For more than a century, Wall Street has been a wealth-building machine. Despite dozens of stock market corrections and bear markets, the average annual return of stocks crushes the annualized long-term returns of Treasury bonds, gold, oil, and housing.
While there are lots of ways to make money in the stock market, buying and holding dividend stocks has consistently been one of the most successful strategies.
Last year, Hartford Funds released a report that, in collaboration with Ned Davis Research, examined the average annual returns of dividend stocks vs. non-payers over a five-decade stretch (1973-2022). What researchers found was an overwhelming outperformance for the income stocks. Dividend payers averaged a 9.18% annual return over 50 years, while non-payers delivered a more modest 3.95% average annual return.
Image source: Getty Images.
What makes income stocks special is that they tend to be profitable on a recurring basis, time-tested, and can offer highly transparent long-term growth outlooks in many instances. Dividend stocks may not be highfliers like the "Magnificent Seven" but can generally increase in value over time and make their patient shareholders richer.
Although studies have shown that dividend stocks with really high yields can sometimes be more trouble than they're worth, deals among ultra-high-yield stocks can be found. If you want to bring home $500 in super safe annual dividend income, simply invest $5,350 (split equally three ways) into the following three ultra-cheap and ultra-high-yield stocks, which sport an average yield of 9.35%!
Enterprise Products Partners: 7.33% yield
The first time-tested and exceptionally cheap income stock that can help you bring home $500 annually from a starting investment of $5,350 that's split three ways is energy company Enterprise Products Partners (EPD 1.80%). Enterprise has raised its base annual distribution in each of the past 25 years.
NYSE: EPD
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Some investors are liable to be skittish about putting their money to work in the oil and gas industry, given what happened just four years ago. A historic demand drawdown caused by COVID-19 pandemic lockdowns crippled drilling companies and sent commodity prices markedly lower. However, Enterprise Products Partners' operating performance was largely spared from this volatility.
What makes Enterprise such a safe investment is its role as an energy middleman. It's a midstream company that operates more than 50,000 miles of pipeline and can store more than 260 million barrels of liquids.
Its secret sauce, if you will, is the structure of its contracts. Enterprise generates around three-quarters of its gross operating margin from long-term, fixed-fee contracts with upstream drilling companies. The fixed-fee aspect ensures that inflation and spot-price volatility for crude oil won't adversely impact its operating cash flow. In other words, management has cash-flow visibility of at least a year into the future.
Visibility is important since it's what guides management's ability to grow the business. Having a transparent outlook gives Enterprise's management team the confidence to make acquisitions and undertake more than $6 billion in major projects (mostly geared toward natural gas liquids).
Despite being a leading midstream energy company and benefiting from a higher spot price for crude oil, Enterprise Products Partners remains inexpensive. Shares can be purchased right now for less than 10 times forward-year earnings, which represents about a 10% discount to its five-year average.
NYSE: PFLT
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PennantPark Floating Rate Capital: 10.99% yield
A second ultra-cheap (less than nine times forward earnings), ultra-high-yield dividend stock that can help you generate $500 in exceptionally safe yearly income from a beginning investment of $5,350 (split three ways) is little-known business development company (BDC) PennantPark Floating Rate Capital (PFLT +3.12%). PennantPark pays its dividend on a monthly basis and raised its payout twice in 2023.
BDCs are companies that invest in the debt or equity (common and preferred stock) of middle-market businesses (i.e,. generally small and unproven companies). While PennantPark has invested approximately $210 million in various equities as of the end of December, its $1.09 billion in debt securities held means it's primarily a debt-focused BDC.
The answer to "Why focus on debt for unproven businesses?" comes down to yield. Since smaller businesses have limited options in traditional debt and credit markets, PennantPark is able to generate well-above-market yields on loans to middle-market companies. As of the end of 2023, the company's debt-securities portfolio boasted a weighted average yield on debt investments of 12.5%.
A hawkish Fed has lifted profits for PennantPark Floating Rate Capital. Effective Federal Funds Rate data by YCharts.
But it's not just the aggregate yield that's impressive. The entirety of the company's loan portfolio sports variable rates.
With the Federal Reserve undertaking the most aggressive rate-hiking cycle in four decades, PennantPark's average weighted yield on its debt securities has catapulted higher by 510 basis points since Sept. 30, 2021 to the aforementioned 12.5%. As long as the nation's central bank holds steady on above-average interest rates, PennantPark will be rolling in dough.
Another interesting aspect of PennantPark's business is that it's done an excellent job of preserving its investment capital and de-risking its aggregate $1.27 billion portfolio. Including common and preferred stock investments, it's put its money to work in 141 companies. That's an average investment size of only $9 million, which ensures that no single investment is critical to PennantPark's success.
Furthermore, 99.99% of the company's $1.09 billion loan portfolio is held in first-lien secured debt. First-lien secured debtholders are first in line for repayment in the event that a borrower seeks bankruptcy protection. The thing is, just one company in its entire portfolio is currently delinquent, representing just 0.1% of the value of its overall portfolio at its cost basis.
Image source: Getty Images.
Altria Group: 9.73% yield
The third ultra-cheap, ultra-high-yield dividend stock that can produce $500 in super safe annual dividend income from an initial investment of $5,350 that's split across three stocks is tobacco company Altria Group (MO 1.11%). Altria has raised its payout 58 times in 54 years and is yielding close to 10%.
The clearest headwind for tobacco companies is that consumers have wised up about the potential dangers of long-term tobacco use. Adult cigarette smoking rates in the U.S. have fallen from around 42% in 1965 to 11.5% in 2021, according to the Centers for Disease Control and Prevention. A shrinking pool of consumers is certainly a concern.
The good thing for Altria is that it sports strong pricing power. Tobacco products contain nicotine, which is an addictive chemical. Even with fewer consumers smoking cigarettes and shipments declining, Altria has been able to somewhat or fully offset sales declines by increasing the price on its products.
Altria accounted for nearly a 47% share of the cigarette market in the U.S. in 2023. The bulk of this comes from premium brand Marlboro, which represented 42.1% of the U.S. cigarette market. It's easy to raise prices when you're the undisputed leader.
NYSE: MO
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However, Altria's future rests on its ability to expand its operations beyond tobacco and into smokeless/alternative products. The company's acquisition of electronic-vapor company NJOY Holdings in June 2023 is a perfect example.
While Altria flubbed badly with its large investment in e-vapor company Juul, it didn't make the same mistake twice when it acquired NJOY. NJOY has received six marketing granted orders (MGOs) from the U.S. Food and Drug Administration, which serve as authorizations for those e-vapor products to be sold.
The vast majority of e-vapor products lack MGOs and could therefore be pulled from retail shelves at some point in the future. NJOY benefits from the safety of its positioning, as well as Altria's decades of marketing and product-development expertise.
Lastly, the valuation makes sense. Though Altria is never going to be the growth story it was decades ago, it's still capable of growing its annual earnings per share (EPS) by a low- to mid-single-digit pace. That makes its forward price-to-earnings ratio of less than 8 a bargain.
