There are a lot of ways to make money on Wall Street. Buying dividend stocks just happens to be one of the smartest and safest strategies to build wealth and generate income.
Approximately 10 years ago, the wealth management division of money-center bank JPMorgan Chase, J.P. Morgan Asset Management, released a report that compared the returns of publicly traded companies initiating a dividend and growing their payout over a period of 40 years (1972 to 2012) to publicly traded companies that didn't offer a dividend over the same time line.
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The results are just what you'd expect. Since dividend stocks tend to be profitable on a recurring basis and are time-tested, they delivered a healthy 9.5% annualized return over four decades. By comparison, companies that didn't pay a dividend scraped and clawed their way to an annualized return of just 1.6% over the same 40-year period.
The biggest challenge for income seekers is simply deciding which dividend stocks to buy. While investors can get wide-eyed looking at companies with supercharged yields, studies have also shown that investment risk goes way up when targeting "ultra-high-yield stocks" -- a phrase I'm arbitrarily defining as stocks with yields of 7% or higher.
However, not all high-octane income stocks are worth avoiding. While businesses with high yields certainly require some extra vetting by investors, steady and outsized income is possible -- and you don't need a mountain of cash to get started.
If you're wanting to generate $100 in super safe annual dividend income, you can do so by investing just $905 (split equally three ways) into the following three ultra-high-yield dividend stocks, which sport an average yield of nearly 11.1%.
AGNC Investment: 14.44% yield
The first ultra-high-yield dividend stock that can produce supercharged, safe dividend income is mortgage real estate investment trust (REIT) AGNC Investment (AGNC 0.97%). AGNC doles out its dividend on a monthly basis and has sustained a double-digit yield in 13 of the past 14 years. In other words, its current yield of 14.4% isn't abnormal or a red flag.
Without getting too far into the weeds, mortgage REITs like AGNC aim to borrow money at low short-term rates and use this capital to purchase higher-yielding, longer-duration assets, such as mortgage-backed securities (MBS). The average yield of assets owned, less the average borrowing rate, equates to net-interest margin. Generally, the higher the net-interest margin for AGNC, the more profitable it is.
However, the past two years have been something of a nightmare for the mortgage REIT industry. An inverted Treasury yield curve, coupled with the steepest rate-hiking cycle in four decades, has increased short-term borrowing costs and reduced net-interest margins across the board. In short, the magnitude of the rate hikes undertaken by the Fed has been more challenging than the simple fact that rates are moving higher, which is typically not great news for the mortgage REIT industry.
But there's a clear light at the end of the tunnel for AGNC, and it seemingly gets brighter with each passing day.
For instance, the Treasury bond yield curve spends a disproportionate amount of time sloped up and to the right. Even though we don't know precisely when the yield-curve inversion will end, history shows that economic expansions last considerably longer than recessions. As a result, long-dated bonds usually have higher yields than short-term bills. When the yield curve rights itself, AGNC's net-interest margin will be primed for expansion.
Another reason to have faith in AGNC and its rock-solid payout is the composition of its investment portfolio. As of June 30, $56.9 billion of its $58 billion investment portfolio consisted of agency MBSs and TBA (to be announced) securities. The key word here is "agency," which means these assets are backed by the federal government in the unlikely event of a default. This added protection allows AGNC to prudently leverage its bets in the MBS space in order to pump up its profit potential. This leverage also supports the company's juicy payout.
PennantPark Floating Rate Capital: 10.8% yield
The second ultra-high-yield dividend stock that can generate $100 in super safe annual dividend income from an initial investment of $905 (split equally three ways) is business development company (BDC) PennantPark Floating Rate Capital (PFLT 0.61%). PennantPark also pays its dividend on a monthly basis and has increased its monthly payout twice this year.
A BDC is a company that invests in either the equity (common or preferred stock) or debt of middle-market businesses. By "middle-market business," I'm referring to companies with microcap or small-cap valuations.
As of the end of March 2023, PennantPark held $157.2 million in preferred and common stock equity and roughly $1.01 billion in debt securities. In short, PennantPark is very much a debt-focused BDC -- and that comes with an assortment of advantages.
To start with, smaller businesses are typically unproven and often don't have access to a wide array of debt and credit solutions. With borrowing options limited for middle-market companies, PennantPark is able to capitalize by receiving an above-market yield on the debt investments it does hold.
What makes PennantPark such a phenomenal stock to buy right now is the fact that 100% of its $1.01 billion debt-investment portfolio is variable rate. Every rate hike by the Federal Reserve is increasing the net-interest income PennantPark is collecting. In the 18-month period between the end of September 2021 and end of March 2023, the company's weighted average yield on debt investments soared from 7.4% to 11.8%.
To boot, PennantPark Floating Rate Capital has wisely protected its investments. All but $0.1 million of its $1.01 billion debt-investment portfolio is in first-lien secured debt. First-lien secured debt is first in-line for repayment if one of the company's borrowers seeks bankruptcy protection. This ensures that no single investment can turn the company's operations upside down.
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Verizon Communications: 8.02% yield
The third ultra-high-yield dividend stock that can generate $100 in super safe annual dividend income from an initial investment of just $905 (split equally three ways) is telecom stock Verizon Communications (VZ 1.17%).
Telecom stocks have been clobbered in recent years for two key reasons. First, historically low interest rates since the Great Recession favored high-growth tech stocks, which left slow-growing telecom companies eating their dust. The other issue concerns lead-sheathed cables for legacy telecom companies and what environment/legal costs, if any, may arise from their replacement.
In my view, the latter concern has been blown completely out of proportion. Any legal expenses tied to lead-sheathed cables would take years to settle in court. Furthermore, lead-sheathed cables make up a very small percentage of cables currently in use in Verizon's network. It's short-term noise that won't impact Verizon's long-term growth story.
Speaking of growth story, while Verizon is a mature company, it does have two needle-moving catalysts. The first, as you might imagine, is the shift to 5G. Though it's both costly and time-consuming to upgrade the company's network, the payoff for Verizon will be an increase in data consumption by its users. Data happens to be where Verizon's wireless segment generates the bulk of its operating margin.
The other big catalyst for Verizon is the company's broadband operations. Even though broadband hasn't been a major growth story in two decades, the rollout of 5G download speeds is encouraging a device replacement and upgrade cycle that's helping the company land new residential and enterprise accounts. Broadband is a dangling carrot that Verizon can use to encourage service bundling and, ultimately, lift its operating margin.
Something else investors should recognize about telecom stocks is that they're providing what amounts to a necessity service. No matter how poorly the U.S. economy performs, consumers aren't going to give up their smartphones or access to the internet. This leads to highly predictable cash flow from Verizon and its peers.
With a payout ratio of 55%, based on consensus 2023 earnings, Verizon's 8% annual payout looks rock-solid.
