In a little over three weeks, we'll turn the page on 2022, much to the delight of professional and everyday investors. The Dow Jones Industrial Average, S&P 500, and Nasdaq Composite have all fallen into respective bear markets this year, while the bond market has produced its worst return ever.
Although there haven't many places to safely put your money work in the short run, one historically surefire opportunity for long-term-minded investors during a stock market downturn is to put their money to work in dividend stocks.
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Want inflation-crushing monthly income? Supercharged dividend stocks can be the answer
Why dividend stocks? To begin with, companies that regularly dole out payments to their shareholders are almost always profitable. It'd be difficult to continue paying cash to shareholders if a company's long-term growth outlook wasn't on a firm foundation.
To add to this point, income stocks are usually time-tested. This is to say that they've navigated their way through countless recessions and economic downturns. Having an established business can go a long way to reducing volatility during inevitable bear markets.
But maybe best of all, dividend stocks simply outperform. According to a 2013 report from J.P. Morgan Asset Management, a division of JPMorgan Chase, companies that initiated and grew their payouts over a 40-year stretch (1972-2012) handily outpaced the returns of non-dividend-paying companies. When compared over the same four-decade time frame, the dividend-paying stocks left the nonpayers eating dust: 9.5% annualized return versus 1.6% annualized return.
However, not all dividend stocks are created equally. Investors would prefer the highest yield possible with the least amount of risk. The problem is that yield and risk tend to move in lockstep once income stocks hit high-yield status (4% and above).
But this doesn't mean all high-octane dividend stocks are bad news. In fact, some can provide steady, inflation-crushing income on a monthly basis. If you want to generate $200 in dividend income each month in 2023, all you have to do is invest $19,500 (split equally) into this ultra-high-yield dynamic duo.
AGNC Investment: 14.65% yield
The first ultra-high-yield income stock that can help you pocket $200 in monthly dividend income is mortgage real estate investment trust (REIT) AGNC Investment (AGNC -0.11%). AGNC has sustained a 10% or greater yield in 13 of the past 14 years, which shows that its current 14.65% yield isn't a typo or anomaly.
Whereas most REITs aim to acquire and lease property, mortgage REITs purchase mortgage-backed securities (MBS). Their operating model usually involves borrowing money at the lowest short-term rate possible, and then using that capital to buy MBSs that offer higher long-term yields.
What makes mortgage REITs such a favorite among dividend investors (aside from their absurdly high yields) is the predictability of their performance. Keeping a close eye on Federal Reserve monetary policy and the interest rate yield curve will tell investors everything they need to know.
The current operating environment for AGNC is undoubtedly difficult. The Fed's hawkish monetary policy has rapidly increased short-term borrowing rates, which in turn lowers its net interest margin -- the yield AGNC receives from the MBSs it owns minus the average borrowing rate. The interest rate yield curve is also flat to inverted. It's the opposite of an ideal scenario for AGNC but is nevertheless the perfect opportunity to pounce on what should be relatively short-term weakness.
The interesting thing about the interest rate yield curve is that it spends a disproportionate amount of time sloped up and to the right. This is to say that longer-dated, maturing bonds carry higher yields than shorter-dated bonds. Since periods of economic expansion last considerably longer than recessions, it would only be logical to expect the movement in the yield curve to favor AGNC and its net interest margin over the coming years.
Additionally, higher interest rates aren't all bad news for AGNC Investment. Though it's made short-term borrowing costlier, it's having a positive impact on the yield of the MBSs the company is buying. Over time, this should help widen the company's net interest margin.
The final selling point on AGNC, which I've touched on countless time before, is the composition of its investment portfolio. Out of $61.5 billion in investments, just $1.7 billion comprises credit-risk transfers and nonagency assets. Put another way, virtually all of its owned assets are of the "agency" variety.
An agency security is backed by the federal government in the event of default. With this added protection in its sails, AGNC can deploy leverage as it sees fit to compound its profits and sustain a mammoth monthly dividend.
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PennantPark Floating Rate Capital: 9.98% yield
The second ultra-high-yield dividend stock that can help you take home $200 every month in 2023 is business development company (BDC) PennantPark Floating Rate Capital (PFLT -0.17%). PennantPark has been paying $0.095/month for more than seven years and is currently yielding 9.98%. When coupled with AGNC's 14.65% yield, we're talking about an average yield for this dynamic duo of 12.32%!
BDCs are companies that invest in middle-market businesses (i.e., those with small-cap and micro-cap valuations). The reason BDCs focus on companies with valuations of $2 billion or less is simple: They have limited access to debt and credit markets. With fewer financing options available, companies willing to take on debt from smaller/unproven middle-market companies can generate above-average yields.
BDCs either focus on purchasing equity or debt. Although PennantPark held $154.5 million in preferred stock and common equity as of the end of September 2022, 87% of its $1.16 billion investment portfolio was tied up in debt. Thus, it's primarily a debt-driven BDC.
The first thing to note is that 99.99% of PennantPark's debt holdings are in first-lien secured notes. First-lien secured debt would be first in line for payment in the event that a middle-market company sought bankruptcy protection. The choice to avoid other debt tiers helps to reduce some of the risk associated with investing in less-proven/smaller companies.
However, don't think for a moment that PennantPark and its team aren't doing their homework. As of the end of the third quarter, just two of its 125 investment were delinquent on their payments, representing a mere 0.9% of its investment portfolio on a cost basis.
But the best thing about PennantPark is that 100% of its $1.01 billion debt portfolio has variable interest rates. With the nation's central bank aggressively raising interest rates to combat historically high inflation, PennantPark is recognizing higher yields on every single note it holds. The company hasn't had to lift a finger yet has seen its weighted average yield on debt investments jump to 10% from 7.4% over the past 12 months (ended Sept. 30).
The Fed isn't done hiking rates, either. And even when the central bank does hit its peak for this hiking cycle, Fed Chair Jerome Powell has been clear that rates will remain elevated for some time. This is all fantastic news for PennantPark Floating Rate Capital's variable-rate-driven debt investment portfolio.
