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 Starwood Property Trust, Inc. (NYSE:STWD) 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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A sky high view of the corporate headquarters indicating the large scale of the company.
Starwood Property Trust, Inc. (NYSE:STWD)
Upside Potential as of August 14: 13.4%
Dividend Yield as of August 14: 9.83%
Starwood Property Trust, Inc. (NYSE:STWD) is a Connecticut-based real estate investment trust company that invests in commercial mortgage properties. The stock surged by nearly 3% on August 3, when it announced its earnings for the second quarter of 2024. Though the company missed analysts’ estimates on various fronts, it managed to improve its debt-to-equity ratio. The company reported that its adjusted debt-to-equity ratio fell to 2.29x from 2.33x, reaching its lowest level in more than two years. A low debt-to-equity ratio benefits income investors because it means the company can allocate more cash toward shareholder returns.
In the second quarter of 2024, Starwood Property Trust, Inc. (NYSE:STWD) has strategically broadened its investments beyond commercial lending, responding to shifts in risk and reward. Currently, over 40% of the company’s assets are invested outside of commercial lending. This diversification, coupled with low leverage ratios, has enabled the company to perform well despite a challenging real estate correction. The company believes that the worst period for the global property sector is over and that the US and Europe are moving towards a period of easing.
Starwood Property Trust, Inc. (NYSE:STWD) has maintained a steady dividend and achieved an annualized return of over 10% since its establishment 15 years ago. Although some businesses may be experiencing a slowdown, others are gaining momentum. The company has never missed a dividend since 2010 and the per-share payout has grown from $0.32 to $0.48 in all these years. With a dividend yield of 9.83% as of August 14, STWD is one of the best dividend stocks on our list.
Overall STWD ranks 7th on our list of the extreme dividend stocks with upside potential. While we acknowledge the potential of STWD 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 STWD 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.
