It's been a challenging year for dividend stocks in sectors and industries (e.g., real estate investment trusts [REITs] and utilities) traditionally known for providing low volatility and market-topping income. The culprit for this poor performance is the hawkish Federal Reserve.
In an effort to combat historically high inflation that briefly surpassed an annualized rate of 9% in June 2022, the nation's central bank has raised its federal funds rate at the fastest pace in more than four decades. Aside from increasing borrowing costs, it's also had a marked impact on Treasury yields.
As recently as two years ago, Treasury bills set to mature in four weeks to one year were yielding around 0.05% to 0.10%. As of the closing bell on Nov. 24, T-bills were sporting yields ranging from 5.284% for the one-year bill to as much as 5.477% for six-month bills.
It's a fairly similar story for Treasury bonds. The 30-year bond, which was yielding merely 1.82% two years ago, is now sporting a considerably more attractive 4.6% yield. Since Treasury bonds have minimal risk to invested principal, they've been a popular choice for income seekers this year.
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But they don't have to be the only choice for super-safe dividend income.
Though there's greater risk to your principal when investing in individual dividend stocks, as opposed to Treasury bonds, there's also the potential to generate considerably more income. Although not all ultra-high-yield stocks are safe, proper vetting can uncover a handful of exceptional income gems.
If you want to more than double the yield of Treasury bonds yet still generate super-safe dividend income, consider putting your money to work in the following three ultra-high-yield stocks, which sport an average yield of 12.91%!
Annaly Capital Management: 14.81% yield
One surefire way to receive more than triple the yield of long-term Treasury bonds is to purchase shares of mortgage real estate investment trust (REIT) Annaly Capital Management (NLY 1.02%). Though a 15% yield is typically viewed as unsustainable for most companies, Annaly has supported an average yield of around 10% over the past two decades and returned $25 billion to shareholders since its initial public offering in 1997.
I'm certainly not going to beat around the bush and tell you that everything is perfect with mortgage REITs because that'd be far from the truth. The past 18 months have arguably been the most challenging time in the industry's history. Rapidly rising interest rates sent short-term borrowing costs soaring, which in turn has adversely impacted Annaly's book value and net interest margin. While these challenges could persist in the very short term, a number of catalysts have emerged for this premier mortgage REIT.
One of the biggest tailwinds for Annaly Capital Management is the Fed's quantitative tightening measures. The nation's central bank wants to reduce its balance sheet, which means it's no longer purchasing mortgage-backed securities (MBS). With the federal government no longer gobbling up higher-yield MBSs, Annaly should be able to feast and meaningfully increase its average yield on MBSs owned over time.
To add to the above, higher interest rates are pushing the yields on MBSs up. Though the expediency of interest rate hikes did Annaly no favors, future MBS purchases will boost its average yield on MBSs.
Another reason income investors can trust Annaly is its focus on agency assets. An "agency" security is backed by the federal government in the unlikely event of default. While this added protection does lower the yield Annaly receives on the MBSs it purchases, it also enables the company to prudently leverage its investments. This leverage allows Annaly to maximize its profit potential and sustain a double-digit yield.
Lastly, the Treasury yield-curve inversion has lessened in recent months. When this inversion completely reverses course and the yield curve, once again, slopes up and to the right (i.e., long-term bonds sport higher yields than short-term bills), Annaly can expect its net interest margin to expand.
PennantPark Floating Rate Capital: 11.1% yield
A second ultra-high-yield stock capable of producing exceptionally safe dividend income that more than doubles the yield on Treasury bonds is business development company (BDC) PennantPark Floating Rate Capital (PFLT 0.61%). PennantPark pays its dividend monthly and has raised its payout twice since the year began.
BDCs are businesses that invest in the debt and/or equity (common and preferred stock) of middle-market companies. By "middle-market," I mean primarily micro- and small-cap companies with market values of up to $2 billion.
As of the end of September, PennantPark's nearly $1.07 billion investment portfolio consisted of $160.9 million in combined common and preferred equity positions and $906.3 million in debt securities. Though PennantPark is tackling both investment avenues, it's primarily a debt-focused BDC.
The advantage of going this route can be seen in the yield PennantPark is netting. Since most middle-market companies are, to some degree, unproven, their access to traditional debt and credit markets is limited. This means financing deals will usually have a premium rate that favors the lender. In other words, PennantPark is generating above-market yields on the debt it holds.
Something else working in PennantPark Floating Rate Capital's favor is that 100% of its debt-securities portfolio is variable rate. Aggressive rate hikes from the nation's central bank are leading to higher profitability. Over the trailing-two-year period, ended Sept. 30, PennantPark's weighted average yield on debt investments rose by 520 basis points to 12.6%.
This relatively under-the-radar BDC has also done a fantastic job of diversifying its portfolio and protecting its principal. Including its equity stakes, PennantPark's average investment size is only $8.1 million. A single debt delinquency or poor-performing equity investment won't rock the proverbial boat.
Further, all but $0.1 million of its $906.3 million debt-security portfolio is in first-lien secured debt. First-lien secured debtholders are first in line for repayment in the event that a borrower files for bankruptcy protection.
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Alliance Resource Partners: 12.81% yield
The third ultra-high-yield stock that can deliver super-safe dividend income that's well over double the yield of Treasury bonds is coal producer Alliance Resource Partners (ARLP -1.63%). The $2.80-per-unit annual distribution from Alliance Resource Partners works out to a yield of roughly 12.8%.
As recently as four years ago, coal stocks were effectively left for dead. The expectation had been that historically low lending rates and the desire for developed countries to reduce their carbon footprints would result in a wave of green-energy projects. While this proved true for some time, the COVID-19 pandemic changed everything.
During the pandemic, virtually all oil and gas producers were forced to reduce their capital spending due to the uncertainty of demand for energy commodities. Even though the worst of the pandemic has now passed, the repercussions of years of reduced capital investment are still being felt. With the crude oil supply remaining tight, coal producers have stepped up to fill the demand void.
While Alliance Resource Partners has enjoyed a healthy uptick in the per-ton sales price of coal, what's really been impressive is management's forward thinking. It's not uncommon for the company to commit and price production up to four years out. With per-ton coal prices particularly advantageous at the moment, Alliance Resource Partners has fully priced and committed nearly 80% of its expected output for 2024.
A conservative approach has also served Alliance Resource Partners well. Despite historically high per-ton coal prices, management has slow-stepped production expansion. Doing so has helped keep the company's debt at manageable levels. Alliance Resource Partners ended the third quarter with $162.6 million in net debt, which means it offers superior financial flexibility relative to its peers.
Alliance Resource Partners has diversified its operations, too. It's been acquiring crude oil and natural gas royalty interests that allow it to take advantage of the rising price of energy commodities. Given the aforementioned tight supply of crude oil globally, higher spot prices should be a positive.
At less than 5 times forward-year earnings, there may not be a cheaper ultra-high-yield energy stock than Alliance Resource Partners.
