This is a guest post by Tom Hutchinson, Chief Analyst, Cabot Income Advisor
Tremble with fear: Interest rates are sky-high these days, people.
The benchmark 10-year Treasury bond yield spiked 90% higher in just the first three months of this year. That stratospheric leap took the rate on the bellwether bond all the way to … 1.75%. And these higher rates are filtering through the bond and fixed income markets.
Now, you can get about 0.75% on a two-year CD. The iShares iBoxx Investment Grade Corporate Bond ETF (LQD) now yields a whopping 2.71%. The yield on a AAA-rate 20-year municipal bond is all the way up to 1.5%. And get this: Rates are likely to move even higher over the rest of the year.
Rates like this could keep you in beer money for a year if you invest enough. Sure, after taxes and inflation you’ll probably lose money. But that’s the brave new world. It looks like these pathetic low rates on traditional fixed income investments are here to stay.
Fortunately, there are other places to find a decent yield and income, even in this low-rate world—namely, in high-dividend stocks.
Yields on certain income-paying securities are higher than they have been in a decade. While the S&P 500 is near all-time highs, many income-paying stocks took a beating during the pandemic and are still priced well below pre-pandemic levels.
Solid companies have maintained their dividends through the tumult. And yields are still extremely high at these low prices. At the same time, businesses are recovering strongly, and prospects are likely to greatly improve as the vaccines unleash a full economic recovery.
You can still get safe and juicy yields in a low-yield world if you know where to look. Here are two of the best high-yield stocks I’ve seen in the last decade.
High Yield Stock #1: Enterprise Product Partners (EPD)
- Distribution Yield: 7.7%
Enterprise is one of the largest midstream energy Master Limited Partnerships (MLPs) in the country with a vast portfolio of service assets connected to the heart of American energy production. It has $36 billion in annual revenues from an unparalleled reach in the industry that is connected to every major U.S. shale basin and 90% of American refiners east of the Rockies. It also has export facilities as well in the Gulf of Mexico.
The key feature of this business is that it’s very stable, sort of like an energy utility. Earnings are not dependent on the movement of volatile oil and gas prices. It’s like a toll collector that charges fees for services of piping and storing oil and gas. In fact, 88% of earnings are fee-based and backed by guaranteed contracts.
The unit price got creamed as demand for oil and gas fell off a cliff during the pandemic lockdowns. EPD fell 40% from right before the pandemic to early November. But that crash was mostly in sympathy with the rest of the sector, as many commodity price-dependent companies saw their profits crash.
Enterprise’s profits only declined about 10% for the year, in one of the most challenging years ever for the industry. Now, the stock is moving back up. EPD is up 42% since the vaccine announcement in early November. But it’s still around 25% below pre-pandemic price levels.
EPD didn’t go up nearly as much as most energy stocks during the big energy stock rally between the beginning of February and mid-March. It wasn’t perceived as “sexy” enough because profits weren’t rebounding as fast since they never went down that much in the first place. But the stock is trending in the right direction and that huge yield is rock-solid.
In 2020, distributable cash flow (DCF) covered the distribution by 1.6 times. That’s tops in the industry and considered very safe. And that’s through one of the worst years ever. Enterprise has also not only maintained but raised the payout every year since its IPO in 1998. EPD’s long history of annual distribution increases makes it a blue-chip stock for income.
High-Yield Stock #2: AGNC Investment Corp. (AGNC)
- Dividend Yield: 8.3%
AGNC is a mortgage Real Estate Investment Trust (mREIT) that invests predominantly in U.S. government-backed residential mortgages. It pays a high dividend yield, currently 8.3%, and makes dividend payments on a monthly basis. This makes AGNC a monthly dividend stock.
While typical REITs own actual physical real estate properties, charge rent, and pass that income onto shareholders, mortgage REITs are a different animal. They buy mortgages and generate income from monthly mortgage payments. A mortgage REIT borrows money at low short-term rates and uses that money to buy mortgages that pay a higher interest rate, making a profit on the difference in rates, or the net interest spread.
AGNC invests almost entirely in mortgages backed by Fannie Mae and Freddie Mac, so there is virtually zero credit risk. However, there is certainly interest rate risk. It’s all about the spread. If the difference between the short-term rates at which it borrows money and the mortgage interest paid increases, so do profits.
There are good times and bad times to own these securities. I believe now is a very good time. Here’s why–interest rates are rising, and the stock price is trending higher.
The Fed has a lot of control over short-term rates, as they set the benchmark Fed funds rate, which is currently near zero. The Central Bank has indicated that short rates will remain at current levels for some time. The bank has less control over long-term rates as the economy strengthens.
In fact, the 10-year treasury rate, a benchmark for longer-term rates including mortgages, is already on the rise. It has more than tripled from the low of 0.5% in the midst of the bear market to 1.57% today. It stands to reason that if the fuller economic recovery that the market is already pricing in comes to fruition, rates should climb further. And there’s room to run. The 10-year rate was over 3% in 2018.
With longer-term rates and mortgage rates rising and short-term rates staying the same, the net spreads and profits at AGNC are likely to climb. The stock has also been consistently climbing for the past year, but it is still a long way from pre-pandemic levels.
A fat yield with a good prognosis for the stock price should make AGNC a big winner for income investors.