The past 15 months have been an unpleasant reminder that stocks can, indeed, move lower. All three major U.S. stock indexes were mired in a bear market last year, with growth stocks getting hit hardest.
But when stock market volatility and uncertainty pick up, buying dividend stocks is a smart strategy investors can turn to. Companies that regularly pay a dividend are often profitable on a recurring basis, have transparent long-term growth outlooks, and have previously demonstrated to investors their ability to navigate choppy waters.
Furthermore, income stocks have substantially outperformed companies that don’t offer a dividend over long periods. A study from J.P. Morgan Asset Management, a division of banking behemoth JPMorgan Chase, found that companies initiating and growing their payouts between 1972 and 2012 produced an annualized return of 9.5%. The annualized return for the nondividend payers over the same time frame was a mere 1.6%.
However, not all dividend stocks are created equal. While most dividend stocks have the potential to deliver for their shareholders, others can be trouble.
What follows are two high-yield dividend stocks you can confidently buy hand over fist, as well as one high-yield income stock you should actively avoid.
High-yield dividend stock No. 1 to buy hand over fist: US Bancorp (5.4% yield)
The first high-yield income stock you can gobble up right now and feel confident doing so is regional bank US Bancorp (USB). US Bancorp is the parent of the more-familiar US Bank.
The tumult that’s hit the banking industry over the past couple of weeks has been unavoidable if you’re an investor who follows the day’s top events. Untimely bets on long-maturing Treasury bonds led to the seizure of SVB Financial and Signature Bank by regulators, and created plenty of indigestion for shareholders of First Republic Bank and other regional banks.
US Bancorp has not been spared from the proverbial wall of worry. But among regional banks, an argument can be made that US Bancorp is on the firmest ground of the bunch. While the potential for a U.S. recession wouldn’t be great news for cyclical bank stocks, this is a company with clear-cut advantages that’s currently an absolute bargain.
Given the current sentiment surrounding regional banks, one of the most important things to know about US Bancorp is that its tangible common equity is more than enough to cover any unrealized losses attributed to investment securities available for sale. In other words, the fifth-largest bank in the U.S. by assets has more than enough capital to cover any mark-to-market losses. That’s in stark contrast to what sacked SVB and Signature Bank.
Something else to consider is that, for the first time in history, the Federal Reserve is aggressively raising interest rates into a tumbling market. The nation’s central bank doesn’t have much of a choice, with historically high inflation representing its top concern. While higher interest rates tend to slow lending and economic growth, it’s a boon for lending institutions that have variable-rate outstanding loans. Even if loan losses were to rise, the increase in net-interest income from sustainably higher interest rates should lift US Bancorp’s earnings per share.
However, the most-defining characteristic of US Bancorp is its digitization push. More than 4 out of 5 active customers were banking online or via mobile app at the end of August 2022. What’s more, 62% of loan sales were being completed digitally, 17 percentage points higher than when 2020 began. It’s considerably cheaper for banks when customers bank digitally as opposed to in-person.
With its historically above-average return on assets as a tailwind, US Bancorp looks like a steal at less than 7 times forward-year earnings and with a yield of better than 5%.
High-yield dividend stock No. 2 to buy hand over fist: AvalonBay Communities (4.2% yield)
The second high-yield income stock you can buy with confidence is residential real estate investment trust (REIT) AvalonBay Communities (AVB). Residential REITs purchase/own apartment communities, which they lease. AvalonBay owned 294 apartment communities that contained nearly 88,500 apartments as of the end of 2022.
Perhaps the biggest knock against residential REITs is the growing likelihood of a U.S. recession. REITs tend to ebb and flow with the U.S. economy, which means a weakening economic outlook has the potential to increase rental delinquencies or vacancies.
Additionally, borrowing costs have risen as the Fed battles inflation. AvalonBay has often leaned on cheap capital to scoop up properties at an advantageous price. Chances are that acquisition activity could be stymied in the short run, given the Fed’s hawkish monetary stance.
While these headwinds might sound worrisome, they should be of little concern to patient investors. One differentiating factor for AvalonBay is that it tends to cater to renters with higher incomes. Individuals and couples with more disposable income are less likely to be delinquent on their rent, or be fazed by minor hiccups in the U.S. economy. While this doesn’t mean AvalonBay is immune to economic downturns, I’d argue it can navigate them better than most residential REITs.
The proof is in the pudding that AvalonBay isn’t having any issue increasing rents on its existing tenants. Economic occupancy was above 96%, as of February 2023, with lease renewal offers for March and April 2023 coming in at an average of 7% above their current lease rate.
Another factor working in AvalonBay’s favor is rising interest rates. Though higher rates have removed the company’s access to cheap capital, it’s also made the option of purchasing homes more expensive. This makes it likelier that existing renters will stick around longer, rather than purchase a home.
Lastly, AvalonBay Communities has done a solid job of reining in costs during a period of economic uncertainty. Digitization and automation efforts, which modestly reduced on-site maintenance and office head count, were instrumental in lifting net operating income by $11 million last year.
The high-yield dividend stock to avoid like the plague: Kraft Heinz (4.2% yield)
On the other end of the spectrum is a high-yield dividend stock that, at first glance, might appear perfect for the current environment but is in reality nothing but trouble. I’m talking about consumer staples giant Kraft Heinz (KHC).
The reason consumer staples stocks are so popular during periods of uncertainty is the general predictability of their cash flow. While consumers may skip certain discretionary purchases, they still need food, beverages, detergent, toilet paper, and a host of other goods and services in any economic environment. As a provider of prepackaged meals, snacks, and condiments, Kraft Heinz fits the mold of a “safe stock” more often than not.
To add, Kraft Heinz owns around two dozen brand-name food and condiment brands, including Oscar Mayer, Philadelphia, Kool-Aid, Jell-O, and Velveeta (along with the obvious, Kraft and Heinz). Kraft Heinz has been able to use its pricing power with these brands to outpace historically high inflation since the beginning of 2022.
But it’s not all peaches and cream, as evidenced by Kraft Heinz’s inclusion on this list as the high-yield stock to avoid like the plague.
Whereas most businesses were thrown for a loop by the COVID-19 pandemic, Kraft Heinz actually benefited from people staying home. The company’s easy-to-make meals and grab-and-go snacks and condiments thrived. However, with the worst of the pandemic over and most people returning to some semblance of normal, it’s unlikely the company’s pandemic bump in organic growth will be sustainable.
We’re already beginning to see evidence that demand for Kraft Heinz’s products is weakening. In the quarter ended Dec. 31, 2022, the company delivered a 10.4% year-over-year growth rate. However, this was accomplished by raising prices 15.2%.
In short, it means volume/mix was actually down 4.8% globally during the fourth quarter. This suggests people are already trading down to less-costly prepackaged foods or foregoing the company’s products altogether.
The other concern for Kraft Heinz is its relatively inflexible balance sheet. The company closed out 2022 with $30.8 billion in goodwill, $42.6 billion in intangible assets, and $19.2 billion in long-term debt, compared to just $1 billion in cash and cash equivalents. Even though it’s generating a healthy amount of cash flow and isn’t having any trouble servicing its debt, there’s simply not enough capital to further its turnaround efforts.
Despite Kraft Heinz being valued at a seemingly reasonable 13 times Wall Street’s consensus earnings for 2024, a complete lack of sales growth and an unfavorable balance sheet make this a high-yield stock to pass on.
— Sean Williams
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Source: The Motley Fool