3 Ultra-High-Yielding Dividend Stocks to Buy

Who doesn’t love dividend income? There’s something satisfying in receiving a fat dividend check and getting that tangible affirmation that your money is working for you. But it gets better: For most investors, qualified dividend income is generally taxed at a lower rate than earned income, so you keep more of your hard-earned money from Uncle Sam’s prying hands.

Even better is getting a supersized payout in a time when your savings account is offering peanuts. Still, there’s a paradox when investing in these ultra-high-yielding stocks. High yields are often a sign that the market has low confidence in the company’s ability to continue to pay. Stocks like this are often called “yield traps.”

But what if you can find companies where the market has it wrong? I believe I have three such stocks in my portfolio: Altria Group (NYSE: MO), AT&T (NYSE: T), and Lumen Technologies (NYSE: LUMN).

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Dividend safety 101 and 202

Before we begin, it’s important to discuss the key dividend coverage metrics that all dividend investors should know — and why they’re all wrong. The most simplistic measurement is the dividend payout ratio: essentially, total dividends divided by net income. This is flawed, because dividends are paid from cash and not net income, which includes non-cash charges like depreciation and amortization.

A better measurement is the free cash flow payout ratio (aka cash dividend payout ratio). Even that is flawed. First, there’s no official measurement of “free cash flow” according to generally accepted accounting principles (GAAP). Most analysts use the backhand formula of cash from operations minus capital expenditures (capex).

However, even tenured analysts misunderstand two critical issues with using free cash flow. The first is that depreciation is simply an estimate and not reflective of the economic generating life of an asset. For example, cars have an estimated useful life of five years, but how many decade-old fleet vehicles have you seen in service? Likely quite a few.

The second issue — which I consider the most critical — is that all capex is not created equal. Maintenance capex (i.e. replacing a roof at a factory) is not as productive as growth capex (buying a new factory for expansion), but it is critical for business continuity.

Unfortunately, companies rarely disclose maintenance capex figures. However, a rule of thumb I employ is maintenance capex should grow annually at the five-year average annual growth rate of revenue or depreciation, whichever is greater.

If revenue and depreciation expenses are decreasing during this time, it’s reasonable to assume that the company isn’t investing in growth and so all reported capex is maintenance. On the other hand, if capex growth significantly exceeds revenue and depreciation expenses, it’s important to investigate further to assess if management is spending on low-profitability projects or if it has been deferring critical maintenance capex until being forced to upgrade.

If owning Altria is wrong, I don’t want to be right

As a tobacco company, Altria faces two distinct yet interrelated problems. The first is that due to a strong government campaign over the last 50 years, including aggressive taxation, smoking rates are near all-time lows. Still, the company has done an admirable job growing cash from operations since 2014, mostly by increasing cigarette prices.

The second is an investor problem: In a world of growing demand for ESG-friendly stocks, cigarette makers rival gun makers for investor antipathy. Ironically, both of these issues have been beneficial for long-term Altria investors. Government regulation has essentially kept new entrants out of the space, including minimizing the threat from substitute products like vaping and e-cigs (to Altria’s detriment with its Juul acquisition). Lack of investor interest has kept Altria’s stock price low and dividend yield above 8%.

Altria is certainly not an ESG stock, but I’d argue it is one of the true standouts in corporate governance. The company has a stated goal of essentially returning every penny it can to shareholders. Last year, its free-cash-flow payout ratio was a serviceable 80%. Barring any unforeseen circumstances, the company will continue to execute on its vision of returning cash to shareholders. That will likely include further dividend increases, building upon Altria’s 50-year streak of raising investor payouts.

AT&T’s debt load and dividend are manageable

AT&T faces the same fundamental issue as Altria in that it has exposure to a declining business: in this case, subscription-based television. This affects the company from the delivery side with its DirecTV subsidiary, but also through its network holdings, Turner Entertainment Holdings and CNN Worldwide. At the same time, AT&T has nearly $160 billion in total debt, a figure rivaling many banks.

Still, the debt is manageable thanks in part to low interest rates and in part to the unique profile of AT&T’s business. Wireless telephony and television have recurrent subscription-based billing. Additionally, both have considerable barriers to entry that keep competition manageable. AT&T’s free cash flow payout ratio was in the 50% range for the last two years, helping the company to pay down approximately $40 billion in debt, which will ease pressure on its cash flow in future periods.

Lumen suffers from the “once bitten, twice shy” phenomenon

Lumen has two issues working against it in the market. The first is that many investors are initially unaware of the company’s history. The second is when they find out the company was formerly CenturyLink, which was a high-yield darling until it cut its dividend by more than half in early 2019.

However, the circumstances have changed. The dividend no longer unmanageable, standing at a free-cash-flow payout ratio of approximately 37% in 2019. Additionally, the company is working to capitalize on lower interest rates by refinancing its debt and using the interest savings to pay off debt. Once income investors see that Lumen isn’t the same CenturyLink, literally and figuratively, it’s likely there will be more upward pressure on the share price.

Jamal Carnette, CFA owns shares of Altria Group, AT&T, and Lumen Technologies. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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