In today's era of low interest rates, investors looking for income from their portfolios are turning to stocks and their dividends as a way to generate cash without being forced to sell their shares. As tempting as that might be, high-yield investing brings with it its own series of problems.
Among these is the reality behind the simple saying that if something seems too good to be true, it probably is. High yields are often the signs of dividend traps -- companies whose dividends are likely to be cut.
Finding stocks with decent yields that have a reasonable chance of continuing to pay or even increase their dividends requires you to look deeper than simply at the company's yield. You have to understand what provides a reason to believe that dividend can continue. Even then, there are no guarantees, but these three stocks have dividends yielding more than 5% and still look like they're worth considering.
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1. The pipeline giant with a cleaned-up balance sheet
Energy pipeline giant Kinder Morgan (KMI -0.11%) got into hot water with the bond rating agencies in late 2015 when it overleveraged itself to rescue the Natural Gas Pipeline Company of America. A threatened downgrade into junk bond status forced Kinder Morgan to slash its dividend and take substantial actions to clean up its balance sheet.
That stronger balance sheet, on top of still-solid operations and cash flows, allowed it to resume increasing its dividend. In fact, even during the worst of the COVID-19 pandemic so far, around the time oil was flirting with prices below $0, Kinder Morgan was able to increase its dividend by 5%. For a company that relies on moving energy around, being able to boost its payment even as its world appeared to be falling apart is a sign of just how much stronger it is today than it was in 2015.
At recent prices, Kinder Morgan offers investors a yield of around 6.9%. Even with that dividend boost and after accounting for changes driven by COVID-19, it expects its dividend payment to be well covered by its operational cash flows throughout the year. This is largely because people and businesses are still using oil and natural gas.
Although energy use is down overall due to the pandemic, pipelines are generally a lower-cost way to move energy around, helping buffer it from the worst of the slowdowns. That gives reason to believe Kinder Morgan will have a great shot at sustaining (and eventually resume increasing) its dividend.
2. A media and telecom titan
AT&T (T -1.21%) may be best known for Plain Ol' Telephone Service, but the modern version of the company goes well beyond copper wire and ringing bell tones. It offers cellphone service, internet service, satellite and streaming television service, and is a content provider through its ownership of Time Warner. In today's era of physical separation and digital connectedness, its communications and entertainment infrastructure is an incredibly important part of keeping people together (and sane).
AT&T offers a yield of around 6.8%, and although that dividend does consume more than 100% of the company's trailing income, the payout is well covered by the company's operating cash flows. AT&T's dividend currently sits at $0.52 per share per quarter, up slightly from last year's level of $0.51.
That combination of slow dividend growth and a high payout ratio is a sign of a mature company that isn't looking to set the world on fire with its growth. Still, with today's low interest rates, investors looking for current income could do worse than receiving that 6.8% cash payment with its potential for some growth.
3. An insurance company with a "rock solid" foundation
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Prudential Financial (PRU 0.78%) cares so much about having a solid foundation that is uses the Rock of Gibraltar as its corporate logo. Prudential's solid foundation is provided by a balance sheet with around $61 billion in equity on it, supported by over $390 billion in bonds.
Like most insurance companies, Prudential makes its money from pricing risk. If it can fairly price its risk, its inflows from premiums should at least balance out its outflows from policy claims. If it can't fairly price its risk, well, that's what the equity on its balance sheet is there for: to provide funding to cover the costs it didn't expect.
In a world with COVID-19, there is heightened uncertainty to be sure, but Prudential's balance sheet should allow it to survive long enough to understand the new risks. With that understanding, it can adjust its premiums for future policies based on what the new risk profile really looks like. That means that even if there is temporary dislocation due to COVID-19, over time, the company will likely wind up OK.
In the meantime, its shares have dropped substantially so far this year due to the near-term risks it faces. That share price drop has given investors the opportunity to buy its stock with around a 7.4% yield. Despite that high yield, the dividend only represents about 60% of the company's trailing earnings, and analysts expect the dividend to be well covered by Prudential's earnings this year and next.
