TBB - Best Dividend Stocks For Passive Income Investors

2023-04-26 10:00:00 ET

Summary

• Dividend stocks are the best vehicle for passive income investing.
• However, not every dividend stock makes for a good passive income investment.
• We share some investment ideas for building a passive income portfolio that you can count on.

Dividend stocks are the best vehicle for passive income investing . This is because they provide the best combination of true passivity, reliability, growth, and ease of diversification of all the passive income investment options.

However, not every dividend stock makes for a good passive income investment:

• Some stocks may pay a dividend, but their yield is simply too low to make it a practical passive income investment. For example, Apple ( AAPL ) and Microsoft ( MSFT ) both pay dividends and even have impressive dividend growth track records. They also have stellar balance sheets and powerful competitive advantages. Nevertheless, their yields are simply too low at present to make them practical passive income generators, though they may very well be great long-term wealth compounders.

• Other stocks may offer an attractive dividend yield, but the payout is ultimately not sustainable due to the balance sheet being weak, the business model being too cyclical, and/or management simply misallocating capital. A business that had to slash its distribution due to the balance sheet becoming overleveraged was Energy Transfer ( ET ) back in 2020 when its investment grade credit rating was put at risk by the crash in energy prices following the COVID-19 outbreak and the Saudi-Russian oil price war. A business that recently went from Dividend King to deeply slashing its dividend is V.F. Corporation ( VFC ) as the cyclical nature of its business combined with inflationary headwinds to force its hand on its dividend. Finally, a business that recently slashed its dividend due to years of gross capital misallocation by management is AT&T ( T ). It overpaid for numerous businesses that ended up significantly underperforming management expectations, leaving it with a pile of debt and weak earnings.
• Still, other income stocks may offer attractive payouts that are even sustainable. However, they do not grow sufficiently over time to make them inflation-resistant passive income streams. An example of this can be found in the fixed income (preferred ( PFF ) ( PFFA ) and bond ( BND )) segments of the market, as fixed income securities do not typically grow their payouts over time. While it is not necessarily bad to have these as part of a diversified portfolio, it is essential to properly diversify elsewhere to make sure you are also getting some income growth. Otherwise, your purchasing power will gradually be eroded by inflation.

In the rest of this article, we will share some investment ideas for building a passive income portfolio that you can count on.

#1. Realty Income Stock ( O )

O is widely regarded as the gold standard triple net lease REIT, and for good reason. First and foremost, it has a very impressive long-term track that includes 27 consecutive years of growing its dividend at a 4.4% compound annual dividend growth rate. This easily beats the average rate of inflation over that span, making it a great high-yield dividend stock for preserving one's purchasing power. Moreover, it has delivered compound annual total returns of over 14% since going public in 1994, making it a tremendous wealth compounder as well.

Last but not least, it enjoys a low-risk profile as evidenced by its A- credit rating, 11,733 properties, 1147 individual tenants, and 8.8-year weighted average triple net lease term remaining. It further enhances its strength by deriving 43% of its rental income from investment-grade tenants and having 95% of its debt unsecured and 88% of its debt at fixed interest rates.

Given its very strong performance during the great recession following the financial crisis as well as during the COVID- 19 lockdowns, O is a great pick for stable sleep well at night passive income during these current uncertain times.

#2. Enterprise Products Partners Stock ( EPD )

EPD is another great source of dependable, ample, and regularly growing passive income. Its dependability stems primarily from its world-class and well-diversified portfolio of midstream infrastructure assets. As a result, it has been able to grow its distribution per unit for 24 straight years, with many more years of growth likely to follow. His portfolio reaches every single one of the United States' major shale basins and ethylene crackers. It also has a strong position in energy exports along the Gulf Coast as well as a competitively positioned petrochemical business.

By generating the vast majority of its cash flows from fixed fee take-or-pay commodity price resistance long-term contracts, EPD has been able to generate double-digit returns on invested capital across a wide variety of economic and energy industry conditions over the years.

Perhaps its greatest strength is its balance sheet, which is arguably the best in the midstream sector. His credit rating is BBB+, but probably should be A-. Its leverage ratio is 2.9x, which is extremely conservative for a business of its nature.

Moving forward, management has signaled pretty clearly that it intends to grow its distribution at a mid-single-digit rate for the foreseeable future. When combined with its low-risk profile and 7.3% current yield, the risk-reward here is very attractive.

#3. Blackstone Stock ( BX )

Last but not least, BX stock is a great passive income generator as well as a long-term wealth compounder. It is the world's largest alternative asset manager, with nearly $1 trillion in assets under management. Despite its immense scale, it still managed to grow its assets under management by 8% year-over-year in the first quarter of 2023. Moreover, his perpetual capital assets under management are growing even faster, up 13% year-over-year in the first quarter to $380.5 billion.

The incredible scale affords the company numerous competitive advantages, including:

• Economies of scale that enable it to hire extremely large and talented pools of employee talent.
• A treasure trove of proprietary industry and macroeconomic data from which they can generate alpha.
• A very strong name brand which assists in raising capital.
• Immense deal flow for both acquiring and selling businesses.
• A low cost of capital.

In fact, BX boasts an A+ credit rating along with substantial liquidity:

This is on top of the nearly $200 billion in total dry powder in its funds.

While Blackstone's dividend has been choppy on a quarter-to-quarter basis due to the lumpy nature of its performance-based fee realizations and its 85% dividend payout ratio policy, over time the company has proven to be a very prolific dividend grower and wealth compounder, significantly outperforming the S&P 500 ( SPY ) in both categories over time:

Investor Takeaway

Dividend investing is an extremely powerful tool for building a reliable, growing, sufficiently diversified passive income stream. However, investors need to be wary of the stocks they buy to fill out their portfolios. Investors interested in taking a completely passive approach may simply want to buy popular dividend growth ETS like the Schwab U.S. Dividend Equity ETF ( SCHD ) and the Vanguard High Dividend Yield Index Fund ETF ( VYM ) and call it a day. However, given that these funds offer sub-4% yields, investors who are willing to do a little bit of research can generate substantially superior yields while still generating attractive growth and enjoying sufficient reliability by investing in stocks like O, EPD, and BX.

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