What makes Wall Street great is that there's no one-size-fits-all strategy to build wealth. Regardless of your risk tolerance, there's a strategy that can work for you.
But among the myriad of investment approaches, buying and holding dividend stocks is unquestionably one of the most successful ways to make money on Wall Street. Companies that regularly return a percentage of their earnings to shareholders in the form of a dividend are almost always profitable, and they're typically time-tested. In other words, they're not companies you're going to worry about when going to sleep at night.
Dividend stocks have a history of outperformance, too. An oft-referenced report released 10 years ago from the wealth management division of JPMorgan Chase found that companies initiating and growing their payouts over a 40-year stretch (1972-2012) produced an annualized return of 9.5%. That was many multiples higher than the 1.6% annualized return for the non-payers during the same 40-year timeline.
Image source: Getty Images.
However, not all income stocks are created equally. While income seekers would prefer to receive the highest yield possible with minimal risk, studies have shown that risk tends to increase with yield.
But there's good news for investors seeking supercharged income stocks. Though value traps exist, there are also high-quality, ultra-high-yield dividend stocks -- those with yields that are at least four times greater than the yield of the S&P 500 -- that can safely deliver for their shareholders.
If you want $2,000 in annual dividend income, all you'd need to do is invest $17,650 (split equally, three ways -- just under $5,900 for each) in the following ultra-high-yield financial stocks, which sport a scorching-hot average yield of 11.34%.
AGNC Investment: 16.13% yield
The first ultra-high-yield financial stock that can help you bring home nearly half of $2,000 each year from your starting investment is mortgage real estate investment trust (REIT) AGNC Investment (AGNC +0.89%). AGNC pays its dividend monthly, and it's averaged a double-digit yield in 13 of the past 14 years.
Mortgage REITs like AGNC make their money by borrowing at low short-term lending rates and using this capital to purchase higher-yielding long-term assets, such as mortgage-backed securities (MBS). The difference between the average yield on the assets AGNC owns less its average borrowing rate is known as "net interest margin." The wider the net interest margin, often the more profitable the mortgage REIT.
NASDAQ: AGNC
Key Data Points
As you can probably guess from the business model, AGNC is highly sensitive to movements in interest rates. The historic pace at which the Federal Reserve has increased the federal funds rate to combat high inflation has sent short-term borrowing costs higher and reduced the value of the assets in AGNC's investment portfolio. But even though the operating climate has been less than ideal in recent quarters, there is light at the end of the tunnel for the mortgage REIT industry and AGNC.
One of the top catalysts for AGNC and mortgage REITs is the Treasury yield curve. Despite being inverted at the moment -- yields on short-term bills are higher than long-term Treasury bonds -- the Treasury yield curve spends a disproportionate amount of time sloped up and to the right, with longer-dated bonds sporting higher yields than bills maturing a few months from now. As the yield curve returns to normal in the years to come, AGNC should see its net interest margin expand.
Additionally, AGNC can actually benefit over time from higher interest rates. Though mortgage REITs typically thrive in lower-rate environments, higher rates will help to lift the average yield on the MBSs AGNC does own over time.
Lastly, $56.9 billion of AGNC's $58 billion investment portfolio has been put to work in agency securities. "Agency" assets are backed by the federal government in the event of default and are what allow AGNC to leverage its portfolio to maximize its profits.
NYSE: PFLT
Key Data Points
PennantPark Floating Rate Capital: 11.86% yield
A second ultra-high-yield financial stock that can help you is the business development company (BDC) PennantPark Floating Rate Capital (PFLT +2.38%). This small-cap, off-the-radar BDC also pays its dividend on a monthly basis and is currently yielding almost 12%.
BDCs are companies that predominantly invest in the equity or debt of small- and micro-cap businesses. Despite holding almost $155 million in common and preferred stock as of the end of June 2023, the bulk of PennantPark's investment portfolio is tied up in debt investments. This makes it a debt-focused BDC with a number of advantages working in its favor.
For instance, most small-cap and micro-cap companies are unproven and, therefore, have limited access to traditional debt and credit markets. This means any financing provided to these smaller businesses will be at an above-market rate. The debt PennantPark does hold often bears higher yields.
Arguably even more important is the fact that its entire $950 million debt investment portfolio sports variable rates. With the Federal Reserve increasing the federal funds rate by 525 basis points since March 2022, PennantPark's weighted average yield on debt investments has expanded from 7.4%, as of Sept. 30, 2021, to 12.4%, as of June 30, 2023. Since the central bank has no intention of easing rates anytime soon, PennantPark's weighted average yield on debt investments is unlikely to decline.
While some investors might be concerned about PennantPark choosing to put its money to work in less-established/unproven businesses, they shouldn't be. As of the end of June, PennantPark's $1.11 billion portfolio, including equity investments, was spread across 130 companies. This means no single investment is critical to PennantPark's success.
Likewise, all but $0.1 million of the company's $950.3 million debt investment portfolio is focused on first-lien secured debt. If one of the company's borrowers were to seek bankruptcy protection, first-lien-secured debtholders would be first in line for repayment. This smart positioning on PennantPark's part (say that three times fast!) ensures its robust monthly payout is sustainable.
Image source: U.S. Bank.
U.S. Bancorp: 6.03% yield
The third ultra-high-yield financial stock is regional bank U.S. Bancorp (USB +0.54%), the parent of the more familiar U.S. Bank.
Bank stocks are cyclical businesses that benefit from disproportionately long periods of expansion. While they do contend with higher loan losses and credit delinquencies during recessions, the U.S. economy spends a considerably longer amount of time expanding than it does contracting. This gives a bank like U.S. Bancorp the opportunity to grow its loan portfolio and expand in lockstep with the U.S. economy over the long run.
On a more company-specific level, U.S. Bancorp's management team, focus on digital initiatives, and acquisition activity are all reasons for current and prospective investors to be excited about its future.
NYSE: USB
Key Data Points
With regard to the former, U.S. Bancorp's leadership has predominantly guided the company away from riskier derivative investments and stayed focused on the bread-and-butter of banking: making loans and taking in deposits. This may sound like a boring way to make a living, but this relatively straightforward approach that avoids excessive risk-taking has often led to superior return on assets (ROA) for U.S. Bancorp when compared to other large bank stocks.
U.S. Bancorp has also done a bang-up job of encouraging its customers to bank digitally. When last updated by the company a year ago, more than 80% of its customers were banking online or via mobile app, with more than 60% of loan sales being completed digitally. Online and mobile transactions are considerably cheaper for banks than in-person interactions, which should improve U.S. Bancorp's operating efficiency over time.
Lastly, U.S. Bancorp can make waves with its acquisitions. The company's purchase of Union Bank from Mitsubishi UFJ Financial Group brought in 1.2 million consumers and small businesses, a growing number of which are banking digitally and have low-cost deposits. Bolt-on acquisitions like the Union Bank deal should allow U.S. Bancorp to steadily expand its bottom line and sustain its above-average ROA.
