High-yield stocks are a great way to generate cash whether you're new to investing or in retirement. But high yields can sometimes be a sign of risk for investors because the market doesn't think the dividend will be steady over the long term.
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We asked three of our investors for a dividend they think the market is overlooking, and Target Corporation (NYSE: TGT), Centurylink Inc (NYSE: CTL), and 8point3 Energy Partners (NASDAQ: CAFD) popped to the top of the list. These may not be the risky dividends the market thinks they are.
An out-of-favor Dividend Aristocrat
Leo Sun (Target): Shares of Target fell 20% this year due to concerns about its sales growth and tougher competition from e-tailers and superstores. Amazon's (NASDAQ: AMZN) takeover of Whole Foods could also hurt its grocery business, which generates over a fifth of its revenues.
However, that sell-off reduced Target's P/E to 12, compared to the industry average of 19 for discount retailers. It also pays a forward yield of 4.2%, which is supported by a low payout ratio of 49%. It has raised that payout annually for 49 straight years -- making it an elite Dividend Aristocrat.
The bears believe Target will get crushed between Wal-Mart (NYSE: WMT) on the brick-and-mortar front and Amazon in e-commerce and groceries. That could certainly happen, but Target is gradually turning around its business by renovating its stores, opening more small-format stores in denser neighborhoods, and investing more heavily in digital channels.
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Those efforts lifted its revenue 1.6% annually last quarter, breaking a six-quarter streak of top-line declines. Its digital sales surged 32%, up from 16% growth in the prior-year quarter. Analysts expect its revenue to rise 1.8% this year. However, markdowns and higher investments caused Target's adjusted earnings to remain flat last quarter, and analysts expect a 10% earnings decline this year.
Target's low valuation and high dividend should limit the stock's downside potential at current prices. But its upside potential could also be limited by Amazon, Wal-Mart, and other rivals -- so investors should carefully weigh the pros and cons before buying.
This high-yielding telecom is in the bargain bin -- but it might deserve to be
Jason Hall (CenturyLink Inc): Shares of telecom CenturyLink are down more than 40% over the past 12 months. This big drop has pushed its trailing dividend yield up to an otherworldly 11.6% at recent prices.
That's a huge markdown and a fat dividend, but it's also not a stock for the faint-hearted. The bottom line is CenturyLink's dividend isn't sustainable, and management is banking on its soon-to-close merger with Level 3 Communications, Inc. (NYSE: LVLT) to offset expenses and increase cash flows enough to change that.
As Foolish colleague Anders Bylund noted a few months ago, CenturyLink paid out $1.2 billion in annual dividends, but it only generated $422 million in cash flows over the prior 12-month period. That's a substantial shortfall in cash flows and dividends paid -- enough for Anders to call CenturyLink a dividend stock that he would never buy.
This is where the Level 3 merger comes in. Management says it will see $975 million in "cash synergies" and will be cash-accretive in the first year post-merger. With the deal now set to close in mid-October, CenturyLink's future -- and that of its shareholders -- rests on the success of this merger.
If you decide to buy shares, understand this: The future of CenturyLink's dividend is directly tied to the success of the Level 3 merger. If you're willing to risk a big dividend cut (that would almost certainly send the stock price down further) if things don't go as planned, buying CenturyLink could work out great -- or not. Buyer beware.
Solar energy's best dividend stock
Travis Hoium (8point3 Energy Partners): High-yield stocks can often indicate that the market doesn't have a lot of confidence in a dividend going forward, meaning the stocks behind them are high-risk investments. But 8point3 Energy Partners is a company whose cash flows are contracted for nearly 20 years into the future, and it owns assets that will have value for decades beyond that.
What separates 8point3 Energy Partners from other yieldcos is the fact that it only owns solar projects, which generate electricity more predictably than other renewables like wind. The company's contracts with utilities, businesses, and homeowners to buy electricity also comes with scheduled price increases, meaning cash flow coming into the company will grow over time. As a kicker for investors, the dividends currently being paid are actually a "return of capital" from buying solar projects, so investors don't have to pay taxes on the quarterly dividend of $0.2721 per share.
The downside of 8point3 Energy Partners is that its high dividend makes it nearly impossible to buy new solar projects that will be accretive to the dividend. Yieldcos usually issue new shares to fund acquisitions, but 8point3 Energy Partners's dividend yield of 7.5% is too high to be used to fund acquisitions, meaning the dividend payout will flatline if the stock doesn't increase. But if the downside to an investment is collecting a 7.5% dividend yield for the next 20 years, that's a yield I would take every day of the week.
10 stocks we like better than Target
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Jason Hall owns shares of 8point3 Energy Partners, Amazon, and CenturyLink. Leo Sun owns shares of Amazon. Travis Hoium owns shares of 8point3 Energy Partners. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.