2 Reasons You Can Trust This Dividend Stock's Nearly 8% Yield
You may have come across the notion that investing in dividend stocks with exceptionally high yields can be deceiving, tempting unaware investors with the promise of a substantial payout that the company cannot sustain. Eventually, the company reduces its dividend, leaving investors severely impacted by a significant drop in the stock's value.
Retail company Foot Locker's shareholders recently experienced this. However, it is important to note that there are instances where the general principle does not apply, and Enbridge, a midstream energy company, appears to be a perfect illustration of this exception.
Enbridge provides investors with a significant dividend yield of nearly 8% based on its current market value. Instead of worrying about a potential reduction, here are two factors that should give investors confidence in the continuation of these substantial dividends.
Enbridge's Payout Is Easily Affordable
To start, let's talk about the nature of Enbridge. Oil and gas resources are not found evenly across the globe; instead, they tend to be plentiful in specific areas with substantial reserves beneath the ground. A notable example of this is the immense deposit of crude oil known as the Oil Sands, located in Northern Canada. It is within this region that Enbridge has established its main headquarters.
Oil and gas need to be delivered to regions such as the Gulf of Mexico for refining and exporting purposes. That's where midstream corporations like Enbridge play a crucial role.
Enbridge possesses and manages extensive networks of pipelines responsible for transporting oil and gas to various locations. Its revenue is generated by the volume of these commodities flowing through its pipelines, much like a toll station along a highway. Although Enbridge primarily focuses on pipeline operations for oil and gas transportation, it also operates a utility business and holds renewable energy resources.
The organization needs to allocate a significant amount of funds for constructing their pipelines, however, once they become operational, they generate substantial returns and demand lesser financial resources for maintenance and preservation. Consequently, this renders it a remarkable choice for receiving dividends.
These initial investments may cause the company's stated profits to appear unbalanced, therefore it utilizes a metric known as distributable cash flow (DCF), which represents the cash profits that can be extracted from the business.
The company's management predicts that it will generate a profit in the range of $5.25 to $5.65 per share in DCF by 2023. Enbridge is set to distribute a quarterly dividend of $3.55 per share to its investors throughout this year. Even if the company achieves only the lowest end of its projected financial performance, its payout ratio would still remain at a modest 67%. Consequently, Enbridge has ample funds to cover its dividend distribution, despite having a relatively high yield.
Continued Growth On The Horizon
Ideally, Enbridge's company would expand in the long run. Earnings would gradually rise, enabling the management to responsibly continue increasing the dividend.
Luckily, investors might find themselves in a favorable position in this case. Referring to information provided by S&P Global, the company's management is of the opinion that the export of crude oil, liquefied natural gas, and renewable energy from North America will experience growth until 2035.
This is significant because Enbridge's company gains the greatest advantage from the quantity of resources it transports, rather than the prices of products like oil or gas. The continuous demand in the upcoming years, along with the reasonable payout ratio of the company, provides a strong likelihood for the dividend to keep growing. Moreover, the management has already raised the dividend for 26 years in a row.
Rock-solid Dividend Pick
Investors do not require a massive increase in the stock's value as Enbridge is already providing an impressive yield of nearly 8% initially. The company's management aims to achieve a steady growth rate, around the mid-single digits, for its DCF (distributable cash flow). Therefore, if the stock's valuation is fair, investors can anticipate attractive annual investment returns in the double digits.
If we assess the worth of the stock by utilizing Enbridge's discounted cash flow (DCF) per share, similar to how a regular business would evaluate earnings per share and the price-to-earnings ratio, the stock is being traded at a mere 6 times its projected DCF per share for 2023.
That appears to be an appealing price assessment if the executives can increase the money inflow by 5% every year. The S&P 500 exchanges at a ratio of 20 times its projected 2023 earnings, and historically improves by approximately 10% per year in the long run.
Receiving a growth rate that is only half of what the broader market offers, but at a valuation that is less than half of the market's value, appears to be a worthwhile and attractive opportunity. Additionally, Enbridge's appealing characteristics are further emphasized by its enticing dividend, which is well-supported by ample funds.
Justin Pope does not hold any positions in the mentioned stocks. The Motley Fool holds positions in and endorses Enbridge and S&P Global. The Motley Fool suggests investing in Foot Locker. The Motley Fool adhere to a disclosure policy.
