Warren Buffett once said:
Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.
Right now, numerous high yield dividend stocks (SPYD) presents investors with such an opportunity. In this article, we will discuss why and share some of our top picks of the moment.
Why High Yield Dividend Stocks Are On Sale Right Now
Many high yield dividend stocks have underperformed so far in 2024 in large part due to the Fed’s indication that it is in no rush to cut interest rates. As Chairman Jerome Powell recently stated:
The labor market is strong — 3.7% unemployment — with the economy strong like that, we feel like we can approach the question of when to begin to reduce interest rates carefully.
Higher interest rates tend to hurt high yield stocks because:
- Many high yield stocks such as triple net lease REITs like Realty Income (O) are viewed as bond proxies due to their very stable, defensive, and attractive cash flows that they pay out to shareholders via dividends. As rates rise, the market’s expected yield from these stocks also increases, thereby pushing down stock prices.
- Many high yield stocks have capital-intensive business models, such as NextEra Energy Partners (NEP). With interest rates rising, so does their cost of capital, thereby weighing on their growth prospects and potentially even threatening their financial strength.
Moreover, given the market’s extreme bullishness on AI stocks, a lot of capital is chasing that part of the market to the detriment of yield-oriented stocks.
This presents value investors a golden opportunity to load up on deeply undervalued and quality dividend stocks to lock in lucrative passive income and attractive long-term risk-reward. If interest rates come down over time, high yield stocks will experience a powerful tailwind as the market reprices their valuations higher. However, even if interest rates remain in their current range for the foreseeable future, many high yield stocks should still deliver attractive returns given how much the market has beaten them down.
For example, Atlantica Sustainable Infrastructure (AY) currently yields over 10% and does not need to access equity markets to support that yield since it is amortizing its project-level debt and is funding capital expenditures and its dividend with internally generated cash flows. Yes, its growth will likely be restricting to a low to mid single digit CAGR over time if it is unable to access equity markets accretively, but when combined with the very high yield, that still provides investors with likely 12-15% annualized total returns even without any valuation multiple expansion.
Another stock that we like right now is W.P. Carey (WPC), as it is yielding over 6%, trades at a discount to its NAV, and is expected to grow its AFFO per share at a ~5% CAGR through 2027. This provides a pretty clear path to double-digit annualized total returns without it experiencing any valuation multiple expansion.
Then there is Enbridge (ENB), which combines a ~5% expected distributable cash flow per share CAGR through 2027 along with a 7.6% yield, also giving investors a very attractive total return outlook without assuming any multiple expansion takes place.
What makes these stocks look even better from a risk-reward perspective is that they all have solid balance sheets with well-laddered debt maturities and significant liquidity with little need for external equity capital to fund their near term growth pipelines. Moreover they all generate very stable cash flows from defensive business models, giving investors high visibility and confidence in their total return outlooks.
Last, but not least, they all could see very significant upside in the event of falling interest rates, as WPC and AY would both then likely be able to ramp up their growth pipelines, thereby driving faster per share cash flow and dividend growth, while ENB would also likely be able to lean into its immense growth opportunities more aggressively as well. Additionally, all three would likely see their valuations trade more in-line with historical averages, thereby providing very significant stock price appreciation on top of their attractive yield and growth.
Investor Takeaway
While the S&P 500 (SPY) is trading at very overvalued levels, dividend stocks in sectors ranging from REITs (VNQ) to utilities and infrastructure (XLU) offer value investors a very attractive opportunity to load up on quality high yielding dividend growth stocks at heavily discounted valuations.
As a result, I am buying stocks similar to WPC, AY, and ENB hand-over-fist and am happy to collect the lucrative and growing passive income while waiting for the market to readjust its valuation of these stocks. Even if it never does and interest rates remain elevated for the foreseeable future, these stocks as currently priced should – in aggregate – still deliver very satisfactory returns. Therefore, I consider investing in quality high yield dividend stocks right now to be a “heads I win, tails I don’t lose much if anything” investment proposition.
