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Regardless of whether you’re a new or tenured investor, last year was a challenge. All three major U.S. stock indexes plunged into a bear market, with the previously highflying Nasdaq Composite getting hit the hardest — a 33% decline.
But when the going gets rough on Wall Street, smart investors turn to dividend stocks. Companies that regularly pay a dividend to their shareholders are almost always battle-tested and profitable on a recurring basis. In other words, just the type of stocks you’d want to own during a bear market.
Image source: Getty Images.
The toughest task for income investors is simply figuring out what to buy. Ideally, investors want the highest yield possible with little or no risk. However, studies show that risk and yield tend to go hand-in-hand once a company’s yield reaches 4%. In simpler terms, high-yield stocks need a lot of extra vetting to ensure they aren’t yield traps.
The good news is there are, indeed, trustworthy high-yielding stocks you can add to your portfolio right now to help navigate a turbulent market. What follows are three ultra-high-yield dividend stocks — an arbitrary term I’m using for stocks with at least a 7% yield — that are screaming buys in 2023.
The first supercharged dividend stock that’s begging to be bought in the new year is mortgage real estate investment trust (REIT) AGNC Investment (AGNC 0.46%). AGNC’s roughly 13.6% yield isn’t a typo. It’s averaged a double-digit yield in all but one of the past 14 years and is a monthly dividend payer.
Though mortgage REITs deal with some complex products (mortgage-backed securities (MBS)), their operating model is easy to understand. Companies like AGNC seek to borrow money at low short-term lending rates and use this capital to buy MBSs with higher long-term yields. The goal for mortgage REITs is net the highest yield possible from their owned assets and pay as little as possible in interest on what they borrow. This difference between what AGNC will net from its owned assets minus its borrowing rate is known as net interest margin.
In 2022, things couldn’t possibly have been worse for AGNC Investment and its peers. The Federal Reserve’s hawkish monetary policy rapidly increased short-term borrowing rates and caused the Treasury bond yield curve to invert. Long story short, it put serious pressure on AGNC’s book value and net interest margin. In 2023, things should be markedly better.
For example, the yield curve spends most of its time sloping up and to the right — i.e., bonds that mature a long time from now have higher yields than short-term-maturing bonds. As the nation’s central bank gains clarity following its aggressive actions last year, the inversion of the yield curve should minimize and/or disappear. That’ll be a positive for AGNC’s net interest margin.
Higher interest rates have also lifted the yields on the MBSs AGNC has been purchasing. Over time, this should help lift the company’s net interest margin and potentially boost profits.
But the most important thing to note about AGNC is the composition of its $61.5 billion investment portfolio. All but $1.7 billion is tied up in agency securities, which are backed by the federal government in the event of default. This added protection is what allows AGNC to deploy leverage in order to increase its profit potential.
The second ultra-high-yield dividend stock that stands out as a screaming buy in 2023 is little-known business development company (BDC) PennantPark Floating Rate Capital (PFLT 2.68%). PennantPark is doling out a double-digit yield and, like AGNC, parses out its payment on a monthly basis.
Without getting too technical, BDCs are companies that invest in small-cap and microcap businesses with valuations under $2 billion (also known as “middle-market companies”). BDC’s usually focus their attention on owning debt or equity. Although PennantPark ended fiscal 2022 (Sept. 30, 2022) with $154.5 million in common equity and preferred stock, the remaining 87% of its investment portfolio was tied up in debt. This makes it primarily a debt-focused BDC.
Why own the debt of middle-market companies? The answer is simple: yield. Since smaller businesses are usually unproven and have limited access to credit markets, BDCs like PennantPark are able to garner above-average yields on the debt they hold. As of the end of September, PennantPark’s investment portfolio had a weighted-average yield on its debt investments of a cool 10%!
Something else absolutely critical to understand about PennantPark Floating Rate Capital is that 99.99% of the debt it holds is first-lien secured. If, in a worst-case scenario, something went wrong with one of its investments, first-lien secured debtholders are first in line for repayment. Since the company’s average investment is only $9.3 million — $1.164 billion spread over 125 companies, including preferred stock and common equity — PennantPark’s investment portfolio is substantially de-risked.
But what makes this company such a no-brainer buy in 2023 is the central bank’s hawkish monetary policy. The entirety of PennantPark’s $1.01 billion in debt investments is variable rate. As lending rates rise, so does the amount of money it collects as the debtholder. Over the past fiscal year, the company’s weighted-average yield on debt investments rose by 260 basis points to the aforementioned 10%. Expect this figure to climb again in 2023.
Image source: Getty Images.
The third ultra-high-yield dividend stock that’s an absolute screaming buy in 2023 is energy stock Enterprise Products Partners (EPD 1.32%). Despite yielding “just” 7.71%, Enterprise is working on a 24-year streak of increasing its base annual payout.
Understandably, some investors might be skittish about putting their money to work in oil and gas stocks, especially considering what happened in 2020. Initial lockdowns tied to the COVID-19 pandemic sent demand, and the spot prices for crude oil and natural gas, off a cliff. Thankfully, this isn’t something Enterprise Products Partners’ shareholders have to worry about.
Enterprise is one of the leading midstream operators in the United States. Midstream energy companies are effectively energy middlemen tasked with moving, storing, or processing, crude oil, natural gas, natural gas liquids, and refined product.
What makes midstream oil and gas stocks so desirable for income investors is the structure of their long-term contracts. Enterprise tends to lean on fixed-fee contracts that produce highly predictable cash flow and remove spot price volatility from the equation. Being able to accurately forecast its annual cash flow is important, since it allows the company to outlay capital for acquisitions and new projects without hurting its profitability.
Another reason investors can confidently buy Enterprise Products Partners in 2023 is the state of the global energy sector. Over the past three years, the industry has endured underinvestment tied to the pandemic. Last year, Russia invaded Ukraine, which adds near-and-long-term supply uncertainty for Europe. In other words, there aren’t many viable ways to quickly increase global production of crude or natural gas. This is a positive for the spot price of crude oil and natural gas, and it’ll likely encourage an increase in domestic production. In short, it’s an open invitation for Enterprise Products Partners to lock in additional long-term contracts.
Currently valued at less than 10 times Wall Street’s forecast earnings in 2023, Enterprise Products Partners stands out as a rock-solid deal among high-octane income stocks.
Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.
*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.
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