Putting some money into stocks at an early age could result in significant gains over a lifetime, a familiar story with high-growth stocks. The tricky bit is finding them at an early stage.
It's also possible with stocks that combine growth with some dividends, allowing you to compound the dividends through investing.
But what about high-yield stocks? Here's a look at three high-yield dividend payers -- oil and gas company Diamondback Energy (FANG 0.32%), the Guggenheim Strategic Opportunities Fund (GOF 0.62%), and energy infrastructure company Kinder Morgan (KMI -0.64%) -- to see if they are fit for the purpose.
1. Diamondback Energy
This oil and gas company pays a base and variable dividend, meaning its payout fluctuates with the price of oil. As such, if you are bullish on the long-term potential for the price of oil to increase and management's ability to continue growing its reserves, then it makes sense to buy the stock and get the compounding from the dividends.
Management has a good track record of growing reserves with a compound annual growth rate (CAGR) of 47% over the last decade and a CAGR of 19.6% in the previous four years. Its current quarterly base dividend equates to an annual rate of $3.36 a share. Management has a hedging strategy that should protect the base dividend down to an oil price of $40 a barrel (its current price is around $90 at the time of this writing).
While the base dividend equates to a yield of only 2.2%, management has a commitment to return at least 75% of the previous quarter's free cash flow in stock repurchases (which boosts the claims of existing shareholders on cash flow) and the variable dividend. By way of example, Diamondback paid a base-plus-variable dividend totaling $2.95 in the fourth quarter of 2022. That gives investors a 7.6% annual dividend yield.
As such, Diamondback is the sort of stock you might add to a diversified portfolio of high-yield stocks, provided you are comfortable with the long-term outlook for energy prices.
2. The Guggenheim Strategic Opportunities Fund
I've covered this closed-end fund previously. At the time of this writing, the fund's net asset value (NAV) is $11.99, meaning its yearly dividend of $2.19 equals 18.3% of its NAV.
It gets worse. The fund is trading at a 24% premium to its NAV, and the NAV has declined by 5% in 2023 and 25% over the last three years, as rising interest rates have pressured the value of its holdings in high-yield corporate bonds and bank loans.
In addition, in recent years, the fund has significantly increased its borrowings via reverse repurchase agreements (selling an asset under an agreement to repurchase it at a higher price) to increase its NAV, and it is using the return of capital (at the detriment of NAV) to fund the dividend -- only 35% of the distribution in 2022 came from net investment income.
The fund probably needs a turnaround in interest rates to make investors feel comfortable that its distribution can be maintained at the current level. As such, it's not a good candidate for a high-yield portfolio because if management cuts its dividend. The initial loss on investing in the stock would significantly set back long-term investors on their march to generating long-term returns.
3. Kinder Morgan
The second energy company on the list currently pays a $1.13 yearly dividend, making its yield 6.8%. That yield and Kinder Morgan's debt reduction in recent years have attracted income-seeking investors, who also like that the company generates most of its revenue from long-term contracts with a fixed fee on a take-or-pay basis. As such, its near- and medium-term outlook is excellent.
But the more profound question -- and one that investors who want to hold the stock until retirement need to consider -- is the long-term outlook for natural gas demand in the U.S. And if it does decline, can export markets offset any decline?
This is a tricky question because the answer is subject to political uncertainty around the future of fossil fuels. Natural gas is a transitional energy source and is a reliable way to support the intermittent nature of renewable energy, and its appeal is obvious. Still, it's a fossil fuel, and there's no shortage of activism working against the fossil fuel industry.
Image source: Getty Images.
As such, Kinder Morgan will only suit very long-term investors who are confident of the role of natural gas in the economy over the next 20 years or so. The good news is that it's not hard to see how political developments could lead to that scenario developing.
