Dividend stocks have been shown to be one of the surest ways to generate wealth over time, while also creating a recurring income stream. Investors seeking to achieve this goal, however, may end up chasing stocks with higher yields, which can sometimes be a mistake. A larger payout can be caused by a plummeting stock price, which could reveal difficulties in the underlying business. This can lead to a company cutting or suspending unsustainable payouts.
That doesn't mean that all high-yield stocks are risky. With that in mind, we asked three Motley Fool investors to choose top companies with high payouts that still offer a measure of safety. They offered up convincing arguments for Ford Motor Company (F -2.16%), Energy Transfer Partners, L.P. (ETP), and National Retail Properties, Inc. (NNN -0.44%).
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Safer than it looks
Daniel Miller (Ford Motor Company): When investors see a dividend yield approaching 6%, it often sends a red flag. A common reason for such a high dividend yield is that the stock price has been pummeled by Wall Street pessimism, which inflated the dividend yield. That's true for Ford Motor Company, which sports a 5.6% dividend yield thanks to its slowing sales in North America and China, coupled with increasing investments for autonomous and electrified vehicles.
Those headwinds are certainly real and part of the reason CEO Jim Hackett took over in 2017. But what investors need to better understand is that while many higher dividend yields are risky, Ford has always planned for its dividend to be sustainable so management wouldn't have to cut the dividend, even during down cycles.
Image source: Ford.
One major factor that makes Ford's dividend sustainable is its decision to pay an annual supplemental dividend rather than a permanent dividend raise. In 2015 Ford, paid a one-time supplemental dividend of $0.25 per share -- for context, Ford's current annual dividend is $0.60 -- followed by a $0.05 and $0.13 payout in 2016 and 2017, respectively. Those supplemental payments will depend on the profitability of Ford in the given year, enabling management to reward shareholders during the good times and save cash during the bad.
As my colleague John Rosevear points out, today's Ford is in a much better position to sail through a deep recession and still pay the dividend. And while Ford's near 6% dividend yield looks risky -- and sounds risky considering the industry cycle is peaking -- management has always planned for this dividend to stay where it is. Right now, that makes Ford's 5.6% dividend yield worth buying as an income play.
A risk worth taking
John Bromels (Energy Transfer Partners) If high yields are indicators of high risk, then Energy Transfer Partners' 12.4% yield ought to be an indicator of astronomical risk! But for this energy infrastructure MLP, the risk appears substantially lower than it did a few months ago, which may make this the time to buy in before the market catches on.
Energy Transfer Partners, which operates more than 71,000 miles of pipelines across the U.S. -- including the controversial Dakota Access Pipeline -- has a well-established yield and a history of increasing it regularly. In fact, the company has never cut its quarterly distribution, increasing it instead almost every quarter since the company went public in 2002. That's one heck of a record of commitment to increasing value for unitholders.
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The market, though, has been concerned about the partnership's balance sheet, which is is awash in debt, and its distribution coverage, which was very thin for much of last year. However, in its most recent Q4 2017 earnings report, the company posted a distribution coverage ratio of 1.3 times, which is a very comfortable margin.
The company also has taken some concrete steps to pay down more expensive debt through asset sales and take on less expensive debt in return, which has cleaned up its balance sheet somewhat -- so the risks seem much more remote. Even if the worst happened and the company's yield were, say, halved, Energy Transfer Partners would still yield more than many of its peers.
Investors should be aware that there are some additional tax reporting requirements for MLP unitholders, which can make them a poor choice for some portfolios. But if that doesn't bother you, you'd be hard-pressed to find this high a yield for this moderate a risk.
High-yield without the risk
Danny Vena (National Retail Properties): The changing landscape brought on by the advent of e-commerce has made investors leery of brick-and-mortar retail, and sent them fleeing from anything having to do with shopping malls. This has resulted in plunging stock prices for a number of real estate investment trusts (REIT) involved in the space. Companies with this special tax structure are required to pay out 90% of the income in the form of dividends.
Investors have been known, however, to "throw out the baby with the bathwater," and National Retail Properties is a classic case of that. The company has seen its stock price plunge over e-commerce fears, falling nearly 28% from highs reached in mid-2016. These concerns are unfounded and belie the actual nature of the company's business.
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National Retail Properties has a diverse group of retail locations that aren't likely candidates for disruption by e-commerce. The properties in its portfolio include gas stations, convenience stores, restaurants, automotive service locations, fitness centers, car washes, and movie theaters. These businesses can't be replicated with online purchases, making them largely immune to the effects that are being experienced by many retailers.
The company invests in single-tenant retail buildings -- not malls -- that have automatic rent increases built into the contracts, which typically run between 15 and 20 years. Tenants are also required to pay the recurring costs of property ownership, like taxes, utilities, and insurance.
A diverse portfolio of 2,764 properties in 48 states helps diversify any risk, and the company has an occupancy rate of 99.1%, and hasn't fallen below 96.4% since 2003.
National Retail Properties boasts a current yield of 4.9%, nearly three times that of the S&P 500. The company also is a Dividend Aristocrat, having increased its payout for 28 years running.
The combination of high-yield, built-in income increases and a long history of payouts make this company the perfect high-yield stock.
