When the curtain closed on 2018, investors were left with the worst year for the broad-based S&P 500 since 2008. Even though stock market corrections -- i.e., declines of at least 10% from a recent high -- are far more common than folks realize, it had been a decade since the stock market ended the year lower, inclusive of dividends paid.
There was certainly no shortage of concerns weighing on the market last year. The ongoing U.S.-China trade war, the flattening of the yield curve throughout the year, the Federal Reserve remaining hawkish during the market's downturns, and President Trump's commentary on the U.S. economy and stock market all contributed. Worse yet, there's no sign that these downside catalysts will abate anytime soon.
Value and dividend stocks come into focus in 2019
As the new year begins, investors are liable to shift their strategies for the first time in a long time. Whereas growth stocks have dominated since the Great Recession, an environment with higher interest rates where growth could slow is optimal for value and income stocks. Let's not forget that, according to a Bank of America-Merrill Lynch report, value stocks handily outperformed growth stocks on an annualized-return basis over the 90-year period between 1926 and 2016 (17% versus 12.6%, respectively).
Dividend stocks offer an especially attractive opportunity for investors in a declining market due to numerous advantages. For starters, they act as a beacon of profitability. Publicly traded companies that share a percentage of earnings with their shareholders usually have time-tested business models and are confident that growth and profits will continue for the intermediate to long term.
Another advantage of dividend stocks is that they can help take the edge off a downturn. Emotions tend to be high when the stock market is in a correction, so receiving a payout (no matter how large or small) can help long-term investors relax and avoid hasty emotion-based decisions.
Perhaps the most alluring aspect of dividend stocks is that their payouts can be reinvested into more shares of stock via a dividend reinvestment plan (DRIP). It can quickly compound investors' wealth, and is one of the more common strategies used by professional money managers.
And lastly, it doesn't hurt to know that dividend stocks have historically outperformed their non-dividend-paying peers.
Dividend stocks have risks and require extensive research
Of course, dividend stocks come with risks of their own. When investors buy an income stock, they'd optimally like the highest yield possible with the least amount of risk. Unfortunately, risk and yield tend to move in lockstep: The higher the yield goes, the greater the likelihood that the payout isn't sustainable over the long run. Since high-yield dividend stocks (typically defined as those having an annual yield of 4% or greater) are often bought for their income, a dividend cut could prove disastrous to their share price.
Another factor investors must remember is that dividend yield is a function of share price. A stock whose share price falls by 50% but has a constant payout will see its dividend yield double. In some instances, this may represent a bargain for income seekers. In other instances, it might represent a problem with the underlying business model of a company. Investors have to be willing to dig into a high-yield company to determine if the business is growing and/or sustainable. If it's not, then it could be a much-feared "yield trap."
Just as the data has shown that dividend stocks outperform their non-dividend peers over the long run, a study from Mellon Capital and FactSet Research Systems found that S&P 500 companies with the highest yields delivered some of the worst returns between 1996 and 2015. In particular, S&P 500 companies with yields between 3% and 4% handily outperformed those with yields of 16% or higher over this 20-year period.
In sum, high-yield dividend stocks carry a lot of risk.
The one ultra-high-yield dividend stock to buy in 2019
But there's one high-yield dividend stock currently sporting a 12.1% yield that looks to be an exception to this data and to the idea that high-yield stocks are dangerous: Alliance Resource Partners (NASDAQ: ARLP).
First of all, let's get those gasps of horror out of the way by noting that Alliance Resource Partners is a coal producer. The coal industry has been ravaged over the past decade by oversupply, high debt levels, and a consistent push by electric utilities to switch to natural gas and other green sources of energy. This wound up dethroning coal as the United States' primary source of electricity generation (natural gas is now at the top of the pecking order), and it sent a number of coal stocks spiraling into bankruptcy. These include the reemerged Arch Coal and Peabody Energy, as well as James River Coal, Westmoreland Coal, Walter Energy, Alpha Natural Resources, and Patriot Coal, to name a few.
But it's important to realize that coal isn't going to disappear overnight. It remains the second-most-important source of electricity generation in the U.S., which is bound to have significant value for the producers that can survive this downturn. In my view, Alliance Resource Partners won't just survive -- it's going to thrive.
One of the biggest differentiating factors between Alliance Resource Partners and its peers is the company's focus on securing future volume and price commitments. According to the company's report for the third quarter, which ended Sept. 30, 2018, it had a respective 32.9 million tons, 17.7 million tons, and 7.9 million tons of production secured for 2019, 2020, and 2021. For context, Alliance Resource Partners produces around 40 million tons per year. By securing these commitments well in advance, the company has minimized its exposure to fluctuations in wholesale coal prices, thereby bringing a level of predictability and stability to its operating cash flow. This is why Alliance Resource Partners has remained very profitable and many of its peers have not.
Another important difference is that Alliance Resource Partners' management team believes in a fiscally conservative approach to expansion. Whereas many of its peers dug themselves into a big hole by spending billions on new projects and acquisitions with the assumption that the coal industry's expansion would extend for years to come, Alliance doesn't bite off too much with acquisitions. Its net debt of less than $415 million and total debt-to-equity of 36% are among the lowest in the industry. This allows management to easily pay down the company's debt over time, leading to superior financial flexibility.
Alliance Resource Partners has also discovered a bounty of opportunity in overseas markets. Having comprised a mere 4.5% of total sales in 2016, exports are expected to account for about 27.2% of total sales in 2018, based on the midpoint of the company's full-year sales forecast. India and China are expected to fuel a rise in global coal demand for at least the next couple of years -- something Alliance Resource Partners can take advantage of.
This is a formula for success in a depressed industry that probably isn't being given enough credit at the moment. While most 12% dividends aren't sustainable, Alliance Resource Partners' payout looks to be. It's the top double-digit dividend stock to buy in 2019.
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