There is no one-size-fits-all investment strategy on Wall Street. Different strategies can work for all types of investors. But among these various blueprints, buying dividend stocks has a storied history of delivering success for long-term investors.
Publicly traded companies that regularly dole out a dividend to their shareholders are virtually all profitable and time-tested. These are businesses that have previously navigated their way through economic downturns and showed Wall Street they're perfectly sound. And most importantly, dividend stocks have handily outperformed companies that don't offer a payout over long periods.
Arguably the biggest pitfall when hunting for income stocks is the possibility of falling for a yield trap. In a perfect world, investors would receive the highest yield possible with little or no risk. In reality, data has shown that high-yield dividend stocks can sometimes be trouble. Since yield is a function of payout relative to share price, a company with a faulty business model and a declining share price can trap unsuspecting investors.
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But a few bad apples certainly won't spoil the bunch. As an example, if you wanted to rack up $500 in quarterly dividend income, you could do that with ease using ultra-high-yield dividend stocks -- "ultra-high-yield" is a term I'm using to describe income stocks with yields of at least 7%. If you were to invest $17,500 (split equally, three ways) in the following ultra-high-yield stock trio, which is averaging an 11.47% yield, you'd net $500 in dividend income every three months.
Verizon Communications: 7.04% yield
The first supercharged income stock that can help you generate $500 in quarterly dividend income with an initial investment of only $17,500 (split three ways) is telecom giant Verizon Communications (VZ -0.53%). The 7% yield Verizon is currently parsing out is just a hair below its all-time high.
One of the reasons telecom stocks are such safe investments has to do with wireless access and smartphone ownership evolving into basic necessities. Despite tough competition and the inevitability of recessions, churn rates for wireless providers like Verizon don't increase much, even during the most challenging times. Wall Street loves predictability, and Verizon's operating cash flow tends to be quite predictable.
Though Verizon is a mature company, it does have catalysts capable of steadily moving its profit needle in the right direction. The most clear-cut of these catalysts is 5G. Verizon has been steadily upgrading its network to handle 5G download speeds. An ongoing device replacement cycle and increase in data consumption helped the company grow its wireless revenue by nearly 6% in the fourth quarter, as well as add more than 1.4 million retail postpaid net additions, which represents its best single quarter in seven years.
However, wireless arguably isn't even Verizon's top-performing operating segment at the moment. The 416,000 broadband net additions in Q4 represent the company's highest number of net additions in more than a decade. Verizon invested heavily in the 5G mid-band spectrum, with the expectation that at-home and business-focused broadband services would improve its cash flow and encourage high-margin bundling. It would appear this bet is paying off handsomely.
The cherry on top for income investors is that Verizon is also historically inexpensive. Income seekers can buy shares right now for less than 8 times Wall Street's consensus earnings for 2023 and 2024. Given the consistency of cash flow described above, this presumably provides a pretty safe floor beneath the shares of Verizon.
PennantPark Floating Rate Capital: 12.02% yield
A second ultra-high-yield stock that can be counted on to help investors rack up $500 in quarterly dividend income from a starting investment of $17,500 is little-known business development company (BDC) PennantPark Floating Rate Capital (PFLT -0.17%). PennantPark is a monthly dividend payer whose board recently increased its monthly stipend by 5% to $0.10/share.
A BDC is a type of company that invests in smaller businesses (often referred to as "middle-market companies"). BDCs have two paths they can take. Either they predominantly purchase the common or preferred stock of middle-market companies, or they can focus on becoming debtholders for these businesses. PennantPark has chosen the latter, with approximately 87% of its $1.15 billion portfolio invested in debt securities as of the end of 2022.
One of the key advantages of choosing debt over equity is that middle-market companies, which usually have valuations of less than $2 billion, allow PennantPark to net favorable yields. Micro-cap and small-cap businesses are typically unproven, which means their access to debt and credit markets may be limited. As a result, a company like PennantPark is able to generate above-average yields on the debt investments it holds.
But here's the really interesting thing about the $998.3 million in debt securities PennantPark holds: Every single penny is variable-rate. Every time the Federal Reserve hikes interest rates in response to historically high inflation, PennantPark benefits in the form of higher yields on its debt investments. Between Sept. 30, 2021, and Dec. 31, 2022, the company's average weighted yield on debt investments climbed from 7.4% to 11.3%!
Lastly, PennantPark's investment portfolio is sufficiently de-risked, despite its focus on smaller/unproven businesses. Including its equity investments, the company has put an average of $9.1 million to work in 126 companies. What's more, all but $0.1 million of its $998.3 million debt portfolio is first-lien secured debt. First-lien secured debt is at the front of the line for repayment in the event that a company PennantPark is invested in seeks bankruptcy protection.
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Alliance Resource Partners: 15.36% yield
The third ultra-high-yield stock that can help you rack up $500 in quarterly dividend income with an investment of $17,500 (split three ways) is coal producer Alliance Resource Partners (ARLP -0.05%). Following multiple quarterly distribution increases last year, I can assure you that its 15.4% yield isn't a misprint.
Alliance Resource Partners is benefiting from a broken energy supply chain. Most people would correlate the world's energy supply issues with Russia's invasion of Ukraine last year -- and that's certainly part of the story. However, the bigger issue might just be that major energy companies have been forced to reduce their capital investments for three years due to demand uncertainty stemming from the COVID-19 pandemic. With little hope of quickly ramping crude oil supply, it's the coal industry that's been the primary benefactor.
But it's not just a higher per-ton coal sales price that's helping Alliance Resource Partners. It's how management has responded to this big uptick in coal demand and pricing. Specifically, the company has been booking volume and price commitments multiple years out. Based on a midpoint guide of 37 million tons of coal production, Alliance has 94% of its forecast production priced and committed for 2023 (as of late January), as well as 64% priced and committed for 2024. This creates highly predictable cash flow that supports its massive distribution.
To add to this point, management has historically approached production expansion opportunities quite conservatively. Even with coal prices considerably higher than where they were three years ago, management has chosen to only modestly expand output. This approach has kept Alliance Resource Partners from getting buried by debt.
The other catalyst to consider with Alliance Resource Partners is that it has a growing oil and natural gas royalties portfolio. If the systemic issues with the global energy supply chain persist, higher energy commodity spot prices should lead to a healthy amount of segment earnings before interest, taxes, depreciation, and amortization (EBITDA).
Priced at roughly 3 times Wall Street's consensus earnings for 2023 and 2024 (also not a typo), Alliance Resource Partners is one of the cheapest stocks on Wall Street.
