Whether you're a tenured investor or have only recently begun putting your money to work in the stock market, it's been a grueling year. Since hitting their respective closing highs, the benchmark S&P 500 and growth stock-dependent Nasdaq Composite fell into a bear market, with respective peak declines of 24% and 34%.
While bear market drops can be scary given the velocity and unpredictability of moves lower, they're historically also the perfect time to do some shopping. Eventually, all double-digit percentage declines in the major U.S. indexes have been cleared away by bull market rally.
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Dividend stocks can be your golden ticket to riches during a bear market
A bear market decline is also the ideal opportunity to consider putting your money to work in dividend stocks.
Publicly traded companies that pay a dividend are often profitable on a recurring basis and time-tested. These are companies that have seen their fair share of economic contractions and recessions, and they've come out stronger on the other side.
What's more, income stocks have a storied history of handily outperforming their non-paying peers. A J.P. Morgan Asset Management report released in 2013 found that publicly traded companies initiating and increasing their payouts between 1972 and 2012 averaged an annualized return of 9.5%. By comparison, stocks that didn't pay a dividend clawed their way to a meager 1.6% annualized return over this same 40-year stretch.
However, not all dividend stocks are created equally. Studies have shown that when dividend yields surpass 4%, risk and yield tend to rise in lockstep. In other words, high-yield dividend stocks can often be more trouble than they're worth. But this isn't always the case.
What follows are three ultra-high-yield dividend stocks -- an arbitrary term I'm using to describe stocks with a yield of at least 7% -- that are screaming buys in September and can be trusted to pad income investors' pocketbooks for a long time to come.
Annaly Capital Management: 13.79% yield
The first passive-income powerhouse investors can confidently buy in September is mortgage real estate investment trust (REIT) Annaly Capital Management (NLY 0.59%). Annaly's nearly 13.8% yield is the highest on this list, and the company has been averaging a roughly 10% yield over the past two decades.
The mortgage REIT operating model is pretty straightforward. Companies like Annaly aim to borrow money at the lowest short-term rate possible, and use this capital to buy higher-yielding long-term assets, such as mortgage-backed securities (MBS). This is how the industry got its name. As a general rule, the wider the gap (known as "net interest margin") between the averaged yield earned from the assets a mortgage REIT owns minus its average borrowing rate, the more profitable the company.
Transparency is what makes mortgage REITs so attractive from an income standpoint. Simply paying attention to the interest rate yield curve and Federal Reserve monetary policy will tell investors what they need to know about the health of mortgage REITs.
Currently, things are incredibly challenging for Annaly. With the central bank aggressively fighting historically high inflation, short-term borrowing costs are rising. At the same time, the yield curve has flattened, or in some instances inverted. The end result has been declining net interest margin and lower book value for Annaly. I mention book value, because mortgage REITs typically trade close to their respective book value.
However, this is an industry that makes for an excellent bad-news buy. For example, even though higher interest rates are increasing short-term borrowing costs, they'll provide a hearty long-term boost to the MBSs Annaly is buying. Over time, this is a recipe for net interest margin expansion.
Furthermore, the U.S. economy spends a disproportionate amount of time expanding, relative to contracting. As a result, the yield curve spends a lot of time steepening, not flattening, which favors Annaly's bottom line.
If you still need convincing, consider this: $74.9 billion of Annaly's $82.3 billion in total assets are agency securities. An "agency" asset is backed by the federal government in the event of default. This added protection allows Annaly to wisely use leverage to its advantage.
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PennantPark Floating Rate Capital: 9.52% yield
If you're an income-seeking investor who loves under-the-radar stocks, let me introduce you to business development company (BDC) PennantPark Floating Rate Capital (PFLT -0.87%). PennantPark has been doling out a monthly payout (yes, monthly!) of $0.095/share for more than seven years.
BDC's come in two forms: those that focus on equity, and those that focus on debt. PennantPark primarily falls into the latter category. Although 13% of its $1.23 billion investment portfolio is tied up in common equity and preferred stock, virtually every penny of the remaining 87% is invested in first-lien secured debt for middle-market companies.
Middle-market companies, which usually have market caps of $2 billion or less, often aren't time-tested, and therefore have limited access to lending markets. PennantPark is able to use to this its advantage and lock in significantly higher yields on the debt it holds.
You might be thinking that focusing its attention on less-proven businesses would lead to higher delinquencies rates -- but this hasn't been the case. Through the first-half of 2022, just two of the 123 companies PennantPark has invested in were on non-accrual, which is the equivalent of delinquent. This doesn't even represent 1% of the company's portfolio on a cost basis.
To build on this point, the company's choice to hold virtually all of its debt portfolio in first-lien secured debt minimizes its long-term risk. First-lien secured debtholders are first in line to be paid if a company has to seek bankruptcy protection.
But arguably the best aspect of PennantPark is that its entire $1.06 billion debt investment portfolio is of the variable-rate variety. Every time the Fed boosts interest rates, the yield PennantPark nets on its first-lien secured debt rises. Over the past nine months (ended June 30, 2022), PennantPark Floating Rate Capital's weighted-average yield on its debt investment portfolio rose from 7.4% to 8.5% without it having to lift a finger.
Antero Midstream: 9.04% yield
The third and final ultra-high-yield dividend stock to buy hand over fist in September is energy stock Antero Midstream (AM 1.50%). Despite lowering its quarterly payout by 27% last year (I'll touch on the reasoning for this in a moment), it's still yielding a juicy 9% for shareholders.
For some investors, it's probably still too soon to talk about owning oil and gas stocks. It was just 2-1/2 years ago when COVID-19 lockdowns sent oil and gas demand careening off a cliff. During a very brief period in April 2020, West Texas Intermediate oil future contracts traded at negative $40/barrel.
However, the issues traditional oil and gas stocks contended with during the pandemic haven't impacted Antero Midstream. The reason? Look no further than the company's name.
Midstream operators are effectively energy middleman. In Antero Midstream's case, it operates natural gas gathering and processing assets, as well as provides water delivery and blending solutions for parent Antero Resources (AR 6.20%) in the Appalachia region of the United States. Since 100% of the company's contracts with Antero Resources are fixed-fee, there's transparency as to the company's expected operating cash flow in a given year. This transparency is important, as it allows Antero Midstream's management team to outlay capital for infrastructure projects and its distribution without adversely impacting profitability.
There's also a logical reason for the company's 27% distribution reduction in 2021. With the price for natural gas soaring, Antero Resources wants to boost drilling on Antero Midstream's acreage. The latter reduced its payout to ensure it has ample capital to invest in new infrastructure to handle the increased natural gas drilling on its acreage. The expectation is for Antero Midstream to generate $400 million in incremental free cash flow by 2025 as a result of this move.
It's also worth pointing out that supply constraints for the domestic and global energy complex can't be quickly remedied. Russia's invasion of Ukraine, coupled with reduced capital investment caused by the pandemic, should keep natural gas prices elevated for years to come. That's even more incentive for parent Antero Resources to drill.
With most large capital investments now in the rearview mirror, Antero Midstream is expected to see a big uptick in free cash flow beginning in 2023. This should give the company an opportunity to reduce its leverage and become even more attractive on a fundamental basis to the investment community.
