Money market funds and CDs aren't cutting it with income investors these days. With interest rates so low it's only natural for risk-averse investors to find themselves in the stock market for all the wrong reasons.
Let's go over a few pointers to help yield chasers make the most of Wall Street.
1. High yields are usually too good to be true
If you run a stock screen and sort for the highest payouts you're literally asking for trouble. The beefiest yields are typically bountiful for a reason. In this climate where low interest rates are the norm you're not going to find a sustainable high yield without a catch.
Even once you work through the tangle of complicated limited partnerships, closed-end funds, and REITs with bright payouts but dim prospects, you're looking for trouble if you aim too high. Even recognizing a name can be a yield-chasing mistake.
ExxonMobil (NYSE: XOM) may seem like a can't-miss opportunity with its 10.4% yield. You should be somewhat familiar with the crude oil and natural gas giant, but do you realize that the stock has shed roughly half of its value in 2020? Investors approaching ExxonMobil at the beginning of the year with its 5% yield may have thought they were buying into a Dow Inc. component with pedigree papers, but they've lost half of their stock value for a stock that was ultimately replaced in the Dow Jones Industrial Average. With consumption trends and profitability going the wrong way it's not realistic to bet on a turnaround anytime soon.
2. Don't sleep on capital gains
If chasing yields can be dangerous it also follows that dismissing low-yielding stocks can be a missed connection. Let's try NVIDIA (NASDAQ: NVDA) on for size. The pioneer of GPU-accelerated computing's $0.16-a-share quarterly distribution doesn't amount to much given the stock's triple-digit price tag. However, don't judge a story's book by its payout cover.
NVIDIA's yield was less than 0.3% at the start of 2020, and it's now even more yawn-worthy at a little more than 0.1%. However, the yield has been cut by more than half because the stock has more than doubled this year. NVIDIA shares have soared 124% as gamers, scientists, and designers flock to its solutions. Income investors may have glossed over NVIDIA with its pedestrian yields, but it would take you roughly two decades of a stock marching in place with a 5% yield to achieve the gain that NVIDIA investors have experienced in less than a single year. Income is nice, but capital gains are better.
3. Find the right balance of reasonable yields and growth
Set your sights lower on the payout front, and you may find a company with strong prospects to keep boosting its distributions as its bottom line improves. NextEra Energy (NYSE: NEE) with its 1.9% current yield will be at the low end of the universe of utility stocks, but it's worth a look.
As a Florida power utility it's in a state where the population is growing, and that obviously matters. It's also the world's largest generator of renewable energy from the wind and sun, making it a no-brainer for the future of power generation. Analysts see earnings climbing at an annualized clip of 8% through the next four years, so the dividend rate that has moved higher for 25 consecutive years should keep moving in the right direction.
Big dividends are nice, but sustainable payouts in improving companies will always be better. Investing in dividend stocks should always be more about your actual investment than the distributions.
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Rick Munarriz has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends NVIDIA. The Motley Fool recommends NextEra Energy. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.