High-yield dividend stocks can be powerful wealth-building tools. The businesses behind them may not be high-growth operations, but when it's done right, investing in such stocks can generate gobs of income you can use right now or reinvest to bolster your portfolio's long-term returns.
The key phrase above was "when it's done right." That means identifying companies with the ability to generate good returns over long periods and buying their stocks at reasonable or good prices. Three stocks that fit this definition today are Valero Energy (VLO -1.10%), Verizon Communications (VZ -0.86%), and Tanger Factory Outlet Centers (SKT -0.84%).
The highest yield in the only market-beating part of the oil & gas business
Over the past decade, only a few oil and natural gas companies have beaten the S&P 500 on a total return basis. And they weren't the major integrated oil companies, the oil and gas services companies, independent producers, or the pipeline companies. The biggest winners in the oil and natural gas industry over the past 10 years were all refining and processing companies: Valero, Marathon Petroleum, and Cheniere Energy.
Refining and processing players sit in an industry sweet spot -- they can more or less make money regardless of whether energy prices are high or low. There haven't been significant additions to refining capacity in the U.S. in many years, so businesses with existing refineries have run at high utilization rates. High utilization rates tend to produce higher margins. Also, refiners and processors make their hay on the difference between raw product prices and refined product prices -- the "crack spread," in refining lingo. Despite wild fluctuations in oil prices over the past decade, crack spreads have remained fairly consistent.
Relatively consistent revenue streams, high capacity utilization, and modest maintenance capital requirements allow refiners to generate high levels of free cash flow. Valero has used much of that free cash flow to reward shareholders. Over the past 10 years, management has boosted the dividend by 460% and the company has bought back 27% of its shares outstanding. That's a repeatable formula for creating lasting shareholder value in a low-to-no-growth industry. At today's share price, Valero has a dividend yield of 3.5%. Combined with its impressive track record of payout increases, that makes it a pretty attractive value proposition.
Even slow growth can deliver good returns with a yield this high
You've probably heard the saying that you have to pay a premium for growth. Conversely, there's a price to pay for investing in low-to-no-growth businesses. Verizon Communications doesn't look too appealing based on its performance over the past decade. It has only returned 30% on a total return basis, and its dividend payouts are only up 26.7% over that period.
Here's the bright side, though. It would appear that much of this weak performance has been priced into the stock. At today's share price, it has a dividend yield of 6.56%. With a yield that high, investors can generate reasonable returns even if earnings and dividend growth are slow for a while and the stock doesn't gain that much. Also, it's worth noting that Verizon's free cash flow is expected to accelerate. Management forecasts that annual capital spending will decline from a range of 14% to 17% of total assets presently to less than 12% by 2024, and predicts free cash flow of between $20 billion and $23 billion in 2023. (It has generated $10 billion in free cash flow over the past 12 months.) Once the company is on the other side of this spending push, management forecasts a 4% annualized growth rate with high free cash flow generation.
Again, 4% growth isn't great. But the combination of modest growth, significant free cash flow generation on the horizon, and a yield of 6.5% makes Verizon look like a relatively solid value proposition.
Stronger-than-expected performance from retail real estate
Tell me if you've heard this one before: News of the death of brick-and-mortar retail has been greatly exaggerated. Yes, e-commerce accounts for a growing portion of all retail spending, and brick-and-mortar's share is shrinking. But that doesn't mean that there aren't good investments to be found among the operators of physical stores -- or the companies that own the real estate in which they reside.
Among the top operators in the retail real estate space, Tanger is definitely worth a look.
The outlet mall operator is seeing improving occupancy rates, higher sales per square foot, higher same-store net operating income, and higher lease spreads (meaning its newly signed leases are more valuable than its older leases.) While many investors were concerned that the pandemic would cripple Tanger's finances, it still has an investment-grade debt rating and it is in compliance with all of its debt covenants with lots of room to spare.
Similar to Verizon, investors shouldn't expect Tanger to grow much. It will get some modest gains from improving same-store sales and a newly built outlet center set to open next year. Still, with a current dividend yield of 5.3%, the company doesn't need to grow at a breakneck pace to reward investors.
A worthwhile trade-off
There are trade-offs in investing. If you're buying high-yield dividend stocks, then you should expect slower growth. But a slower growth rate doesn't necessarily mean a bad investment, especially in times of high-interest rates and contracting valuations. Based on their records of growth, what they can expect in the future, and their current valuations, these three companies' stocks look like good values to pick up today.
