Stock market volatility isn't for everyone. Although some level of volatility is an inescapable part of being an investor on Wall Street, not everyone is thrilled with the idea of their growth stocks moving up and down at larger multiple than the broader market on a regular basis. That's where dividend investing can come in handy.
Publicly traded companies that pay a regular dividend to their shareholders are usually profitable and have demonstrated to Wall Street they can safely navigate choppy waters, when they arise.
What's more, income stocks offer an extensive history of outperformance, so long as you're patient. According to a report published by J.P. Morgan Asset Management, a division of banking giant JPMorgan Chase, back in 2013, companies that initiated a dividend and grew their payout generated an annualized return of 9.5% between 1972 and 2012. Meanwhile, publicly traded stocks that didn't offer a payout trudged to a meager 1.6% annualized return over the same 40-year time span.
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But you don't have to settle for just an average dividend stock when putting your money to work on Wall Street. With proper vetting, ultra-high-yield dividend stocks -- an arbitrary term I'm using to describe income stocks with yields of 7% and above -- can safely pad your pocketbook on a regular basis and provide reasonable protection against stock market volatility.
For example, if you want $300 in quarterly dividend income, you'd only need to invest $8,700 (split equally) into three ultra-high-yield dividend stocks, which sport a jaw-droppingly high average yield of 13.86%.
AGNC Investment: 14.95% yield
The first supercharged income stock that can deliver a sustained double-digit yield is mortgage real estate investment trust (REIT) AGNC Investment (AGNC -0.11%). AGNC has averaged a double-digit yield in 13 of the past 14 years, is currently doling out nearly 15%, and pays its dividend on a monthly basis.
Mortgage REITs like AGNC are businesses that seek to borrow money at the lowest possible short-term lending rate. They then use this capital to purchase higher-yielding long-term assets, such as mortgage-backed securities (MBSes).
The reason mortgage REITs can be so investor-friendly is that following the Treasury yield curve and Federal Reserve monetary policy is all that's needed to gauge how well or poorly companies like AGNC are performing. Understanding the slope of the yield curve and the direction and velocity of interest rate movements can speak volumes about the mortgage REIT industry.
Last year was about as bad as it gets for mortgage REITs. An inverted yield curve and rapidly rising interest rates sent short-term borrowing costs screaming higher. In turn, this reduced the net interest margin for AGNC -- the "net interest margin" being the average yield on assets owned minus the average borrowing rate.
However, buying mortgage REITs when they're at their worst has historically been a smart move. That's because the yield curve spends a lot of time sloped up and to the right (i.e., bonds with longer maturities having higher yields than shorter-dated bonds). As the yield curve returns to its normal state at some point in the future, AGNC should see its net interest margin meaningfully improve.
The same can be said about rising interest rates. While the speed at which rates are rising hasn't been favorable for short-term lending, it is a positive for the yields on the MBSs AGNC continues to buy. Over time, this can boost the company's net interest margin.
As one final note, the majority of AGNC's investment portfolio is packed with agency securities. These are assets protected by the federal government in the event of a default. This added protection allows AGNC's management team to lever its bets and bolster its profits.
PennantPark Floating Rate Capital: 11.73% yield
The second ultra-high-yield dividend stock that can help you generate $300 in quarterly dividend income with an initial investment of $8,700 (split equally, three ways) is under-the-radar business development company (BDC) PennantPark Floating Rate Capital (PFLT -0.17%). PennantPark also pays its dividend on a monthly basis, and its board recently increased its dividend by 5% -- from $0.095 a share to $0.10 a share.
In simple terms, BDCs invest in the equity (common stock and preferred stock) or debt of small-cap businesses with valuations of less than $2 billion. Although PennantPark does hold nearly $153 million in common and preferred stock, the lion's share of its investments -- $998.3 million, to be precise -- are tied up in debt instruments.
One of the main advantages of holding debt tied to smaller businesses can be found in the yield PennantPark is receiving. Since middle-market companies are often unproven, their access to debt and credit markets can be limited. This allows PennantPark to net above-average yields on the debt it holds.
Then again, the biggest catalyst for the company is given away by its name: "Floating Rate Capital." The entirety of its $998.3 million debt portfolio is variable rate. With the nation's central bank having no choice but to rapidly increase interest rates to combat stubbornly high inflation, each rate hike is lifting the interest income-earning potential of PennantPark's debt investments. Between Sept. 30, 2021, and Dec. 31, 2022, the company's weighted average yield on debt investments rocketed from 7.4% to 11.3%. If the Fed chooses to keep rates higher for a longer period, it'll be positive news for PennantPark and its shareholders.
While investing in smaller companies might sound risky on paper, PennantPark has managed this risk two ways. To begin with, it's spread its $1.15 billion portfolio, including equity investments, across 126 companies. With an average investment size of only $9.1 million, no one company can sink the proverbial ship.
The other risk-reducing move by management is to invest in first-lien secured debt. All but $0.1 million of the company's $998.3 million debt portfolio is first-lien secured debt. If one of the companies PennantPark is invested in seeks bankruptcy protection, first-lien secured debtholders are first in line for repayment.
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Alliance Resource Partners: 14.89% yield
The third high-octane ultra-high-yield stock that can help collectively produce $300 in quarterly dividend income from an initial investment of $8,700 (split equally) is coal producer Alliance Resource Partners (ARLP -0.05%). Alliance Resource raised its quarterly distribution multiple times in 2022 and is currently parsing out a nearly 15% yield.
Chances are that you're scratching your head and wondering why a coal producer would be a smart investment to generate supercharged income. With most developed countries pushing clean-energy initiatives and aiming to reduce their carbon footprints, coal has been a relatively shunned/forgotten industry for years.
However, the COVID-19 pandemic changed things. Though initial lockdowns led to historic demand declines for all energy commodities, it's coal that's come out smelling like a proverbial rose. Three years of capital underinvestment in the oil and gas industry, coupled with Russia's invasion of Ukraine, has constrained oil and gas supply and allowed the coal industry to become the diamond in the rough.
Beyond just benefiting from higher per-ton coal prices, Alliance Resource Partners has a number of company-specific tailwinds. The most notable is the fact that a sizable portion of production is being booked multiple years in advance. Based on a midpoint forecast of 37 million tons of coal production in 2023, Alliance Resource had 94% of this output priced and committed as of the end of January for this year, along with 64% of output for 2024 priced and committed. Locking this production in years in advance at favorable per-ton prices leads to juicy margins and highly predictable operating cash flow.
Speaking of cash flow, Alliance Resource Partners increased its unit repurchase program to $100 million in January. Having a buyback in place, along with raising its quarterly distribution 180% on a year-over-year basis, is all made possible by the transparency of the company's cash flow.
In addition to its coal operations, Alliance Resource Partners has also been acquiring royalty interests in the oil and gas space. If the global energy supply chain remains broken, there's a reasonable chance we'll see oil prices remain above their historic average. This would lead to steady or growing earnings before interest, taxes, depreciation, and amortization (EBITDA).
With its forward-year price-to-earnings ratio of just 3, you'd struggle to find a cheaper stock parsing out a juicier dividend.
