Real Estate

High yield dividend stocks

Buying high yield stocks is a great way to create long term dividend income. Passive income can help provide for your retirement, but it can also help grow your wealth over the long term. If you reinvest your dividends rather than spending the money, the effect of compounding comes into play. That will greatly increase your returns over time.

But finding the right stocks isn’t as easy as just buying the highest yield. Some high yield dividend stocks have problems attached. Let’s look at the top ten yields in the S&P 500 and see what we can learn.

LBrands – a value trap

LBrands (LB) is a retailer which operates various well known brands – Victoria’s Secret, Bath & Body Works, and La Senza. These are highly discretionary purchases – no one needs a pink satin bra or a lavender-scented shower gel. LBrands is also squarely in the targets of Amazon.com, so perhaps it’s not surprising that it has posted two guidance cuts this year and is seeing its margins squeezed. The dividend yield is currently standing at a monstrously large 9% – but there are enough problems that you shouldn’t rely on it. Another bad year, and it might have to cut the dividend. This is a classic value trap.

Solid yields in utilities and telecoms

PPL, a gas and electric utility, yields 5.6% and looks a better bet. Utilities are always a sector where yields are relatively high. Utilities don’t tend to grow very fast but have stable and secure income based on subscriber contracts. The payout ratio at PPL is only 71%, so dividends should be secure, and there are no clouds on the horizon. Indeed if PPL plays its cards right putting the smart, clean energy grid in place, there could be upgrades to come.

Similar to utilities in their earnings are telecoms operators like AT&T, which yields just over 6%. It’s the biggest telco, with almost impregnable market share, recurring revenues, low churn, and a payout ratio of under 60%. Another good choice.

That might not be the case at Ford Motor, which sits on the same 6% yield. Unlike your phone which has to be paid for every month, a car is a one-time big ticket purchase, and the auto industry is currently facing major headwinds. Ford has interesting ideas about electric vehicles and the Transportation Mobility Cloud, but they won’t translate to earnings for a while. Still, the payout ratio is a measly 40%, so unless things go very wrong, very quickly, the dividend’s safe.

Tobacco is a high yielder

Philip Morris International yields 5.5% and looks pretty set to pay out. Of course, you may not feel happy about buying a tobacco stock. If you are, you’ll get a decent yield together with growing earnings. On the other hand Nielsen Holdings, on a not very different yield, looks like one to avoid. Its shares crashed in July as the CEO stepped down, and free cash flow is falling alarmingly. The dividend might not be safe – so like LBrands, our advice would be to stay away.

REITs dominate the yield index

That’s six of the top ten, all in different sectors. The other four are all in the same sector – REITs. That’s not surprising; REITs, like utilities, have strong recurring income. Even better, they have ‘pass through’ tax status, so they pay out 90% of their rental stream directly to investors as dividends. Uncle Sam doesn’t take a cut before the money reaches you. (Afterwards, of course, that could be different, unless you keep your REITs in an IRA.) Ventas, Welltower, HCP and Iron Mountain all make the top ten and we reckon they’re among the best protected yields on the market.