Today's low-interest rate environment has forced many investors to put money to work in the stock market to generate income. Unfortunately, many of these investors simply buy the highest-yielding dividend stocks they find, which can be a mistake. Heres how to be selective and pick the best dividend stocks.
Image source: Getty Images.
With that in mind, let's take a closer look at the five highest-yielding stocks from the S&P 500 to see if any of them could be worth owning:
Data source: Finviz.com.
Telecoms in trouble?
Income investors will likely notice immediately that Frontier Communications and CenturyLink offer massive payouts. That's because regional telecoms offer limited growth prospects, so managers opt to return profits to shareholders in the form of massive dividend payments.
That sounds attractive, but income investors should always look at a company's payout ratio before they hit the buy button:
Data sources: Yahoo! Finance and Finviz.com. TTM = trailing twelve-month.
Frontier Communications doesn't even have a payout ratio because its net income over the past four quarters is negative, which is a big red flag. Meanwhile, CenturyLink's payout ratio of 128% means that the company's dividend payment exceeds its net income, which is not a good sign, either.
Another fact that should give investors pause is that both of these companies have been on the decline. Over the past five years, both Frontier and CenturyLink have seen their net income drop considerably. What's more, analysts think that both companies are going to report big drops in net income next year, too.
With suspect payout ratios and net incomes heading in reverse, investors would probably be wise to avoid both of these stocks.
A company in transition
Seagate Technology is a data-storage company that has hit a rough patch. Demand for the company's legacy hard-disk drives has been on the decline. That's caused the company's revenue and profits to drop drastically over the past five years:
The earnings plunge has pushed Seagate's payout ratio up to 200%, which means that its dividend payment currently far exceeds its profits. That figure hints that it could be on the chopping block soon.
Thankfully, the demand for cloud computing should ensure that this company's main business won't completely disappear anytime soon. Better still, Seagate's free cash flow production is meaningfully higher than its net income, so its dividend isn't in as much danger as its payout ratio suggests.
Still, given the company's declining profits and lofty payout ratio, investors should probably approach this stock with caution.
REITs to the rescue?
Many income investors have turned to real estate investment trusts, or REITs, to help them generate a strong yield. REITs are required by law to pay out at least 90% of their net income as distributions, which often gives them yields that vastly exceed the market's in general. Iron Mountain and Host Hotels and Properties are REITs that currently yield 6.6% and 5.5%, respectively, which makes them worthy of further study.
Host Hotels and Properties owns a collection of high-quality hotels that are spread throughout the world. While the hotel business can be quite lucrative while the economy is heating up, demand can nosedive when tough times approach. During the Great Recession, Host Hotels was forced to slash its dividend payment, which was an unpopular decision with shareholders. The long recovery has allowed management to grow its payout consistently over the last few years, but the company's dividend is still well below its 2008 high.
Image source: Host Hotels and Properties.
Iron Mountain is a provider of storage and information management services. The company counts 94% of the Fortune 1000 as customers, which makes its business extremely well diversified. What's great about this business is that its customers sign multiyear agreements, which helps protect the company from downturns. Better yet, this business benefits from low maintenance costs, which helps it fund a strong -- and growing -- dividend.
Are any of them worth buying?
I must admit that Iron Mountain is my favorite stock from this list. I like that the company operates a boring but reliable business that counts a number of high-profile companies as customers. Those factors give the company a great chance at steadily improving its revenue, income, and distribution in the years ahead. Thus, if you are on the hunt for a high-yield dividend stock, Iron Mountain might be right for you.
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Brian Feroldi has no position in any stocks mentioned. Like this article? Follow him on Twitter where he goes by the handle @BrianFeroldi or connect with him on LinkedIn to see more articles like this.
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