handle the transmission, storage, and processing of crude, natural gas, and liquefied natural gas. Enterprise Products Partners operates more than 50,000 miles of transmission pipeline, 23 natural gas processing facilities, and can store 14 billion cubic feet of natural gas. Its volume-based contracts with drillers produce highly predictable operating cash flow each year.
The predictability of Enterprise Products Partners' cash flow is particularly important, given that it allows the company to outlay capital for new infrastructure projects and acquisitions without adversely impacting profitability or its distribution.
Speaking of distributions, at no point during the worst of the pandemic did Enterprise Products Partners' distribution coverage ratio dip below 1.6. This ratio describes how much distributable cash flow was generated from operations relative to what was disbursed to investors. Any figure below 1 would imply an unsustainable payout.
Taking into account that oil and natural gas are now at or near multidecade highs, the future for energy infrastructure-kingpin Enterprise Products Partners is as bright as ever.
AGNC Investment Corp.: 12.14% yield
A second high-yield stock that can help pad your pocketbook with $5,000 in annual dividend income is real estate investment trust (REIT) AGNC Investment Corp. (AGNC -1.00%). The company's 12.1% yield is the highest on this list, with AGNC parsing out a double-digit yield in 12 of the past 13 years.
Without digging too far into the weeds, mortgage REITs like AGNC aim to borrow money at low short-term rates and then use this capital to purchase higher-yielding long-term assets, such as mortgage backed securities (MBS). The wider the gap between the average yield on assets held minus the average borrowing rate (this "gap" is known as net interest margin), the more profitable mortgage REITs can be.
At the moment, AGNC is navigating its way through a difficult environment. With the prevailing inflation rate hitting a 40-year high and the Federal Reserve expected to raise interest rates, short-term borrowing costs are rising. To boot, the Treasury yield curve has flattened, which is often a short-term negative for the book value of mortgage REITs like AGNC.
But on the flip side, higher interest rates and a brighter long-term outlook for the U.S. economy should allow AGNC to generate higher yields from the MBS it is purchasing. This should positively impact the company's net interest margin over time.
Furthermore, AGNC Investment Corp. almost exclusively purchases agency securities. These are assets backed by the federal government in the unlikely event of default. Although this added protection lowers the yield AGNC receives on the MBS it buys, it also allows the company to lean on leverage to pump up its profit potential.
When things look the bleakest for mortgage REITs is precisely when it's time for opportunistic investors to pounce. That time is now.
Alliance Resource Partners: 5.88% yield
The third high-yield dividend stock that can help you generate $5,000 in annual income with an initial investment of $60,300 is coal producer Alliance Resource Partners (ARLP -0.62%).
Unlike Enterprise Products Partners, Alliance Resource Partners was briefly forced to shelve its robust quarterly distribution. A sizable demand drawdown for coal, coupled with weak pricing, required the company to conserve capital during the height of the pandemic.
But what a difference two years can make! Despite most countries pushing for green-energy solutions, the International Energy Agency's Coal 2021 report estimated that coal demand grew by 6% in 2021. Meanwhile, the per-ton price for coal has jumped from less than $30 during the pandemic to more than $320, as of April 19, 2022. This has given Alliance Resource Partners plenty of reason to boost its output.
Another reason to be excited about this company's future is its history of locking in volume and price commitments well in advance. Alliance Resource Partners entered 2022 with roughly 89% of its coal volume priced and committed and has been booking production out into 2024. This operating cash flow transparency is particularly helpful when management is deciphering whether to boost production or pare capital expenditures.
Investors should also be aware that Alliance Resource Partners holds royalty interests in oil and natural gas properties. The aforementioned multidecade highs for energy prices should provide a healthy boost to royalty revenue and oil-and-gas-based earnings before interest, taxes, depreciation, and amortization (EBITDA).
Coal stocks may not be the growth story they once were, but this conservatively managed producer with a relatively low debt-to-equity ratio of 36% has all the tools necessary to make income investors richer over time.