One of the best things about investing on Wall Street is that there is a strategy that can satisfy everyone. With thousands of publicly traded companies and exchange-traded funds (ETFs) to choose from, there are ways for investors with varying risk tolerances to grow their wealth over time.
But among these seemingly countless action plans, buying and owning high-quality dividend stocks is a hard strategy to beat. Recently, analysts at Hartford Funds, in collaboration with Ned Davis Research, updated their datasets for an in-depth report (“The Power of Dividends: Past, Present, and Future”) that they released last year that tracks the outperformance of dividend stocks over the past year examined over the last few years in the long term.
According to the report’s findings, dividend-paying companies achieved an average annual return of 9.17% over half a century (1973-2023) while being 6% less volatile than the benchmark S&P 500. What’s more, publicly traded companies that have adopted and increased their distributions have returned an even more impressive 10.19% annualized over 50 years, with 11% less volatility than the S&P 500.
On the other hand, publicly traded companies that offer no dividends have earned more modest annual returns of 4.27% between 1973 and 2023, with a yield of 18%. more more volatile than the S&P 500.
Companies that pay a regular dividend are typically profitable, proven, and able to provide their shareholders with transparent long-term growth prospects. In other words, they are exactly the kind of companies that are expected to increase in value over time.
As we head into May, two stocks with extremely high monthly dividends and an average yield of 8.29% are attractively valued and begging to be purchased by opportunistic, long-term investors.
Time to Grab: Real Estate Income (5.75% Yield)
The first high-dividend yield stock to pounce on in May is none other than the leading name among retail real estate investment trusts (REITs). Real estate income (NYSE:O). The REIT has made 646 consecutive monthly dividend payments to its shareholders and has increased its payout in each of the last 106 quarters. (That’s more than 26 years, for those of you keeping score at home.) Suffice it to say, distribution is incredibly safe.
There are two reasons why Realty Income stock has significantly underperformed the S&P 500 since the summer of 2022. The first trigger is rapidly rising interest rates, which drove up government bond yields. Income investors have been somewhat reluctant to put their money into stocks when they can achieve comparable returns to short-term Treasury bills with lower capital risk.
The other concern for Realty Income is the health of the U.S. economy. Although the economy is currently growing, select forecast indicators and monetary-based metrics suggest that a recession may be imminent. It’s not uncommon for retailers to struggle during recessions.
The flip side of this concern is that economic downturns are short-lived. While there have been two expansions that exceeded the 10-year mark, not a single U.S. recession since the end of World War II has lasted longer than 18 months. In short, the retail leasing landscape benefits from longer periods of expansion.
What makes Realty Income such a special dividend stock is its extensive commercial real estate (CRE) portfolio. After completing its acquisition of Spirit Realty Capital in January, the company had more than 15,450 CRE properties. Here’s the kicker: Approximately 89% of the total rent tied to these properties is “resistant to economic downturns and/or insulated from e-commerce pressures,” according to the company.
Realty Income’s strategy is to lease to branded companies that operate standalone businesses in industries that attract customers regardless of how well or poorly the U.S. economy and stock market performs. Examples include rentals to grocery stores, convenience stores, dollar stores, hardware stores and drug stores. Together, these five industries account for approximately 40% of Realty Income’s annual contract rent.
The REIT’s leadership team also has a long track record of properly vetting its lessees. While the average S&P 500 REIT has had a occupancy rate of 94.2% since the beginning of this century, Realty Income’s historical average occupancy rate is 400 basis points higher (98.2%) over the same period. We’re talking consistent adjusted funds from operations that simply can’t be achieved by other retail REITs.
Also, don’t overlook Realty Income’s push beyond the retail industry. The company has completed two deals in the gaming industry and formed a joint venture in the last two years Digital Realty Trust in November to develop customized data centers for rental.
Shares of Realty Income can be purchased by income investors for less than 12 times consensus 2025 cash flow. For comparison, that’s a 32% discount to the average cash flow multiple over the last five years.
Time to grab: PennantPark Floating Rate Capital (10.82% return)
A second stock with an extremely high dividend yield that is definitely worth buying in May is the unknown Business Development Company (BDC). PennantPark Floating Rate Capital (NYSE:PFLT). PennantPark has been paying a monthly dividend since July 2011, just a few months after its debut as a public company. The monthly distribution of $0.1025 has more than doubled in less than 13 years.
Without getting too complicated, BDCs are companies that invest in debt and/or equity (common and preferred stock) of generally untested/smaller companies, referred to as “middle market companies.” Although PennantPark Floating Rate Capital ended 2023 with just over $180 million in preferred and common stock, the lion’s share of its investment portfolio ($1.09 billion) is tied up in debt. This makes it a debt-oriented BDC.
While there are pros and cons to both approaches, the undeniable appeal of focusing on debt lies in the returns PennantPark can generate. By focusing on middle-market businesses that have limited access to traditional financial services, PennantPark is able to achieve above-average interest rates on the loans in which it invests.
Arguably the biggest selling point for potential investors is that 100% of the company’s debt portfolio has variable interest rates. Since March 2022, the Fed has conducted the most aggressive rate hike cycle since the early 1980s. The weighted average return on debt investments at PennantPark increased by 510 basis points to 12.5%.
While most investors count down the days until the country’s central bank considers cutting its federal funds rate, PennantPark continues to benefit from this inactivity. As long as protective inflation remains stubbornly high, the Fed may have no choice but to keep interest rates above 5%. This is excellent news for PennantPark’s loan portfolio.
The company’s management team also deserves great credit for protecting its capital and maximizing returns. Including share capital items, investments as of December 31 were spread across 141 companies. This represents an average investment size of $9 million. No single investment is critical to PennantPark’s success.
In addition, at the end of 2023 only one company had no provisions (i.e. late payments). This defaulting entity represents only 0.1% of the cost base of PennantPark’s overall portfolio. In other words, smart decisions have been made when it comes to which loans PennantPark holds.
To top it off, all but $0.2 million of the company’s $1.09 billion of debt is senior secured notes. In the event that a borrower applies for protection from creditors, the debtors secured by a lien are first in line for repayment. This is another example of management wisely protecting their company’s client.
At around nine times next year’s consensus cash flow, PennantPark Floating Rate Capital looks like a brilliant buy for patient income seekers.
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Sean Williams holds positions in PennantPark Floating Rate Capital. The Motley Fool has positions in and recommends Digital Realty Trust and Realty Income. The Motley Fool has a disclosure policy.
Time to Pounce: 2 Ultra-High-Yield Monthly Dividend Stocks Committing to Being in May was originally published by The Motley Fool