When it comes to dividend stocks, there is often a trade-off between yield and safety. In many cases, the higher the yield, the less secure that payment tends to be, and vice-versa. Intuitively, this makes sense. If a company is only paying out 10% of its earnings in the form a dividend, a whole lot has to go wrong in order for that payment to be in jeopardy.
On the other end of the spectrum, if a high-yield stock is paying out 100% of its earnings as dividends, even a small hiccup in the business can put the dividend in danger of being reduced.
Occasionally, investors can find high dividend stocks that offer both high income today, and a strong underlying business model. The three stocks highlighted here have 5%+ yields along with sustainable payouts.
Safe High-Yielder #1: AT&T (T)
Telecommunications giant AT&T is perhaps the quintessential high-yield, dividend growth stock. The company has not only paid but increased its dividend for 35 consecutive years.
Now some may point out that the pace of dividend increases has not been particularly impressive. Indeed, dating back to 2008 AT&T has “only” increased its dividend by an average compound rate of 2.2% per annum. The $1.60 dividend payment in 2008 has grown by $0.04 annually to $2.04 in 2019.
However, there are three important counterpoints. For starters, each and every year you would still be receiving a higher income stream. It’s not spectacular growth, but it’s still way better than a frozen or reduced payment. Second, the well above average starting yield makes up for the slow growth rate. At the current quotation near $35, AT&T’s beginning dividend yield equals 5.8%. You don’t need much growth from that point to achieve a reasonable result.
Finally, the payout ratio is getting better over time. AT&T’s earnings-per-share growth rate has not grown exceptionally fast either – coming in at under 5% annually since 2008 – but this is still higher than the dividend growth rate. Back in 2012, AT&T’s dividend payment took up 78% of earnings. Today the dividend makes up about 57% of anticipated earnings. This “extra” breathing room allows for a safer dividend and additional funds that can be diverted towards paying down the company’s debt load.
The value proposition looks interesting as well. This year AT&T is expected to earn $3.60 or so per share. With a 2% growth rate, you might anticipate receiving $10.60 or so in dividend payments to go along with a future earnings-per-share number of ~$4.00 after five years. With a multiple of 12 times earnings – moderately below the company’s long-term average – that would imply the potential for a future price of ~$48. Add in the $10.60 in dividend payments and you come to ~$58.60 after half a decade in nominal terms. Against the current price of $35, this implies the potential for 10.9% annualized gains.
Naturally this does not have to work out – shares could trade at a higher or lower multiple and growth may never formulate. The point is that the 5%+ dividend yield, which happens to be becoming better covered over the years, leads the investment thesis.
Safe High-Yielder #2: Royal Dutch Shell (RDS.B)
Shell’s dividend history is not as impressive as AT&T’s, but it still offers a compelling income stream. Since 2015, the ADR dividend payment has been held steady at $0.94 per quarter or $3.76 annually. With a current share price near $57, this works out to a 6.6% starting yield.
This is an important factor that is not usually apparent in a stock chart. For instance, consider an investment in Shell back in July of 2015 when shares were trading around $57. Here we are today – now four years later – with shares still trading around $57. From a stock chart view, it might appear as though nothing happened – you’ve ended where you began. Yet from a total return perspective, you would have now collected sixteen $0.94 quarterly dividend payments for a total of $15.04. Your total return would have been over 26% or around 6% on an annualized basis. That’s not terrific – but it is a far cry from “nothing.”
Shell’s dividend coverage is much spottier as a result of oil price volatility and in turn, underlying earnings volatility. Back in 2011 the company was only paying out 39% of its earnings as cash dividends. In the commodity downturn of 2015 through 2017, the dividend easily exceeded earnings – yet the company kept the payment steady, leaning on the balance sheet. Today, the dividend payment makes up ~65% of anticipated earnings.
With something like Shell you’re not going to get the nice, reliable dividend increase year-after-year or even a payout under 100% every single year. Yet what the company can deliver is a well above average starting dividend yield that patiently delivers a solid income stream. To that point, during the company’s Management Day held in June, Shell indicated that it was fully committed to the current (and potentially growing dividend) to go along with $125 billion in shareholder distributions, including dividends and share repurchases, during the 2021 to 2025 timeframe.
Safe High-Yielder #3: Altria (MO)
A third example of a strong business with a 5%+ starting yield is Altria Group – the parent company of Philip Morris USA – operating in cigarettes (~90% of the business) and smokeless products.
The large caveat with Altria is the industry, cigarettes, with general observations being the negative health effects and the declining industry. Certainly this is not a company for everyone. Interestingly, despite the long-term decline in the industry, Altria has still proven to be a solid investment over the years.
The top line growth has not been particularly impressive. Back in 2009 revenue for Altria came in around $23.5 billion. This year the expectation is somewhere around $24 billion – representing a barely existent growth rate for a decade now. Yet this is only part of the story. What’s missed is the idea that Altria has been able to grow in other ways.
The net profit margin has jumped from 15.5% in 2009 to over 30% today. Moreover, the share count has been reduced by 10% or so as well. These two factors allowed negligible top line growth to turn into ~9% average annual compound earnings-per-share growth. In turn, the dividend has grown right alongside, posting its own ~9% growth rate and generating a substantial income stream for investors along the way.
Altria is currently paying an $0.80 quarterly dividend, or $3.20 annually, which could be increased in the short-term. Against a share price of $46 this works out to a starting yield of nearly 7%. Now risks remain – most notably the continued decline in the industry and the idea that this payout consumes around 75% of anticipated profits. Yet if history is any guide, Altria has additional levers to grow aside from top line results alone.
In short, the three companies above offer starting dividend yields in excess of 5% with strong underlying business models to boot. This does not mean that the securities must perform well in the future. However, there is a precedent for the strong income streams leading the way for reasonable or better returns. If you’re looking for an above average income stream – and particularly if you don’t want to be forced to sell shares in the future – these securities offer a nice starting list for that endeavor.
This article was authored by Bob Ciura. Bob is Senior Vice President of Sure Dividend LLC. He is responsible for all content on Sure Dividend and its partner sites. He has a Bachelor’s degree in Finance from the University of DePaul, and an MBA from the University of Notre Dame.