We recently compiled a list of the 10 Extreme Dividend Stocks With Upside Potential. In this article, we are going to take a look at where Enterprise Products Partners L.P. (NYSE:EPD) stands against the other extreme dividend stocks with upside potential.
Investors often prefer high-yielding stocks for immediate returns. However, dividend growth stocks offer more substantial long-term advantages, such as increasing income, capital appreciation, and reduced volatility. While many investors are drawn to the instant rewards of high-yield stocks, it’s important to be cautious with excessively high yields, as they can indicate underlying financial difficulties. Analysts recommend careful consideration when dealing with very high yields. That said, the stock market is a bit of a wild card—past performance isn’t a reliable predictor of future outcomes. While dividend growth equities have provided strong returns in the past, high dividend yield stocks have also performed well, showing robust returns. This is due to the stock market’s inherent volatility—what works at one time may not be as effective later, and the timing of successes is often uncertain.
Also Read: 10 Best Dividend Stocks with Over 9% Yield According to Analysts
Yin Chen and Roni Israelov, in their study Income Illusions: Challenging the High Yield Stock Narrative, published in the March 2024 Journal of Asset Management, divided stocks into high-dividend and low-dividend categories based on their median dividend yield from the previous year. They examined how dividends affected investment returns under different scenarios. Their research spanned from January 1964 to December 2021 and included the top 1,500 U.S. stocks. The high-dividend portfolio outperformed in both returns and risk, achieving an average annual return of 13.8% with 15.6% volatility. In contrast, the low-dividend portfolio delivered lower returns of 11.8% but with significantly higher volatility at 21.9%. This led to a 3.6% difference in the compound annual growth rate. In addition, the high-dividend portfolio experienced smaller drawdowns during market corrections. Despite the high-dividend stocks’ overall superior performance throughout the entire sample period, investing in a long-short portfolio yielded nearly a 1% annual loss from 2003 to 2021, with the best returns occurring between 1983 and 2002.
Studies like these can confuse investors who often believe that high-yield dividend stocks are inherently risky. However, that’s not always the case. When investing in high-yield stocks, it’s important to evaluate several key metrics, such as payout ratios and debt levels. High-yield stocks usually pay out a significant portion of their free cash flow as dividends, resulting in a high payout ratio. They may also use debt to fund these dividends, leading to higher leverage and increased risk. These factors can make high-yield stocks more vulnerable to dividend cuts during tough times, which can reduce income and potentially lead to significant declines in stock prices.
If payout ratios, debt levels, and fundamental metrics align well, investing in high-dividend stocks might not be a poor choice. Analysts have supported these equities, though it depends on specific market conditions. Brian Belski, BMO’s Chief Investment Strategist, has noted that the “indiscriminate selling” of high dividend payers presents a potential opportunity for investors. He pointed out that, over the past thirty years, high dividend-yielding stocks have only underperformed the broader market during two periods: the tech bubble and the pandemic. Belski suggested that such abnormal underperformance often signals a turning point, with these stocks typically experiencing a strong recovery afterward. Historically, they have outperformed the broader market by over 20% on an annualized basis from trough to peak in relative year-over-year returns for nearly a year, and continue to show above-average performance for nearly two years following the peak.
If this situation holds true and the fundamentals continue to be solid, we would be interested in including these equities in our portfolios as well. With that, let’s look at some of the best dividend stocks with upside potential.
Our Methodology:
For this list, we screened for dividend stocks with yields higher than 7% as of August 14. Then, we narrowed down the choices by finding stocks with the highest upside potential according to analysts. Among those stocks, we chose companies that have relatively stable dividend histories, however, a lot of the companies on the list don’t have a consistent record of paying dividends due to their exceptionally high yields. Many of the companies listed below are part of the REIT and energy sectors, as these industries are generally known for their high yields. The stocks are ranked in ascending order of their upside potential, as of August 14.
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Aerial view of a refinery tower surrounded by the sprawling landscape of pipelines in an oil & gas midstream facility.
Enterprise Products Partners L.P. (NYSE:EPD)
Upside Potential as of August 14: 18.16%
Dividend Yield as of August 14: 7.36%
Enterprise Products Partners L.P. (NYSE:EPD) is a midstream natural gas and crude oil pipeline company that provides related products and petrochemicals. The company benefits a lot from its business model as midstream companies own essential infrastructure like pipelines, storage facilities, and transportation systems. These assets are crucial for linking the upstream sector (drilling) with the downstream sector (refining and chemicals) and for connecting to global markets. These companies typically earn revenue by charging fees for the use of their infrastructure, making them toll-taker businesses. Consequently, their financial performance is more influenced by energy demand than by energy prices. Since energy demand remains strong even when prices are low, this provides stability.
Enterprise Products Partners L.P. (NYSE:EPD) is also a great investment from a dividend point of view. Firstly, it has strong cash generation capabilities. In the second quarter of 2024, the distributable cash flow (DCF) came in at $1.8 billion, up from $1.7 billion in the same period last year. Its operating cash flow also grew to $2.1 billion during the quarter, from $1.9 billion in the prior-year period. For the twelve months ending June 30, 2024, the company’s payout ratio, which includes distributions to common unit-holders and buybacks of partnership common units, was 55 percent of adjusted cash flow from operations.
In addition to this, Enterprise Products Partners L.P. (NYSE:EPD) has raised its dividends for 26 consecutive years. On July 11, the company announced a 1.9% hike in its quarterly dividend to $0.525 per share. In the second quarter of 2024, the company’s DCF covered these dividend payments by 1.6 times, and it retained $661 million in DCF. As of August 14, the stock offers an impressive dividend yield of 7.36%. Analysts hold a consensus Strong Buy rating on EPD with a $33.7 price target, showing an 18% upside potential.
Overall EPD ranks 5th on our list of the extreme dividend stocks with upside potential. While we acknowledge the potential of EPD as an investment, our conviction lies in the belief that some deeply undervalued dividend stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for a deeply undervalued dividend stock that is more promising than EPD but that trades at less than 7 times its earnings and yields nearly 10%, check out our report about the dirt cheap dividend stock.
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Disclosure: None. This article is originally published at Insider Monkey.
