The S&P 500 may not have the rich history of the Dow Jones Industrial Average, but when it comes to the most accurate representation of the health of the U.S. stock market and economy, it's by far the best indicator.
Comprised of 500 of the largest companies, the S&P 500 offers a remarkable advantage for investors: 425 of its components, or 85%, pay dividends. Considering that the stock market is undergoing its first correction since Oct. 2011, the importance of dividend-paying stocks cannot be overstated.
With this in mind, and the S&P 500 down more than 10% over the past week, now is a great time to take a brief look at some of the S&P 500's highest dividend stocks and determine whether or not you can trust these yields.
CenturyLink (NYSE:CTL): 8.6% dividend yield
Anyone worried about CenturyLink cutting its dividend anytime soon can breathe a bit easier, as the global communications giant announced on Tuesday that it was keeping its payout steady at $0.54 for the quarter. With a payout of $2.16 per year, CenturyLink is forecast to pay out 89% of its estimated 2015 earnings and 92% of its estimated 2016 profit.
But could this dividend eventually come under pressure? It's certainly plausible considering the increasing demand on communications providers to invest heavily in new infrastructure, as well as the ongoing exodus away from high-margin legacy businesses (e.g., landlines). In fact, following CenturyLink's most recent quarter, the company announced the layoff of 1,000 employees to cut expenses. Thus, while investors may find stability in CenturyLink's dividend in the near-term, its longer-term growth prospects are cloudy at best, making this a stock that might be best avoided.
Frontier Communications (NASDAQ:FTR): 8.5% dividend yield
Rinse and repeat! The two highest dividend stocks within the S&P 500 are both telecommunications companies, with Frontier closely trailing its peer CenturyLink in total yield. However, in Frontier's case shareholders have witnessed two substantial dividend cuts since the Great Recession (as well as a 5% dividend increase within the past year).
So what's the story with Frontier? The company is trying to balance higher-margin content growth opportunities in Internet and cable with previously high-margin landline assets that are declining as wireless access around the country improves. Years ago it purchased landline assets in 14 states from Verizon, and it recently agreed to acquire additional assets from Verizon in three more states. These deals do help the company gain broadband exposure, but they can also be burdensome as voice customers slowly dwindle.
But the key point investors will want to take note of is that Frontier's free cash generation remains steady at around $1.30 per share per year. As long as Frontier can maintain or grow its free cash flow, there's only minimal concern on my part that it won't be able to maintain its dividend.
ONEOK (NYSE:OKE): 7.7% dividend yield
It shouldn't be a big surprise that we find an energy name near the top of the highest dividend stocks list given that oil and gas drillers, servicers, and pipelines have been absolutely hammered over the past year. But natural gas liquid gathering, storage, and processing company ONEOK may be on the receiving end of more pessimism than is deserved, despite halting what had been a steadily growing dividend payout earlier this year.
Stating the obvious, weaker natural gas liquid prices could rein in total natural gas production in the coming years. If drillers cut their production, then it could be difficult for pipelines and storage companies like ONEOK to land new contracts, or at least land new contracts at favorable prices.
But what matters for ONEOK is that a decline in natural gas liquid prices is also likely to improve demand from businesses and consumers. A push in the U.S. toward cleaner fuels should help grow the demand for natural gas and NGLs over the long run. Also, a majority of ONEOK contracts are locked in for the long-term and fee-based, meaning it has minimal free cash flow concerns until 2018 based on its current payout. It's possible ONEOK's stock may come under temporary pressure from the broader market pullback, but this appears to be a healthy midstream company that income investors would be wise to dig more deeply into.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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