When looking for income stocks, there is certainly no shortage of choices. And there are several types of income stocks investors have to choose from. Some stocks don't pay high dividends, but the companies are rock-solid, predictable, and have long histories of raising their dividend every year. Others emphasize creating high levels of current income, and the elevated risk may justify the reward potential in many cases. With that in mind, here are three of our contributing writers' favorite income stocks to help you get started.
Dan Caplinger : The real estate investment trust arena has become increasingly popular over the past 15 years, as investors have looked beyond traditional dividend stocks in their search for higher yields. So-called mortgage REITs like Two Harbors Investment (NYSE:TWO), which typically own mortgage-backed securities and related investments, have produced amazing dividend yields for shareholders, and when interest rates are favorable, they can do so while giving investors potential for capital gains as well.
One concern that many have about mortgage REITs now is that if interest rates rise, the favorable trends that have supported high yields could disappear. Yet Two Harbors stands out from many of its peers because of the strategic moves it has made to protect itself against rising rates. On one hand, investing in non-agency mortgage-backed securities allows Two Harbors to use lower levels of leverage in its business model, which in turn reduces its exposure to higher rates. At the same time, Two Harbors also uses instruments like excess mortgage-servicing rights that can perform better in a rising-rate environment to act as a hedge.
Overall, Two Harbors isn't entirely invulnerable to the potential for Federal Reserve rate moves once they start coming. Yet with a 10% yield, the risk is worth contemplating in relation to the potential rewards of owning the stock.
All stocks come with some degree of risk, and Alliance Resource is no different. Weakness in coal demand and pricing is set to disrupt a more than decade-long streak of adjusted EPS growth for Alliance Resource Partners. Additionally, tougher environmental regulations have made coal's outlook, at least in the near term, less than rosy.
But Alliance Resource Partners has a few tricks up its sleeve that its peers don't. To begin with, it has limited exposure to highly volatile wholesale coal price movements. The majority of Alliance Resource's coal is contracted many years out at a fixed price, leading to guaranteed and predictable cash flow. The company also tends to focus on selling to domestic utilities that plan to continue relying on coal rather than switching over the natural gas. It means less of a worry for investors in terms of being blindsided by a sudden reduction in coal demand.
Another key point is that Alliance Resource Partners' balance sheet and cost structure are worlds better than its peers'. Alliance Resources production costs are typically lower than its peers', and its slightly more than $800 million in net debt compares very favorably to the $2 billion-$5 billion in net debt that some of its peers are coping with. As bankruptcies and asset sales shake up the coal sector, Alliance Resources may be able to pick up additional market share within the industry.
Lastly, the company recently announced its 29th consecutive quarterly dividend increase. Currently yielding 11.4% and sporting a forward P/E of just 7, I believe this is an income stock that dreams are made of.
Digital Realty owns 130 properties and operates in North America, Europe, Asia, and Australia, giving it a geographically diverse revenue stream. It also is actively expanding through both development and acquisitions, with 1.2 million square feet of rentable space in active development. The potential for future expansion is huge, with data storage needs growing rapidly, and Digital Realty's size and financial strength give it a competitive edge to take advantage of any opportunities that come up.
For example, Digital Realty recently agreed to acquire data center operator Telx, which has lots of opportunity to unlock value. According to Digital Realty, 15 of Telx's 20 data centers have occupancy rates of less than 80%. If it can meet this target, it would add an extra $65 million in earnings per year, which shouldn't be too hard given that Digital Realty's overall portfolio occupancy is well above 90%.
This is just one example of Digital Realty's opportunities, and should help the company keep up its record of market-beating performance. It currently pays 5.3% annually, and has increased its payout at an average rate of 14% per year over the past decade. So, while it may not pay quite as much as the other stocks mentioned here, it does have a history of some pretty nice raises. The stock performance is even more impressive, with average total returns approaching 19%, a remarkable performance to sustain for such a long period.
As long as companies need innovative data storage solutions, there will be no shortage of opportunities for Digital Realty's strong performance to continue, which could produce excellent results for income investors.
Dan Caplinger, Matthew Frankel, and Sean Williams have no position in any stocks mentioned. The Motley Fool recommends Alliance Resource Partners. 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.