High-yield dividend stocks are a beautiful thing, especially if you invest for income. After all, dividends are money. And money is one of those things where more is better, asserts Tom Hutchinson, income expert and editor of Cabot Dividend Investor.
On the surface it may appear that the bigger the dividend, and higher the yield, the better. But that is rarely true. More often than not, a very high yield is a red flag.
The first thing that needs to be considered regarding a high dividend, or any dividend for that matter, is whether it is safe and sustainable. Often times, a yield becomes high because the stock price has fallen considerably. A stock price usually falls because of poor operational performance, which imperils its ability to sustain the dividend.
Consider a few relevant factoids about the history of dividend stocks. From 1972 through 2018, the S&P 500 provided an average annual return of 7.3%. But a deeper look inside the numbers tells a different story. Dividend-paying stocks on the index averaged about 9% per year while stocks that didn’t pay dividends average just 2.4% per year.
Further dissecting those dividend payers paints an even clearer picture. While dividend-paying stocks in general averaged 8.78%, stocks that cut or eliminated their dividend averaged a negative return over the period, even less than stocks paying no dividend.
History is pretty clear on this one: Don’t own a stock that cuts the dividend. At the same time, stocks that grew the dividend averaged nearly a 10% per year return over the same period. That makes a big difference over time.
The point is that it is generally not wise to be allured by a 8%, 9% or 10% yield on a stock that will have difficulty maintaining the dividend and is less likely to grow it.
Over time, you should fare much better with a more modest high yield on a company that can sustain the payout and likely grow it over time. I found two such high-yield dividend stocks.
Enterprise Product Partners (EPD) — yielding 6.27%
This is one of the largest energy infrastructure companies in the U.S. with a vast portfolio of pipeline and storage assets connected to the heart of American energy production.
It has over $36 billion in annual revenues from an unparalleled reach in an industry that is connected to every major U.S. shale basin and 90% of American refiners east of the Rockies, and offers export facilities as well in the Gulf of Mexico.
Since the stock’s initial public offering in 1998, it has averaged more than a 15% annual return. The company has a stellar balance sheet with investment grade ratings and a monster 6.27% current dividend yield well supported with one of the lowest payout ratios of all its peers. Enterprise has also grown the dividend in each of the last 20 years.
And the future looks very bright. The American oil and gas industry is booming like never before in our history. The U.S. is now the world’s largest producer of both oil and natural gas. Yet there is still insufficient infrastructure to accommodate the dramatically increased flow. That’s a growth opportunity for EPD.
Over the last several years this master limited partnership (MLP) has spent heavily on expansions that are now coming on line. It has another $3.5 billion in new assets going into service of the rest of this year and plenty more in the years ahead.
The stock is still cheap, as energy stocks have not yet recovered from the oil price crash between 2014 and 2016. But things are turning around and this stock should perform well going forward.
Brookfield Infrastructure Partners (BIP) — yielding 4.87%
The world’s infrastructure is insufficient and falling apart. How bad is it? The American Society of Civil Engineers just gave the state of our infrastructure a grade of D+.
And the rest of the world is even worse. Developed countries all over the world have aging systems in desperate need of replacement. In emerging markets, systems are often woefully insufficient to accommodate growing urban populations and more advanced economies.
Bermuda-based Brookfield Infrastructure Partners has been successfully investing in infrastructure assets all over the world for 10 years. It was early to a party that is now growing by leaps and bounds. It owns some of the most defensive, income-generating assets in the world that are near monopolies in their area. It’s worked.
Since its 2008 IPO the stock has averaged over 16% in total annual returns (with dividends reinvested). The stock has a very low payout ratio among its MLP peers and has grown the payout at an average 10.4% per year for the last five years.
Despite the terrific historical performance the stock is still reasonably price because it had a rare bad year in 2018, down almost 20%. The reason it was down is because Brookfield shifted its strategy to accommodate the rush of opportunities coming into the space. They sold lower performing assets to buy higher-margin ones.
In the interim profits fell and the market didn’t like that. But now the newly purchased higher-margin assets are starting to come on line and should boost profits.
BIP seems to be regaining favor with the market as it’s up over 27% so far this year, with room to run as it’s still below the 2017 high. For those reasons, it’s one of my two favorite high-yield dividend stocks.
