Stocks that pay large dividends aren't necessarily the best bets for investors over the long term. A high yield can be a sign that an underlying business is no longer stable and investors are expecting a dividend cut in the future.
However, some high dividend yields are the result of the market not appreciating a stock's long-term cash flow potential. Here, three Motley Fool contributors identify their favorite high-yield stocks: AT&T (NYSE: T), Western Digital (NASDAQ: WDC), and NextEra Energy Partners (NYSE: NEP).
Time to add this telecom to your portfolio
Todd Campbell (AT&T): It's not a flashy stock, but its dividend yield is so enticing that AT&T ought to be in every income investor's portfolio at this point.
Granted, the market's moved miles away from the landline phones that turned it into a household name. But connectivity remains key to empowering the next generation of smartphones, tablets, and electronics, and AT&T is still a critical company in that arena.
Its network enables millions to communicate (or simply surf) effortlessly and the approaching rollout of 5G, a faster network, should offer plenty of tailwinds to revenue-friendly data demand.
Admittedly, competition in wireless is fierce, but AT&T's also taken steps to diversify its revenue. In addition to its bread and butter, it's acquired DirecTV and Time Warner, giving it important access to consumers' growing appetite for entertainment. The Time Warner deal alone netted it HBO, a powerhouse with the highly popular Game of Thrones.
Last year, AT&T produced a staggering $43 billion in operating cash and $22 billion in free cash. This year, free cash flow could increase another 16%, giving it plenty of dividend-friendly financial flexibility. With multiple levers to fuel dividend increases and a stately 6.3% yield, AT&T is arguably a bargain worth buying.
A hated stock approaching a cyclical bottom
Leo Sun (Western Digital): Western Digital lost about 40% of its value over the past 12 months as sales of its traditional hard disk drives dried up with sluggish PC sales and weak enterprise demand, and sales of its flash-based products were hit by tumbling NAND prices.
But after that sell-off, WD trades at just 12 times forward earnings and pays a forward dividend yield of nearly 4%. Furthermore, there are strong indications that WD's core businesses are hitting a cyclical bottom. Sales of PCs should accelerate again once Intel resolves its chip shortage issues, and NAND prices could stop declining in the second half of 2019.
WD's revenue fell 27% annually last quarter as its non-GAAP earnings per share tumbled 95%, but its guidance for the fourth quarter (for a 27% annual drop in revenue and a 94% EPS decline) suggest that its multiquarter declines are finally bottoming out.
Wall Street expects WD's revenue to fall 19% this year, followed by a 3% dip next year. Its EPS is expected to drop 67% this year and 20% next year. Those forecasts look discouraging, but they should start rising again if the volatile chip shortage and NAND headwinds finally fade away.
WD isn't the ideal income stock for conservative investors, since it generated negative free cash flow last quarter and it's funding its dividend with cash reserves. However, the stock could approach a cyclical bottom soon, and its business could rebound quickly on easier year-over-year comparisons.
An energy dividend to own for decades
Travis Hoium (NextEra Energy Partners): Not all dividends are created equal and I think one of the things investors need to look for is the long-term stability of any payout. In energy, there aren't many dividends more sustainable than NextEra Energy Partners, a renewable energy yieldco with 5,330 megawatts of operating assets. The company's assets are backed by long-term contracts to sell energy to utilities, which keeps funds flowing into operations and ultimately as dividends.
What's unique is that the average contract to sell energy is 17 years in duration, so there's a long runway of known cash flow. On top of the reliability of existing contracts, because of the way NextEra Energy Partners is structured, management expects that at least the next eight years of dividends to be tax-free "return of capital" distributions.
The yieldco strategy has been tried before and companies have fallen flat, but what makes NextEra Energy Partners different is its sponsor NextEra Energy, which has 21 gigawatts of assets and backlog of renewable energy projects in its portfolio. A flow of projects being dropped down to NextEra Energy Partners keeps the dividend growing and the contracted life long, making this 4.3% dividend yield a great buy in any market.
Dividends of different flavors
Telecom, technology, and energy can all have great dividends despite their diverse business models. Investors looking for strong payouts with more stability than you might expect can start their search with AT&T, Western Digital, and NextEra Energy Partners.
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Leo Sun has no position in any of the stocks mentioned. Todd Campbell has no position in any of the stocks mentioned. Travis Hoium has no position in any of the stocks mentioned. The Motley Fool recommends NextEra Energy. The Motley Fool has a disclosure policy.