There's one fantastic dividend play out there that no one seems to be pouncing on.
And it's probably not the one you're guessing.
It's not REITs
The cat is out of the bag on real estate investment trusts (REITs) -- particularly mortgage REITs. Every investor with eyes sees the mind-blowing 15-20% dividend yields at American Capital Agency (Nasdaq: AGNC), Resource Capital (NYSE: RSO), and Annaly Capital.
This play works if the Fed keeps the hammer down on rates and enables the fantastic interest rate spreads these companies are capitalizing on. That would help keep the profit train rolling and, since they're REITs that have to pay out 90% of their taxable incomes, the dividends flowing.
The way to determine the best of breed here is to compare REITs on leverage ratios (less debt is better), the frequency of share offerings (since they can't hoard cash, share offerings are an unfortunate reality), and the dividend payouts as a percentage of funds from operations (earnings plus depreciation and amortization).
But the dividend play I'm thinking of doesn't rely on government stimulus and isn't constrained by mandatory payouts that increase bankruptcy risk.
It's not the telecoms, either
Telecoms have some tasty dividends, as well. Big players like Verizon and AT&T are yielding around 6%. But the rural telecoms Frontier Communications (NYSE: FTR) and Windstream (Nasdaq: WIN) trump them by doling out 7%-8%.
For the rural players, there isn't much growth opportunity except through consolidation -- e.g. Frontier's purchase of a huge chunk of Verizon's rural assets this past summer. The bet here is basically that Frontier and Windstream can maintain their cash flows (and high dividends) longer than the market thinks.
Maybe they can. But the dividend play I'm thinking of is in a sector where consolidation is a bigger opportunity.
And it's not MLPs
Like REITs, master limited partnerships (MLPs) get special tax treatment in return for huge payouts -- 90% of their cash flows. However, rather than being real-estate-based, MLPs generally tend to be energy plays.
Because of the need for consistent cash flows, energy pipeline operators are a popular choice in this space. Think Kinder Morgan Energy Partners (NYSE: KMP), Enterprise Products Partners (NYSE: EPD), and Enbridge Energy Partners, which are paying out dividends in the 5%-7% range.
Pipelines get their money not from selling oil and natural gas but from charging others to transport the commodities. Buying into these types of companies on price weakness (when yields are highest) can be a great dividend play. But I like the one I'm think of more.
The dividend opportunity everyone's missing
The opportunity I'm thinking about is small banks. Depending on your mood, this may sound either (1) boring or (2) crazy to you, but that's exactly why it's such an opportunity.
In good times, no one cares about these stocks. They get no press, and they're just plain boring. But in these bad times – say, right after a financial crisis led by the banking industry -- many investors are viewing the whole sector not as boring but as toxic.
But it isn't.
In fact, there are a bunch of really quality banks out there that didn't leverage themselves up and didn't load themselves up with subprime mortgages. They continue to stick to the business model that has made banks money for years and years and years: Take deposits. Lend those deposits out to low-risk borrowers. Pocket the interest rate spread between the two.
The trick is separating the good banks from the bad banks.
Since I started personally buying up small bank stocks a year and a half ago, no small bank has impressed me more than Community Bank System (NYSE: CBU). Beyond its strong balance sheet, its strong dividend payouts, and the fact that its bad loan percentage is still the same as it was during 2005. Community Bank System is the gold standard because of management's focus on the shareholder. As a small example, management actually sends out an 8x11-inch postcard each quarter explaining the bank's results in plain English!
It's banks like Community Bank System that make buying a basket of small banks on price dips the most overlooked -- and potentially profitable -- dividend opportunity I see.
As much as I like them, though, small banks should only be part of a well-balanced dividend portfolio. So for more dividend ideas, including "one dividend stock for the rest of your life," check out the Motley Fool's free dividend report by clicking here.
