High-yield dividend stocks (those with yields above 4%) have a mixed reputation among investors. On one hand, they offer attractive cash distributions that can be reinvested to take advantage of the power of compounding. On the other hand, an unusually high yield may signal underlying issues with the company's fundamentals, such as declining earnings, cash flow, or growth prospects.
However, this does not mean that high-yielding stocks should be avoided altogether. They can still play a valuable role in a diversified and long-term portfolio, especially if the cash distribution is reinvested over a 10- to 20-year period. This approach can build a solid cushion against possible share-price declines when the dividend is eventually repurposed as a passive income stream.
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Here are two high-quality stocks with towering yields that would make perfect candidates for such a strategy.
British American Tobacco: A 9.77% yield
British American Tobacco (BTI -0.51%), or BAT, is one of the largest tobacco companies in the world, with a portfolio of well-known cigarette brands such as Camel, Kent, Newport, and Lucky Strike. However, the company is facing a major headwind from the secular declines in smoking worldwide and the regulatory restrictions on advertising in most countries.
To adapt to these changes, BAT is focusing on its new products category, which includes heated tobacco, vapes, and oral nicotine pouches. These products are expected to drive the company's future growth and profitability. The market, however, seems skeptical about this strategy and has pushed BAT's shares to near their 52-week low. Its stock also trades at an exceptionally low forward price-to-earnings ratio of 6.36 as of this writing.
What's the appeal of BAT as a dividend stock? Despite this fundamental weakness, BAT still generates enormous free cash flows, and its blistering 9.77% yield is well covered by earnings. To wit, the company sports a fairly low payout ratio of 59.1%.
While further secular declines in global smoking rates are inevitable, BAT's transition to a smokeless future is underway, and the market arguably isn't properly valuing the company's strong free-cash-flow generation. As such, it might be a smart idea to begin to accumulate shares of the tobacco giant while it remains deeply undervalued, with an eye toward converting the stock to a healthy passive income stream in your retirement years.
Vector Group: A 7.8% yield
Vector Group (VGR -0.58%) is a leading U.S. cigarette company that was founded in 1873. It specializes in discount cigarette brands, such as Montego, Eagle 20's, Pyramid, Grand Prix, Liggett Select, and Eve, which appeal to cost-conscious smokers. Besides its tobacco business, Vector Group also owns a real estate segment, but the overwhelming majority of its revenue comes from selling low-priced tobacco products. Unlike its peers in the premium cigarette market, the company has experienced an increase in sales volume over the past decade, presumably because of its competitive pricing.
The company has maintained a consistent quarterly-cash distribution since 2020, which translates to a generous 7.8% annualized yield. However, Vector Group's payout ratio of 72% is relatively high, suggesting that further dividend growth may be slow in materializing. On the positive side, the company's shares are trading at a low 8.83 times forward earnings, and it is one of the few major cigarette manufacturers projected to report positive revenue growth in 2024. Overall, Vector Group offers a high yield, an attractive valuation, and a robust underlying business.
