I love dividend stocks. I love fat dividend stocks even better. And I know you do, too. Dividend investing is hot.
That's what led to my pick of National Grid, which I called an "outstanding dividend stock" in a January article. The stock is up 16% (dividend-adjusted) since that time, while the S&P climbed just 3.8%. I put my own money on the line, too, as I had promised. Massive dividends, like National Grid's 6% yield, tend to help drive a stock higher. In fact, research indicates that big yields can lead to attractive total returns.
But buying the market's fattest dividends without analysis can be fraught with peril. So below I'm going to highlight 10 stocks with scary high yields, one of which you can buy now.
Make way for Foolishness
Investment manager Tweedy, Browne surveyed the academic and professional literature across decades in order to examine the returns of high-yield stocks. Tweedy discovered:
- "There is substantial empirical evidence to support a direct correlation between high dividend yields and attractive total returns."
- "At least one study found that high dividend yield stocks outperformed other value strategies as well as the overall stock market return in declining markets."
Attractive total returns, less volatility, outperformance? Those are great findings for dividend investors like us, who love fat yields. But Tweedy also provides a caveat.
- "Three of the studies found that the best returns were not produced by the highest yielding decile or quintile, but rather by the next highest yielding one or two deciles, or the next highest yielding quintile."
In other words, be very careful around the market's highest yields. Massive yields are often a sign that investors don't expect the dividends to last long (and thus Tweedy's advice to move down the ladder). But I think there's one player here that is smartly managed and could still be a solid investment.
9 for the road
With that advice in mind, I shuffled through all the stocks traded on the major U.S. exchanges. I looked for market caps greater than $1 billion (for some stability), ranked them by dividend yield, and came up with 1,204 stocks. Finally, I broke them up into deciles, or groups of about 120.
The yields on this top decile ran from 37% all the way down to about 6%, right what National Grid offers now. Let's take a look at the nine highest yields in that group:
Market Cap (in Billions)
American Capital Agency
Cypress Sharpridge Investments
Invesco Mortgage Capital
|Companhia Siderurgica Nacional||$16.8||13.8%|
Terra Nitrogen Co., L.P.
Source: Capital IQ, a division of Standard & Poor's.
Those yields all look tempting. Who wouldn't like 14% or more every year? But "every year" is exactly what's in doubt. Every company except Companhia Siderurgica (steel) and Terra Nitrogen (fertilizer) number among a specialized category of REITs. Those industries are all characterized by volatile boom-and-bust cycles. Because so much of the appeal of these companies is in the dividend, any disruption would likely see their stock prices crater.
The seven remaining companies all play in the same sandbox; they're mortgage REITs that are feasting on low short-term rates and buying mortgage securities at higher long-term rates. There's still a lot to like about these companies. They're obligated to pay out 90% of their net taxable earnings, since they're organized as REITs. They're earning generous returns with low interest rates, and it doesn't look like that might change too soon. Unemployment remains high, which is good for these players, and the Federal Reserve can't credibly raise rates, so these companies could make a nice hedge for the rest of your portfolio.
But they all rely on heavy leverage to generate those massive dividends, and any hiccup in the credit markets could disrupt their business. Look at the debt-to-equity ratios to get a sense of the leverage:
|American Capital Agency||662%|
Source: Capital IQ, a division of Standard & Poor's.
Of these, I particularly like Annaly. I own it in my own portfolio, and I've added it to my public-facing portfolio here at The Motley Fool. The company has seen bad markets and has been operating since 1996, much longer than peers American Capital Agency (2008), Cypress Sharpridge (2009), Invesco (2008), and Hatteras (2007). Chimera was founded recently, but is run by the same folks as Annaly. And unlike some other players, Annaly buys only government-backed mortgage securities, so there should be little to no default risk in its portfolio.
While many justifiably question the staying power of Annaly's dividend, the stock has achieved an 18% increase in value (dividend-adjusted) since it's been public. That's a great return and reflects the savvy management at the helm.
But Annaly may not be for everybody. The stock will certainly get hurt when interest rates rise and the company has to cut the dividend. Investors will want to closely observe the Federal Reserve and see if interest rates might increase in the near future. While I see that as a remote possibility, since unemployment remains high and growth is stagnant, it's always a possibility. It will take years for unemployment to get down to reasonable levels. So I'm confident enough in this pick that I'll be adding real money as soon as the Fool's Rules permit.
Foolish bottom line
Annaly can make a great addition to your portfolio, but you should diversify that position with other yields that will grow year after year -- exactly the kind of stocks in our special free report "13 High-Yielding Stocks to Buy Today." Hundreds of thousands have requested access to this report, and today, I invite you to download it at no cost to you. To get instant access to the names of these high yielders, simply click here -- it's free.
Jim Royal, Ph.D., owns shares of national Grid and Annaly. The Motley Fool owns shares of Annaly and Chimera. Motley Fool newsletter services have recommended buying shares of National Grid. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.