Investing in 2022 has been an adventure. All three major U.S. stock indexes have plunged into a bear market, and the bond market is suffering through its worst year on record. There simply haven’t been many safe-havens for investors to avoid the short-term carnage.
But when the stock market plummets, opportunity presents itself for patient investors. That’s especially true when it comes to dividend stocks.
Dividend stocks can offer golden opportunities during market pullbacks
Publicly traded companies that pay a regular dividend are often profitable on a recurring basis, have clear long-term growth outlooks, and have navigated their way through previous economic/market downturns. In other words, they’re just the type of companies you’d want to own during periods of heightened volatility and uncertainty.
What’s more, income stocks have a long history of handily outperforming companies that don’t offer a dividend. Back in 2013, J.P. Morgan Asset Management released a study that compared the average annual return of publicly traded companies that initiated and grew their payouts between 1972 and 2012 to publicly traded companies that didn’t pay a dividend over the same time frame. As expected, the dividend stocks creamed their opposition, with an annualized return of 9.5% versus 1.6% over four decades.
However, not all dividend stocks are created equal. In an ideal world, investors would receive high yields with minimal risk. But the world isn’t ideal.
Studies have shown that risk and yield tend to go hand in hand when payouts top 4%. Since yields are a function of paid dividends to share price, a struggling business with a plunging share price could lure unsuspecting income investors into a “yield trap.”
Thankfully, not all high-yield stocks are bad news. The following three “ultra-high-yield dividend stocks” — a term I’m using to describe stocks with yields of 7% or above — have all been vetted and are begging to be bought in November.
Verizon Communications: 7% yield
The first passive-income powerhouse that’s ripe for the picking in November is telecom stock Verizon Communications (VZ). With the exception of a few weeks during 2010, Verizon’s yield has never been this high.
It’s important to recognize that the catalyst behind Verizon’s soaring yield is its terrible share-price performance. Since hitting an all-time closing high in late 2019, Verizon stock is off 40%. That’s a huge move for a company that’s been historically far less volatile than the S&P 500.
The reason Verizon has been so downtrodden in 2022 can be traced to Federal Reserve monetary policy. Interest rates are rising rapidly, which isn’t great news for a company that leans on debt to pay for costly infrastructure projects and acquisitions. However, the concern surrounding this headwind has likely been overstated.
The standout catalyst for Verizon continues to be the ongoing move to 5G. Following a decade where no significant progress was made to wireless download speeds, the rollout of 5G wireless services over the next couple of years should encourage businesses and consumers to upgrade their devices and increase their data consumption. Verizon’s wireless segment generates its best margins from data, so this is a needle-moving development.
To add to this point, Verizon aggressively deployed capital in 2021 to acquire 5G mid-band spectrum. The goal of its purchase is to expand 5G broadband services to 14 million businesses and 50 million U.S. households by the end of 2025. Even though broadband isn’t exactly a fast-growing trend anymore, the bundling potential with Verizon’s other services can boost margins.
Valued at just over 7 times Wall Street’s forecast earnings for 2022 and 2023, Verizon is cheap and begging to be bought.
Alliance Resource Partners: 8.1% yield
A second ultra-high-yield dividend stock that’s begging to be bought in November is coal producer Alliance Resource Partners (ARLP). Yes, I really said “coal producer,” and no, its 8.1% yield is no joke.
Like most energy companies, Alliance Resource Partners was hammered by the initial stages of the COVID-19 pandemic. Lockdowns led to energy commodity prices tumbling across the board. Even Alliance Resource had to halt its dividend payment for a short period to conserve capital during this heightened uncertainty. But what a difference two years makes!
Due to a number of factors, such as Russia’s invasion of Ukraine and reduced capital investment by global energy majors during the pandemic, the global supply of energy commodities can’t be quickly ramped up. The end result is across-the-board energy commodity inflation that should be sustained for years. In Alliance Resource Partners’ case, the coal sales price it received per ton sold jumped 40.5% in the September-ended quarter from the previous year.
But higher coal prices are just one reason this company can outperform. What’s made it such a success among income investors is management’s forward-looking approach.
Alliance Resource is constantly locking in volume and price commitments multiple years in advance. It’s fully booked its forecast production in 2022 and has 32.9 million tons and 22.8 million tons, respectively, committed and priced in 2023 and 2024. For context, it’ll likely produce close to 38 million tons in 2023. Having this production locked in so far in advance secures operating cash flow and leads to few surprises.
In addition to coal production, Alliance Resource Partners generates oil and natural gas royalties. Without getting too far into the weeds, higher crude oil and natural gas prices should lead to higher royalties — plain and simple. With the global energy complex challenged, these energy commodities should sustain above-average spot prices.
Coal stocks may not be the best buy-and-hold opportunity over the next 20 years, but Alliance Resource Partners, which has a forward price-to-earnings ratio of just 4, has the potential to make its shareholders notably richer over the next five years.
Enterprise Products Partners: 7.6% yield
The third ultra-high-yield dividend stock begging to be bought hand over first in November is oil and gas stock Enterprise Products Partners (EPD). Enterprise has raised its base annual distribution for 24 consecutive years and is currently doling out an inflation-fighting 7.6% yield.
For many income investors, the drubbing that oil stocks took in 2020 is still fresh on their minds. The demand collapse of fossil fuels during pandemic lockdowns briefly sent West Texas Intermediate crude-oil futures into the negative. Although drilling and exploration companies tend to ebb and flow with the spot price of energy commodities, Enterprise Products Partners avoids a lot of this volatility.
The company’s not-so-subtle “secret” is that it’s a midstream provider. In layman’s terms, it’s an energy middleman tasked with getting crude oil and natural gas from the fields to refineries. Enterprise operates over 50,000 miles of transmission pipeline, can store 14 billion cubic feet of natural gas, and has two dozen natural gas processing facilities.
The best thing about midstream oil and gas companies is that they almost exclusively work with fixed-fee or volume-based contracts. The structure of these contracts removes inflation and spot-price volatility from the equation. As with Alliance Resource Partners, Enterprise is able to accurately forecast how much cash flow it’ll generate in a given year. That comes in handy when setting aside capital for infrastructure projects and acquisitions.
Something else that demonstrates the safety of Enterprise Products Partners’ operating model is its distribution-coverage ratio (DCR). The DCR measures how much distributable cash flow was generated from operations, relative to what was paid to shareholders. A figure of 1 or lower would signify an unsustainable payout. At no point during the worst of the pandemic did its DCR fall below 1.6.
Enterprise Products Partners should be a prime beneficiary of broken energy supply chains. Higher-than-normal energy commodity prices are expected to entice domestic drillers to up their production in the coming years. That should lead to even more long-term fixed-fee contract opportunities for the company.
At less than 10 times Wall Street’s forecast earnings for 2023, Enterprise Products Partners looks like a steal.
— Sean Williams
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Source: The Motley Fool