Investing in dividend stocks is a logical strategy for any long-term investor. We’ve already discussed how stocks that pay out a dividend offer higher, more stable total returns over time. Essentially, this site is dedicated to investors who see stocks as pieces of businesses that pay them a part of their profits every quarter or every year.
This straightforward and simple approach to investing leads many investors into making a common mistake – picking the highest yielding stocks. It’s tempting to start a fresh hunt for investment opportunities by asking yourself “Which are the highest dividend stocks?” Dividend investors are so driven by their portfolio’s yield that they often turn a blind eye to everything else and focus exclusively on how much a stock pays them.
If you want to invest in dividend stocks successfully, you need to strike a balance. It’s not just about figuring out which are the highest dividend stocks, but understanding which are the best dividend stocks. The best, in this case, means stocks with a high yield, minimal risk, and favorable growth opportunities.
What A Great Dividend Looks Likes
A great dividend is a sustainable one. In other words, a high dividend is useless if the company it is attached to is likely to under-perform or go bankrupt. A high dividend is also useless if it’s unpredictable.
Let’s take an example. Say a stock trades at $100 and pays out a $30 dividend. That’s a whopping 30% dividend yield which is pretty much unheard of in the real world. However, it turns out the stock was borrowing money to keep its controlling shareholder happy with a fat dividend. The company faces perpetual decline and the stock price is cut by half over the course of the year. This means any investor who was seduced by the high dividend yield will have a holding period return of -20% ($50+$30/$100).
On the other hand, let’s assume the company is not in decline and did not borrow money to fund the dividend. Instead, the stock price rises 10% over the course of the year. However, the $30 dividend paid last year was a one-off dividend funded by proceeds from the sale of a massive property the company used to own. This year the dividend is only $2.
Both scenarios are bad for dividend investors who expect a regular and consistent dividend. Which is why a healthy dividend must meet the following criteria:
- High dividend coverage
- Reasonable payout ratio
- Low debt
- High margins
- Growing cash flows
- History of growing dividends
- Good management
- Good industry prospects
All these factors are covered in the Dividends Health Check article published last year. In this article, we’re going to ask ourselves which are the highest dividend stocks and do they pass the health check?
Which are the highest dividend stocks?
Here’s a list of the ten S&P 500 stocks with the highest dividend yield.
- Frontier Communications Corp (FTR) Dividend yield: 21.4%
- Century Link (CTL) Dividend yield: 8.33%
- Mattel Inc. (MAT) Dividend yield: 6.83%
- Iron Mountain (IRM) Dividend yield: 6%
- Ford Motor Co. (F) Dividend yield: 5.23%
- Kohl’s Corp (KSS) Dividend yield: 5.21%
- Macy’s Inc (M) Dividend yield: 5.16%
- Seagate Tech (STX) Dividend yield: 4.99%
- Kimco Realty Corp (KIM) Dividend yield: 4.91%
- Verizon (V) Dividend yield: 4.95%
Each one of these stocks offers a dividend yield substantially higher than the S&P 500 average. The index yield 1.94%, which means that even the last entry on this list (Verizon) offers a yield 2.5 times higher.
Frontier Communications, meanwhile offers a whopping 21.4%. At that rate, the stock will return your the purchase price within 5 years in hard dividend cash.
But which are the highest dividend stocks worth investing in? Are there any red flags that should concern investors? Let’s pass these top ten through the health scan.
The stock with the highest dividend yield in the list above is probably the best example for why you shouldn’t make investment decisions based on yield alone. Frontier has struggled to turn a profit for several years. The dividend yield, sustained by its cash reserves, was already in the double digits. This year the stock price has depreciated remarkably, which has pushed the yield even higher. There’s a high chance the company will be unable to sustain the dividend and will be forced to cut soon.
Similarly, CenturyLink, Seagate Technology, and Mattel have all had a rough year and are currently paying out more than they earn. The payout ratio for all three of them is 186%, 147%, and 165% respectively. Paying out more than the company earns is never a good strategy.
Verizon has struggled to maintain free cash flow generation since 2016. This past year the company managed to generate $5.1 billion in free cash flow and $13.6 billion in net income, but paid out a massive $9.3 billion in dividends. The telecoms company is struggling to create the cash it hopes to payout to investors, which could imply a dividend cut is on its way.
That leaves us with the five remaining stocks on this list.
The Last Five
Ford Co., Macy’s, and Kohl’s are all part of industries that are unfavorable at the moment. But that doesn’t make them bad companies. Instead, these are some of the best performers in a difficult market.
Macy’s has been in the process of downsizing to make the business more efficient. The stock has plunged more than 50% since 2015, but that presents a good buying opportunity for income-seeking investors. The company is selling property to fund its dividend, which is still half the annual free cash flow.
Next is Kohl’s which is considered a contrarian investment. The stock price and annual revenues have fallen 50% over the past few years, but the company generates $1 billion in free cash flow and only pays out $400 million in dividends. Really attractive.
Ford may be a boring company, but analysts have their hopes up for a motor company with some powerful models in its portfolio. The company is a bit of mixed bag, with sizable debt, but a management that seems capable of managing it and paying out a reasonable rate of dividends. Last year, the company generated more than enough of free cash flow from operations to fund its dividend.
Iron Mountain is another REIT. The trust has consistently growing revenues and AFFO that covers the dividend. The fact that no single client makes up more than 1% of its portfolio makes it a safe bet.
Finally, there’s Iron Mountain and Kimco. Kimco is a REIT with a healthy rate of dividend, Funds From Operation growth over the past few years. It also has a healthy rate of dividend coverage which makes the dividend safe.
The dividend stocks with the highest yields aren’t always the winners. As you’ve seen here, only half of the top ten dividend stocks on the S&P 500 are worth consideration. Picking the perfect investment requires a little research, a healthy dose of skepticism, and considerable conviction.
But once you’ve figured out the which are the highest dividend stocks with the best prospects and healthiest balance sheet, take the plunge.