Before you buy a high-yield stock, you need to make sure you understand the basics of the business you are buying.
Buying stocks based on one aspect of a company is a mistake, but often, investors get fixated. Income-focused investors, for example, often give dividend yield too much sway in their investment decisions. That can be a mistake. Take three of the highest yielders in the S&P 500 index as a starting point. Altria (MO -0.88%), AT&T (T 0.84%), and Healthpeak Properties (NYSE: DOC) have huge yields, but they all have warts, and one looks like it could be a terrible long-term investment. Here's what you need to know before buying any of them.
Altria: Avoid businesses that are dying
Altria has a huge dividend yield of 9.3%. It has increased its dividend regularly for years. It hails from the consumer staples sector, which is generally considered a conservative area of the market. It also has a dominant position in the market it serves thanks to its ownership of an iconic brand, Marlboro. That last fact is actually the problem.
Altria is a tobacco company that sells cigarettes in the United States, where smoking has been increasingly frowned upon. To put a number on that, the company produced 76.3 billion cigarettes in 2023, down from 101.8 billion cigarettes in 2019. That's a 25% drop in just five years! The company has managed to offset the impact of the volume decline by steadily increasing its prices. But, at some point, price increases will likely exacerbate the decline. Most investors will be better off avoiding a business that appears to be in long-term decline.
AT&T has a dominant position but a lot of debt
AT&T has a sizable 6.7% dividend yield. It has increased the dividend annually for years. It is one of a small number of large, dominant cellular communication providers in the United States. Its coverage network is large, and it would be hard and expensive for an upstart company to replace it. In other words, AT&T has an entrenched position in a business that attracts a large group of loyal customers who happily and reliably pay their monthly cellphone payments. AT&T generates a lot of cash flow to support its dividend.
The problem with AT&T's business is that it is capital-intensive. It was not only expensive to build, but the company also has to maintain it and upgrade it as cellphone technology advances. AT&T's balance sheet is heavily leveraged because of this. While the use of leverage isn't unusual in the cellphone space, its debt-to-equity ratio of 1.3 times is not the lowest of its comparable peer group and has risen 40% over the past five years. Although the dividend is likely safe, investors need to understand that AT&T's balance sheet needs to be monitored closely.
Healthpeak Properties is designed to pay dividends
Healthpeak Properties is a bit different from the other two stocks here because it is a real estate investment trust (REIT). This is a business structure specifically designed to pass income generated from institutional-level rental properties on to investors in a tax-efficient manner. The high 6.6% dividend yield isn't that unusual in the REIT space. However, it is still important to understand exactly what Healthpeak Properties does.
This REIT, as its name implies, owns medical properties, specifically medical offices and medical research facilities. Over time, given the increasing size of older age cohorts, this should be an attractive focus. However, buying properties generally involves the use of debt, and interest rates have been on the rise of late. That will lead to higher operating costs, a fact that has investors worried about near-term performance. Fourth-quarter 2023 financial results were, essentially, flat year over year. So, there is a reason for concern, but over time, it seems highly likely that Healthpeak's business focus will allow it to continue paying a reliable and sizable dividend.
One to avoid, two to learn about
At the end of the day, most investors will probably want to avoid Altria's high yield and slowly dying business. AT&T and Healthpeak are much better companies on which to spend your valuable time doing research. That said, both of these high-yield stocks have problems to face in the near term, though over the long term, their strong businesses will probably allow them to keep paying dividend investors well for sticking around.
Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends Healthpeak Properties. The Motley Fool has a disclosure policy.
