Recession Playbook Part II: 4 Secure High Yield Dividend Plays
***This article was written in late March when these yields were even more attractive. However, due to certain obligations in my life, I was unable to write it in its entirety and have it published. The stocks listed herein remain good buys; however, they aren’t quite as good as they were.
Before I dive into the analysis, I want to discuss a few points regarding dividend growth investing (DGI) and investing in general. I have recently witnessed a growing trend in which investors are seeking out yields in excess of 10%. Where I’m from, we call such a yield a “sucker’s yield”. There ain’t no free lunches in the market to put it another way. 10% plus yields scream to the investor, “This is incredibly risky. There’s a good chance this dividend is not sustainable, and the slightest change in market conditions could result in it being slashed, along with your income. What’s more, this company may not remain solvent.”
That’s what a 10% yield tells bond investors, as when a bond boasts such a yield, it’s almost unequivocally referred to as a junk bond. So if you wouldn’t own a junk bond yielding 10%, why would you own a junk stock yielding 10%?
Now, some of you may be thinking: “You’ve dashed my hopes of 10% yields! What good is the stock market anyway then?!” Well, if you do it right, you can have your 10% yields, and they may even become 25% or 40% yields over the proper time horizon, as one of SeekingAlpha’s most beloved investors likely experiences with his “buy and hold forever” strategy (@Buyandhold 2012), though I can’t be sure as to what his exact yields on cost are, so take my last statement with a grain of salt.
Source: My Recent Home Depot Article
So this gentleman now receives a yield of 24% on his original investment! Now, let’s take a look at the security of that yield:
So he’s receiving 24% on his original investment ($100k x 24% = $24,000 for example), and this yield is iron clad. That is, Home Depot is paying out only 54% of his free cash flow. And while, yes, Home Depot will suffer from the potential recession, its yield is most likely not going anywhere. Further, many areas around the United States have deemed Home Depot essential services. @Vandooman has a safe 24% yield, on which he can almost surely rely for income.
Ok, I get it. I get it. Some of my readers are in their 60s, 70s, 80s, or even 90s. You don’t have time to wait for dividend growth to get you your 24% yield!
Well, I am sorry to say that investing just does not have shortcuts. Nothing in life offers shortcuts to the front of the line, without the corresponding risk of being sent to the back (aka a dividend elimination)! That is true in anything we as humans do. Whether it’s exercising, learning a new skill, investing, or developing a relationship with another person, there’s one common theme: You need patience and time. Nothing happens overnight.
As it is in life, so, too, is it in investing.
Alright, enough chatting! Let’s take a look at 4 high yield dividend opportunities for you to buy today! For the following 4 picks, I will focus primarily on their financials. I will provide links to my more in-depth discussions, or articles that I find cover these securities well.
Lest I make this article far too long, I will focus the following on the security of each company’s dividend. Most of these companies you know already, and they are generally easy to understand.
Pick #1: The Home Depot
Home Depot is once again reaching the “blood in the streets” level. Could it fall more? Sure. But today, one can purchase a secure 4% yield that has much room to grow over the coming years, especially once the dust settles from the virus, and interest rates crater to points never seen before.
The Home Depot’s Business
I discussed Home Depot’s business at great length in this article recently. Home Depot has cratered since, however, I’d like to point out that the returns projected in that article will likely still transpire over the coming decade, but they may be slow to arrive over the coming year or two. In that article, I essentially highlighted the methods by which Home Depot has differentiated itself from its online retail competitors. Additionally, I highlighted that Home Depot’s business is actually one where most of the products it sells cannot be efficiently sold online; therefore, there will always be demand for DIYers and professional builders to seek out Home Depot’s offering.
So let’s check out the dividend in a series of charts:
As can be seen above, Home Depot’s dividend yield has not been this high since the great recession. This is the market telegraphing to us that the level of risk in the yield is now higher. So let’s check out what that risk might be. That is, how secure was this yield prior to a potential 30% decline in free cash flow due to a virus induced recession.
As can be seen above, Home Depot has maintained a conservative cash payout ratio of about 50% for the last couple years. This cash payout ratio has increased rapidly not because Home Depot’s business free cash flow hasn’t been growing; rather, it’s grown because Home Depot’s dividend has grown rapidly.
The above chart illustrates that Home Depot has grown its dividend at approximately 20% annually for the last 10 years.
In closing, Home Depot has a highly secure yield that will continue to grow quickly over the next ten years. For more on the returns one should expect from Home Depot, please use my price target in this article and use today’s share price as your starting price; with which you’ll be able to easily determine potential returns from Home Depot.
Pick #2: Broadcom
- Author’s Note: I wrote this article when Broadcom (AVGO) was trading at much lower levels. I edited the rest of the article to reflect present conditions; however, I am keeping the original charts for Broadcom, as it illustrates my analysis to a better degree.
Broadcom’s rapid decline is easily understandable. The company produces and sells semiconductor chips that are essential for the function of various communication devices. Many of these devices are manufactured in China, then shipped abroad in an array of different products. Hence, Broadcom’s exposure to the epicenter of the virus has resulted in the decimation of its share price. Further, with demand cratering for the electronic devices in which Broadcom’s chips are installed, it’s no surprise that the company’s stock has been sold off aggressively.
But it’s not all bad. The company’s yield is approaching that “sucker yield” level; however, as I will demonstrate, there’s a very high likelihood that Broadcom does not slash its dividend, and once the virus dissipates, some degree of Broadcom’s projected 11% top line growth in 2020 will continue yet again.
First, let’s start with Broadcom’s dividend yield, which we see below.
As you can see, its dividend yield is the highest it’s been in the company’s history. At 6%, we’re getting to the point where we must be extremely, extremely skeptical. So let’s play out some scenarios aided by the data we have for Broadcom.
As can be seen above, Broadcom’s cash payout ratio was 48% prior to the virus. Now, let’s project that Broadcom experiences a 30% decline in free cash flow this year.
In a 30% free cash flow decline scenario, Broadcom’s free cash flow would become $6.65B, which still exceeds its current dividend payment “obligation” of $4.5B, which creates Broadcom’s 6% yield.
Alright, how about a completely nightmarish scenario where its free cash flow (and correspondingly its revenues) declined by 50%? Even in such a circumstance, Broadcom would be able to continue to pay its dividend, albeit with not much comfort.
For a much more in-depth dive into Broadcom, please read my article on it here, entitled “Oil Might Be Dead, But Chips Are Just Getting Started”.
Pick #3: BlackRock
In February, I wrote about BlackRock, although my review was not very flattering. My math told me that BlackRock (BLK) would underperform the market by a pretty good margin when the share price was in the high $500s. I wrote that one should wait until the low $400s to enter into this high yielder.
And now the day to buy has come!
For those that aren’t aware of BlackRock’s business, it’s the largest asset manager on earth. BlackRock produces and manages the wildly popular iShares ETF line, in which millions will invest over the coming year, as they scurry away from individual stocks and into safe havens. And while BlackRock’s business will inevitably suffer due to its fee structure (which is often based on value of assets under management), it will continue to faithfully pay its dividend to its investors.
And here’s the math to support that claim!
First, let’s start with BlackRock’s dividend yield.
As can be seen above, BlackRock’s yield has not been this high since… well, forever.
So does that mean it’s unsafe? Let’s investigate further.
As can be seen above, its cash payout ratio has been quite high lately, which does not portend strength in its dividend moving forward. However, in light of BlackRock’s balance sheet, which has $5B in cash and $3B in receivables, the company will likely initiate a year worth of dividend freezes, while maintaining its current dividend policy. This will be so because the company’s free cash flow should decline between 15% and 30% due to the current economic turmoil, just as it did during 2008-2009.
As can be seen above, in a 30% decline scenario, BlackRock would indeed reach a cash payout ratio somewhere around 100%, which is the point at which all free cash flow is being paid out in the form of a dividend. This is also the point where the dividend’s security comes under severe scrutiny.
But I believe that with its balance sheet strength, the potential shortfalls will be easily swept away.
The graph above illustrates this cushion that BlackRock possesses to defend its dividend.
If you’d like to read a much more in-depth analysis of BlackRock, please check out my article entitled, “BlackRock’s Stagnant Growth Is Positioning It For An Underwhelming Decade Ahead“. And to be clear, while it was a bad buy at $575, it’s a fantastic buy at or below $400!
Pick #4: Verizon
The prior three stocks have a very high likelihood of beating the market over the coming decade, if one were to buy them at this week’s prices. Verizon (VZ), on the other hand, likely won’t beat the market, but it will provide stable, secure dividend income for those whose goals revolve around income.
As can be seen above, Verizon’s dividend hasn’t spiked all that high relative to the other stocks I highlighted in this article. Such is the case for a couple reasons:
- Verizon provides a utility-like communications service that is now more important than it’s ever been. The last expense consumers will remove from their financials is their Verizon subscription. What’s more, Verizon’s customers are largely wealthier folks (relatively speaking), who can afford the premium service that the company offers.
- Verizon’s cash payout ratio is very low, meaning that it could actually grow its dividend during this potential recession.
Verizon is the premium cell phone carrier in the U.S. As someone who serves in the U.S. Army, I have a very large data sample from which to select and study.
In almost all cases, if your fellow soldiers have service at some base in BFE in the U.S., those soldiers have Verizon. T-Mobile (TMUS) and AT&T (T) struggle to provide service on many military bases throughout the U.S, which is the yardstick I use to determine who provides the highest quality service in the U.S. T-Mobile is certainly the worst, but AT&T isn’t that much better.
Further, these soldiers who use Verizon actually get 4G often in the middle of nowhere, while T-Mobile and AT&T struggle to make basic phone calls. My point is that Verizon is categorically the best cell phone carrier in the U.S. That is, the company has a veritable moat that enables them to charge more, which in turn rewards shareholders.
And here’s the evidence of this moat:
According to Business Insider, Verizon has a customer retention rate of 90% versus a customer retention rate of 84% for AT&T. So my personal experience largely aligns with consumer experiences as well, as evidenced by Verizon’s higher retention rate.
Now, let’s turn our attention to Verizon’s cash payout ratio.
As can be seen above, Verizon consistently maintains a very conservative cash payout ratio at about 60%. Now, let’s check out what this means in terms of actual dollar amounts.
As can be seen above, Verizon’s free cash flow exceeds its total dividends paid over the last 12 months by $6B.
I expect that that will not change materially due to a recession. In fact, I wouldn’t be surprised if Verizon raised its dividend this year, as it did during the great recession.
There are two key takeaways with which I’d like my readers to leave this article:
- Investing is a long term game (for 99.9% of investors), and even for short term, successful traders, maintaining a long term perspective is essential for their success. There are countless other ways to generate yield rather than buying a 10%+ yielding stock or junk bond that will almost assuredly implode.
- For each of these stocks, I analyzed their “cash payout” ratio, which is essentially (Total Dividends Paid/Free Cash Flow). This differs from a company’s “payout ratio” in that it removes non-cash expenses that can create distortions in a company’s ability to pay its dividend. FedEx (FDX) is a huge offender of creative accounting that communicates a distorted ability to pay its dividend when in reality the company isn’t generating sufficient cash as to cover its dividend (without using debt to fund it)
The manner in which I go about my investing operations entails purchasing non-dividend yielding stocks/non-share repurchasing stocks that will one day generate a dividend/buy back shares.
To further illustrate my strategy, take for example the financial lifecycle of a human being. There is the accumulation phase and there is the distribution phase. During the accumulation phase, a human being is at their peak productivity. They are taking on debt to fund their lives. They are aggressively growing every facet of their life. Eventually, however, they will reach the point at which they want to bask in the fruits of their labor. Thus, they enter into the distribution phase.
And I’ll say it again:
As it is in life, so, too, is it in investing.
Companies engage in the same lifecycle. They begin in the “accumulation phase”, and at some point, they reach the distribution phase. The key is to find the companies that are in the sweet spot of distribution, where you generate yield immediately, but also have the opportunity to grow the yield over the next 5, 10, 20, and 30 years. In the above chart, these companies would be “55-65” years old.
I will stop here, as this article could get ridiculously long!
As always, thanks for reading; please remember to follow for more; and happy investing!
Disclosure: I am/we are long AVGO, HD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have my eye on initiating a position in BLK. I won’t buy VZ simply because the total return isn’t significant enough, but for the right investor, VZ could be a great buy, as its dividend will continue to grow safely at a modest, but reliable pace. WM is another stock that has become attractive that fits this bill!
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.