Dividend stocks are a multi-purpose instrument of the markets. They offer investors a dual route to profitable returns, including some defence against challenging market conditions along with a stable source of passive income. This is an attractive combination.
The best dividend stocks will provide inflation-beating income based solely on the dividend and backed by a long-term history of reliable payouts. For investors, it's a win-win situation: when stocks go up, you make money, but when they go down, you can still make money.
Wall Street analysts aren't shy about recommending companies with high dividend yields, and we found two among their recent picks with dividend yields as high as 10%. That's already a solid yield, but these stocks also have a "Strong Buy" rating from analysts - so let's dive into the data and find out what makes them such interesting additions to a portfolio.
Sunoco LP $SUN+0.9%
First up is Sunoco, one of the big American brands. The company has a long history in the energy industry, primarily as a manufacturer and supplier of motor fuels. Sunoco's product line includes various formulations of gasoline, diesel and jet fuel, which are offered in both branded and unbranded versions. The company manages a distribution network consisting of gas stations, convenience stores, independent dealers and commercial distributors with more than 10,000 locations in 40 states.
Sunoco's retail fuel sales are supplemented at gas stations and convenience stores with the usual "value-added" products, including snacks and beverages, and the company also provides dispensing facilities for gas station and fleet customers.
Sunoco is making a significant contribution to the expansion of the "green" economy and is developing solutions for the recovery of mixed fuels, i.e. gasoline, diesel and aviation fuels that have become mixed and unusable in the transportation pipeline. The company collects and processes these mixed fuels into usable products, reducing both fuel waste and pollution damage.
Given all this, Sunoco's latest quarterly update was somewhat mixed. The company reported Q2 FY23 earnings of $5.75 billion, down 26% from the prior year, although that amount beat expectations by $28 million. The bottom line, while profitable, was not as optimistic; the earnings per share figure of 78 cents was 47 cents per share lower than expected.
For dividend investors, the key metric is distributable cash flow, which was reported at $175 million for the second quarter, which compares favorably to $159 million in the second quarter of the prior year. This supported the declaration of a second quarter dividend of 84.2 cents per common share, or $3.36 annualized. At the annualized rate and current stock valuation, the dividend represents a yield of 7.1%, more than double the average dividend seen among S&P 500 companies and nearly double the 3.7% annualized inflation reported for August.
According to Justin Jenkins, a five-star analyst at Raymond James, Sunoco is notable for its ability to remain profitable and generate cash, qualities that will support a continued high dividend yield. He writes of the company, "Given the strong execution, confidence in continued profitability improvement and growth potential through medium-term business optimization and M&A opportunities, we remain constructive on Sunoco. These efforts, coupled with capital/cost discipline, have enabled us to generate significant free cash flow, which has provided the balance sheet with solid flexibility that will be used to further grow the business (both organic and inorganic). Although the macroeconomic environment continues to "throw sticks", we see a stable to positive volume trend in 2023, supported by increased fuel margins. This is complemented by a healthy list of attractive acquisitions and organic projects that create long-term value, with further M&A likely to contribute to growth."
Jenkins also rates SUN stock as Outperform (Buy) with a target price of $53, suggesting room for 12% upside over the next 12 months.
Five recent analyst ratings for SUN include 4 "Buy" ratings versus 1 "Hold" rating, implying a consensus rating of Strong Buy. Based on an average target price of $51, the stock has a one-year upside potential of 7.5%; adding in the dividend, the total return potential is close to 15%.
Ares Capital Corporation $ARCC-0.5%
The next stock on our list is Ares Capital Corporation, a BDC or business development company. These companies are specialty lenders that provide credit and financial services to small businesses that don't necessarily qualify for the services of traditional commercial banks. ARCC's combination of equity financing, lending services and the provision of financial instruments is essential to its clientele and fills an important gap in the U.S. small business environment.
Since going public in 2004, ARCC has invested more than $21 billion in 475 companies and delivered a 12% return to shareholders. The company boasts a market capitalization in excess of $10.7 billion, making it the largest publicly traded BDC in the U.S. markets. The portfolio behind this performance is diverse and balanced, with a healthy asset mix. Of the total, 22% is in software and services, 11.3% in healthcare services and 8.7% in commercial and professional services. Other sectors represented in the portfolio include energy, insurance and consumer durables. Less than 42% of the portfolio consists of senior secured first lien loans and another 18.1% of senior secured second lien loans.
For investors, results are the most important. Ares reported total investment income of $634 million for 2Q23, up from $479 million in 2Q22 - a 32% increase year-over-year and beating guidance by $11 million. At year-end, Ares reported earnings of 58 cents per share, 1 cent above estimates and well above the 46 cents per share reported in 2Q22. The company boasted cash and liquid assets of $411 million as of June 30, a 35% improvement over year-end 2022.
Profitable operations and solid cash reserves support the company's 3Q dividend, which was declared on July 25 with a payout on September 29. The dividend of 48 cents per common share amounts to $1.92 annualized and yields 10%. The company's dividend history dates back to 2004, when regular quarterly payouts alternated with variable extraordinary payouts.
KBW analyst Ryan Lynch points to Ares' history of generating returns and surviving the ups and downs of credit cycles. He says of the stock, "ARCC has a great underwriting and credit quality track record, has delivered some of the best economic returns in the sector, and has a best-in-class credit platform. ARCC has one of the longest histories and has been through several credit cycles with very good results. ARCC's dominant platform and broad, long-standing sponsor relationships will help it continue to capture a significant share of the growing direct lending market. ARCC has a best-in-class commitment structure that is low-cost, diverse, long-term and flexible with multiple investment grade ratings that have funded and will continue to help fund the growth of their portfolio."