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Dividend Investing Ideas Center

4 Dividend-Friendly Industries


For dividend investors, finding the perfect balance between yield, consistency, and risk is often difficult to nail down. Many times an alluring high yield turns out to be a sour investment, while other times a company simply is not returning enough to its shareholders despite its stability and performance. There are, however, several corners of the market that do offer these characteristics. In this piece, we’ll explore four “dividend friendly” industries, highlighting how and why these companies are able to offer such attractive and sustainable yields.


Utilities


Utilities is by far one of the most popular sectors to invest in if you’re looking to beef up your portfolio’s income stream. Before we get into how exactly utilities companies pay out so much in dividends, first we should talk about what kind of services and goods these companies provide.

Utilities companies provide inelastic (or defensive) goods, meaning that no matter what the economy is doing, people will always need to use electricity, heating, and water. Therefore, utilities companies will always have a steady flow of revenues coming in, even if the market is in or headed into a recessionary period.

In addition to a steady stream of revenues, utilities companies also benefit on the “cost” side of the equation. Typically these firms operate through a “cost plus” model, which is a pricing strategy that seeks to maximize the rates of return of companies. Essentially, the cost these companies undertake to expand operations is based on a regulated rate, which ensures that the firm earns a sufficient rate of return on their invested capital. Investors should note, however, that not all utilities are regulated companies – some are unregulated and are therefore subject to more risk and volatility [see also The Ten Commandments of Dividend Investing].

With costs kept in check and a reliable stream of income, utility companies are able to pay out more to their shareholders, and can also afford to increase these payments over the years.


REITs


Real Estate Investment Trusts (REITs) are also known for their high yields. REITs are different than other securities in that the government requires REITs to maintain 75% of their assets and income in real estate. Furthermore, REITS are required to distribute 90% of their earnings to shareholders through dividends.

Investors should note, however, that these companies are exempt from paying income taxes on the returns paid to shareholders, meaning individual shareholders are responsible for paying these taxes.

These regulations are the primary reason why these securities have such lucrative yields. In addition, REITs are also attractive because their dividends are typically secured by ongoing rent and long term leases. In general, REITs are considered to be relatively safe investments – although the housing crisis did have an unprecedented negative impact on this industry.

For those looking to invest in these securities, be sure to do plenty of research on the different types of REITs, as each have different risk/return profiles as well as distribution histories.


MLPs


Master Limited Partnerships (MLPs) are publicly-traded limited partnerships, the majority of which operate as energy infrastructure companies. These firms own and operate natural gas and crude oil pipelines and storage tanks. MLPs’ business model is often referred to as a “toll road,” as essentially these companies generate fee-based revenues, which gives them a risk/return profile that’s more comparable to a utility company rather than an energy producer or explorer.

MLPs can benefit from some favorable tax treatments. By generating at least 90% of income from natural resource-based activities (such as transportation and storage), an entity can qualify as an MLP and not be taxed as a corporation. So the IRS treats shareholders of an MLP as partners, making the MLP itself a pass-through entity and allowing investors to avoid double taxation of earnings [see Everything Dividend Investors Need to Know About MLPs].

In addition, MLPs feature a further tax break, as a good portion of those high distributions qualify as tax-free return of capital rather than ordinary income. That allows taxes on 80% of MLP distributions to be deferred until investors sell their partnership shares; only 20% is immediately taxable as ordinary income.

Because of these tax advantages, MLPs pay out a significantly higher amount of distributions to their shareholders. Furthermore, MLPs are able to support those high dividends because the bulk of the profits made are based on the volume of oil or gas that flows through pipelines, not on the price of the fuel.


Telecommunications


Another investor favorite, telecommunications equities are known for featuring high yields and stable returns. Like utilities, telecom companies provide inelastic goods and services, meaning that no matter what the economy is doing, people will always need telephone services. Therefore, telecom companies will always have a relatively steady flow of revenues coming in.

Prior to the rapid growth of mobile communications, telecom revenues depended on consumers using landlines. These firms were highly regulated, making them very similar to utilities companies. Mobile technology, however, has created new opportunities for these companies.

Now telecom companies make the majority of their revenues from sales of mobile devices and lucrative data contracts. Telecoms do, however, spend large sums of money on network expansion, as the demand for mobile technologies continues to skyrocket. Investors should note that there are still companies that focus on traditional landlines and other lower-margin services [see also 7 Impressive Facts About AT&T’s Dividend].

With a stable stream of income and an inelastic demand for their products and services, telecoms are able to pay out relatively large dividends. Investors should be aware that sometimes it looks like these companies pay dividends that greatly exceed earnings; however, because telecoms have large capital expenditures that depreciate over long periods of time, the companies actually have more cash on hand than their earnings suggest.


The Bottom Line


For those looking to find the perfect mix between yield and stability, these four industries are a great place to start. Furthermore, investments in these industries often serve as great building blocks for those looking to construct or maintain solid long-term portfolios.

Be sure to visit our complete recommended list of the Best Dividend Stocks, as well as a detailed explanation of our ratings system here.

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