High Dividend Stocks-2020-02-20

When referring to high dividend stocks, investors generally imply equities with above-average dividend yields.

As the dividend yield is a key metric used to determine the level of dividend distributions, astute investors — especially those seeking significant income payouts  — always look for high dividend stocks. However, high dividend stocks could be deceptive and result in significant losses if not also supported by capital gains, which can override dividend payouts easily and deliver overall losses.

High dividend stocks are fairly simple and easy to find. Most financial advice websites and stock brokerages offer tools to analyze and easily identify high dividend stocks, such as the Dividend Screener available at DividendInvestor.com. However, investors must consider more than merely high dividend yields to make sure that they invest in equities with best prospects for long-term total returns. Therefore, before rushing and loading any individual portfolio with high dividend stocks based purely on the dividend yield, investors must understand the metric, its relation to the share price and overall total return in invested funds.

Dividend Yield

Income-seeking investors generally use the dividend yield as the initial and most commonly used measurement to evaluate the level of potential dividend income offered by prospective investment equities.

The formula to calculate the dividend yield is quite simple. The calculation is a simple ratio of any stock’s cumulative total of all annual dividend payouts and the equity’s current share price. This ratio is generally multiplied by 100 to express the dividend yield as a percentage.

However, while the dividend yield is easy to calculate from readily available information, investors must use the correct parameters and accurately interpret the results. The simplicity of the calculation offers investors basic information on the amount of earnings distributed to shareholders quickly. However, that same simplicity represents only one facet of the equity’s overall performance, which can be misleading on its own. Therefore, investors must use the dividend yield along with other financial metrics and indicators to select the best investment vehicles for their portfolios.

The largest concern regarding the dividend yield is its inverse relationship with the equity’s share price. Because of this inverse relationship, a dividend yield rises as the share price deteriorates. Therefore, fast rising dividend yields, which might seem like a positive indicator, can be mere consequences of a substantial share price decline.

For instance, over the past 12 months, the Kohl’s Corporation (NYSE:KSS) has increased its dividend yield 60% to 6.2%, which is more than three times the average yield of the overall market. However, the company advanced its annual dividend distribution amount only 9.8% over the same one-year period. The reason for the 60%-plus yield increase is primarily a 30% share price decline over the trailing 12 months.

Further Considerations

Therefore, while identifying high dividend stocks is a priority, investors must also consider other aspects to ensure that the high yields are truly positive indications of an equity’s performance. Instead of analyzing multiple variables, a simple way to ensure a positive outlook is to consider the equity’s total return on investment over a particular time frame. The total return is also a relatively simple measure that combines the stock’s capital gains and dividend income payouts over a specific time and expresses that gain as a percentage increase over the share price from the onset of the particular time span.

Moreover, investors should make sure that the total return is at least slightly higher than the current dividend yield. A total return that is even fractionally above the dividend yield indicates that while most of the gains came from dividend income distributions, the share price did not decline, or the stock at least traded flat for the desired period. Understandably, a total return that is higher than the current yield, implies positive asset appreciation in addition to income payouts. A total gain that is twice the current dividend yield signals that one half of the total return over the particular period originated from dividend payouts, and the other half was from rising capital gains.

High Yields Do Not Translate Always into High Returns

A quick search with the Dividend Screener from DividendInvestor.com reveals several hundreds of high dividend stocks that offer yields in excess of 4%, which is twice the current market average of approximately 1.98%. The dividend yields in this group of equities go as high as 50% for GasLog Partners L.P. (NYSE:GLOP). However, GasLog Partners has a market capitalization of just $200 million. While the 50% dividend yield is certainly high and might be tempting to some investors, the company delivered a 70% total loss for the trailing year on the account of a 75% share price drop only since the beginning of 2020, and a decline of more than 80% since mid-February 2019.

To get information from more stable equities, investors should consider companies with market capitalizations of at least $1 billion. With a $2.13 billion market capitalization, the Antero Midstream Corporation (NYSE:AM) has the seventh highest yield among the high dividend stocks. However, even the 27.8% yield is irrelevant as Antero’s share price declined enough to offset all the dividend income payouts from the past year and deliver a total loss of more than 58%.

Despite topping the list of high dividend stocks, the top 10 equities with market capitalizations of $1 billion have delivered total losses of at least 33% in the trailing 12 months.

Dividend-Driven Gains

With the 11th highest yield, USA Compression Partners L.P. (NYSE:USAC) is the first equity on the list that delivered fractional gains for the trailing year. While USAC’s share price ended only slightly higher for the trailing year, dividend income of nearly 14% delivered more than 93% of the equity’s gains for the trailing 12 months. However, with a current dividend payout ratio of 3,500%, the company might not be able to maintain its dividend payouts much longer. Since dividend income accounted for nearly all of the company’s gains over the last year, suspension of dividend payouts would eliminate almost all returns and make the stock not desirable.

Currently, the equity that delivered significant total returns from a combination of dividend income payouts and asset appreciation — Vector Group Ltd. (NYSE:VGR) — has a dividend yield of slightly less than 12%. While less than half the Antero Midstream Corporation’s 27.8% yield, Vector Group’s dividend payouts accounted for more than a third of the company’s 34.8% total return over the trailing 12 months.

Additional Metrics

As already indicated, identifying only high dividend stocks is not sufficient to generate long-term total returns. In addition to high yields, investors must consider additional metrics, such as the dividend-payout-ratio and the share-price-trend, before making any investment decision. Furthermore, investors should analyze the magnitude of annual dividend hikes as well as streaks of consecutives dividend boosts. While offering yields that are lower than the top equities, companies with long streaks of dividend hikes tend to outperform equities without dividend distributions. A special group of S&P 500 stocks with at least 25 years of consecutive dividend hikes, dubbed Dividend Aristocrats, have outperformed their non-dividend counterparts in the index by nearly 11% just over the past decade. To offer long streaks of steadily rising dividend payouts, companies with extended records of rising dividends generally must reduce their yield to support long-term payout appreciation.

Types of High Dividend Stocks

Companies in some sectors of the economy tend to offer dividend distributions that are higher than market averages. Most companies in the Technology sector funnel their earnings back into research and development to achieve or maintain some technological edge over the competition. Therefore, only the largest, oldest and well-established Technology sector companies offer dividend income payouts to their shareholders. However, the 1.18% average dividend yield of the Technology sector is significantly below the market average.

Because of even higher costs to develop products other than the Technology sector, companies in the Health Care sector pay a dividend with an average yield of just 0.52%. Consumer Goods and Services sectors offer average dividend yields of approximately 2%. However, the current 3.03% average yield of the overall Utilities sector is 50% higher than the market’s average. Companies in the Basic Materials sector offer an average yield of nearly 4%. The Financials sector offers the highest yields – currently at 4.13%.

Types of business entities included in the Financial sector are one of the main reasons for high dividend yields. Created in the 1980s, to promote investing in industries with high capital requirements like the Energy sector, Master Limited Partnerships (MLPs) enjoy certain tax benefit that directly relates to the high dividend yields. Contingent on distributing at least 90% of the annual earnings to the limited partners, MLPs do not have to pay any corporate taxes. Passing through most or all of their earnings results in high dividend yields.

Another type of business entity with the same tax benefit as MLPs is a Real Estate Investment Trust (REIT). While dividend yields range from 3.36% for Office REITs to 6.2% for Hotel & Motel REITs, the segment’s overall average exceeds 5%.

More High-Yield Equity Types

In addition to MLPs and REITs, Business Development Companies (BDCs) are also pass-through entities with no corporate tax liability following a distribution of at least 90% of total earnings as dividends. BDCs generally raise funds from individual and institutional investors to offer financing and loans for mid-sized and small companies. Because of their small size and generally higher risk exposure, large banking institutions do not offer the necessary financing. However, these companies still need expansion and short-term operational financing, which is exactly what BDCs provide.

The equity type that offers highest dividend yields are Closed-End Funds. With assets and underlying holdings actively managed by the fund’s portfolio manager, closed-end funds are intricate types of mutual fund whose shares trade on an exchange. With different types of closed-end funds yielding between 4.9% (foreign-investments-funds) and 8.4% (domestic-equity-funds), the average dividend yield for this group of investments is more than 6%.

Summary

High dividend stocks are certainly the best way to generate substantial income distributions sought by income investors. Invariably, a high dividend yield indicates high distributions of earnings in relation to the equity’s share price. However, therein lies its first and biggest conundrum. A sudden drop or a steadily declining share price will give the false impression of a high or rising dividend yield. The high yield will deliver substantial income payments. However, the asset depreciation will generally more than offset all dividend distributions to deliver total losses. Therefore, investors must consider additional equity metrics beyond a mere dividend yield. Some of the additional considerations are the total return on an investment over a specific period, dividend payout ratio and a long and steady track of annual dividend hikes.

Like with most investments, the greater the returns from higher yields also come with increased risk. Additionally, some of the equities achieve their elevated yield rates by higher leverage. While effective under  normal circumstances and market conditions, highly leveraged equities can collapse under even the slightest downturns. Under downward pressure from general market corrections or individual stock instability, high yield equities can be forced to cut, suspend or even outright cancel their dividend distributions.

Therefore, while potentially beneficial for delivering strong dividend income, high dividend stocks require more frequent monitoring and attention than lower-yield equities with long streaks of steadily rising dividend payouts and moderate payout ratios. As it must meet the individual investor’s specific goals, every investment portfolio will be different and follow a different investment strategy. However, diversification is always a good strategy approach.

Thus, income investors should include in their portfolio a combination of low-risk moderate dividend yield equities for the long run and some riskier high-dividend stocks that require frequent monitoring and adjustments. The ratio of the moderate-yield and high-yield equities in a portfolio will vary according to each investor’s needs. Even the same investor should have different ratios of riskier high-dividend equities and more stable but moderate-yield securities in their portfolio at different times.

The important consideration is that different types of equities included in one’s portfolio account only for a portion of the portfolio’s total assets and are a good fit for the overall investment goals and strategies. Also, in addition to high dividend stocks, investors must diversify and balance their portfolio with varied alternative-investment-vehicles, such as non-dividend equities that offer high capital gains, Exchange-Traded Funds (ETFs), bonds, mutual funds, cash or commodities — including precious metals. 

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