Looking for a big dividend yield in the current low-interest-rate environment? Be careful! In many cases, a stock's yield is high because the share price is down. Often it's because a dividend cut is on the table, meaning the yield you'll end up getting will be far less than what you signed up for. At the same time, there are opportunities to buy downtrodden dividend stocks that have high yields and are perfectly safe. And if it's steady income you're looking for, these can turn out to be excellent for opportunistic investors.
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We asked a group of our contributing investors to write about three companies that have seen their stock prices fall but sport big dividends, and they came up with two telecom giants in Centurylink Inc (NYSE: CTL) and Verizon Communications, Inc. (NYSE: VZ), and a low-cost coal producer, Alliance Resource Partners, L.P. (NASDAQ: ARLP).
Do our experts think these three are worth buying at current prices? Like many things in investing, it's not cut-and-dried. Keep reading to find out the details that matter so you can make the decision that's right for you.
When rock-bottom might get rock-bottom-er
Jason Hall (CenturyLink): As a CenturyLink shareholder, I'm optimistic the company will be able to sustain its dividend, which yields an eye-popping 10.5% at recent prices. But I'm not blindly convinced that my hope will be reality. Hope is a terrible investing thesis, especially in a company that has seen its stock fall by half in recent years and is dealing with a decline in its core business.
The reality CenturyLink faces is that its current profits are insufficient to support its current dividend: In the first half of 2017, the company earned $0.33 per share in net income while paying out $1.08 per share in dividends. You do the math.
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Management says the Level 3 Communications merger, on track to close before year-end, will fix this imbalance and then some. This merger will lead to a big cash-flow boost as a result of tax benefits from combining the two companies and should also lead to cost reductions once the companies are combined. It should also lead to growth moving forward, versus CenturyLink's declining business. Management says that by year-end, the payout ratio will be in the mid-70% range. That's a pretty huge improvement if all the "shoulds" work out.
That's a lot of "shoulds" to have to count on, and any one thing not going right could be all it takes for the company to fall short. That would almost certainly lead to a dividend cut and potentially knock the stock even lower.
Bottom line: The risk-taker in me says it's worth the risk to potentially capture almost 11% in annualized yield. So I've invested a small stake for the "higher-risk" part of my portfolio but have no plans to buy more before the merger plays out. If you're willing to take on the risk that things don't go perfectly and the dividend gets cut, it could work out swimmingly. But if you're investing for income you'll count on in a few years, there are stocks with far safer yields that you should buy instead.
A lumbering giant that’s priced accordingly
Chuck Saletta (Verizon Communications): Telecommunications titan Verizon Communications isn’t expected to light the world on fire. Its earnings are expected to grow at a mere 1% annualized rate over the next five or so years, due in part to intensifying competition among wireless network providers.
Fortunately for those considering buying its stock, its expected slow growth is well known among investors. Verizon Communications’ shares fetch a mere 16 times trailing earnings, well below the 24 times of the overall S&P 500. That makes it a relative bargain in the current market. Thanks in large part to those low expectations, Verizon Communications sports a current yield of around 4.8%, which is more than twice the S&P 500’s yield.
Perhaps best of all, unlike many high-yielding companies, Verizon Communications’ dividend is well covered. It currently only pays out around 60% of its earnings in the form of dividends, giving the company a substantial portion of its earnings capacity to reinvest in protecting its market position.
As emerging technologies like 5G wireless come to market, Verizon will need to continue investing in new infrastructure to remain competitive. The fact that it retains around 40% of its earnings today enables it to make those investments without necessarily having to cut its dividend to do so.
It’s rare to find a company with both a high yield and enough financial flexibility to invest in emerging technologies to remain relevant. With Verizon Communications, you get that rare combination of both, which is what makes it a high-yielding stock available at a relative bargain price today.
Getting better despite the price drop
Reuben Gregg Brewer (Alliance Resource Partners, L.P.): If you're looking for rock-bottom prices, then look no further than coal miner Alliance Resource Partners' nearly 20% year-to-date decline. Over the trailing five-year period, the partnership is down over 60%. But there are two interesting things to note here: First, it has a distribution yield of more than 10%, and second, the coal miner is actually doing reasonably well.
When Alliance reported second-quarter results, it also announced a 14% distribution increase. While coal prices were lower year over year in the second quarter, the partnership expects to cover its 2017 distribution by a robust 1.7 times. That's a huge margin of safety in the partnership space where coverage of 1.2 is considered good. In other words, despite tough times, the fat distribution looks pretty solid.
As for Alliance's coal business, the picture is a bit mixed. For example, Alliance shipped 6% more coal in the second quarter, which helped offset lower coal prices and supported earnings. That type of solid showing is par for the course. Longer term, Alliance has managed to remain profitable throughout the coal downturn while many competitors have been forced to seek bankruptcy protection. Alliance has proven it's a survivor in a troubled market, which is impressive given the negatives in the coal industry.
You see, there's no question that thermal coal is in a long-term downtrend. That said, the coal industry is far from dead. The U.S. Energy Information Administration (EIA) believes coal will remain an important part of the U.S. electric grid through 2040 (and likely beyond). But here's the key for Alliance: The EIA thinks that the Interior Region, in which Alliance is focused, will increase its share of U.S. coal production from 20% to 26% over that span. So Alliance is actually well positioned, even if coal is in slow decline.
This is not an investment for conservative investors. But Alliance offers a beaten-down unit price, a big yield, and a surprisingly strong position in a slowly declining industry. You just have to be willing to dig deeper than the negative coal headlines to see that the future isn't as bleak as it might first look for high-yielding Alliance Resource Partners.
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Chuck Saletta has no position in any of the stocks mentioned. Jason Hall owns shares of CenturyLink. Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Verizon Communications. The Motley Fool recommends Alliance Resource Partners. The Motley Fool has a disclosure policy.