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 Saratoga Investment Corp. (NYSE:SAR) 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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Saratoga Investment Corp. (NYSE:SAR)
Upside Potential as of August 14: 12.83%
Dividend Yield as of August 14: 13.33%
An American capital market company, Saratoga Investment Corp. (NYSE:SAR) ranks eighth on our list of the best dividend stocks with upside potential. The company provides debt financing and equity capital to middle-market companies. The stock has dropped nearly 17% over the past year, lagging behind its peer, Capital Southwest Corporation, which saw an increase of more than 7.5% during the same period. However, analysts believe that the company is well-positioned to perform well this year because of its strong operating performance. The company’s performance is supported by the high quality, resilience, and balance of its $1.096 billion portfolio, even amidst current challenges. Despite facing significant issues with two portfolio companies, Pepper Palace and Zollege, the company has taken decisive steps. In fiscal Q1 2025, it further reduced the value of both investments by $1.2 million, bringing their total remaining fair value to $4.4 million. The company has assumed full control of these investments through agreed-upon restructurings with previous sponsors. The restructuring of Zollege was completed in the first quarter, and the restructuring of Pepper Palace is approaching. The company is making management changes, improving capital structures, and adjusting business plans, which could enhance future recovery value.
In addition to its operating performance, Saratoga Investment Corp. (NYSE:SAR) is benefitting from stable interest rates as market forecasts suggest little change for the rest of the year. This stability has resulted in increased recurring net interest margins for the company’s portfolio in the most recent quarter, compared to the previous year. The company’s strong reputation and distinctive market position, combined with the ongoing development of sponsor relationships, are creating appealing investment opportunities for high-quality sponsors. Moreover, there are early indications of a potential uptick in mergers and acquisitions (M&A) within the lower middle market, as seen by several recent repayments. The company reported investment income of $38.7 million for fiscal Q1 2025, marking an 11.7% increase from the same period last year.
Saratoga Investment Corp. (NYSE:SAR) is one of the best dividend stocks on our list as the company has been growing its dividends consistently for the past seventeen quarters. It currently offers a quarterly dividend of $0.74 per share and has a dividend yield of 13.33%, as recorded on August 14. Street analysts maintained a consensus Strong Buy rating on SAR with a $25.06 price target, showing an upside potential of 12.83%.
Overall SAR ranks 8th on our list of the extreme dividend stocks with upside potential. While we acknowledge the potential of SAR 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 SAR 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.
