These 2 Dividend Stocks Have Double-Digit Yields — but Are They Safe?

Investors who rely on income from their portfolios have had to deal with a conundrum. For years, interest rates on bonds and other traditional fixed-income securities fell to historically low levels, and most bondholders couldn’t get enough income from their bonds to make ends meet. That forced a number of investors into the stock market, where some companies paid higher dividend yields but which involved having to take on the added risk that stocks entail.

In the natural resources sector, we’ve seen huge price increases in key commodities lift the prospect of many companies. The improved outlook has in many cases caused not only share prices to rise but also led to companies paying out more to their shareholders in dividends. Yet with some of the better-known players in energy and materials now paying out double-digit percentage yields, it’s reasonable to ask whether those dividends are too good to last. Below, you’ll learn more about two companies, Rio Tinto (RIO -0.77%) and BP Prudhoe Bay Royalty Trust (BPT 1.34%), and find out whether their impressive dividend yields look sustainable.

Mining success at Rio Tinto

Rio Tinto is one of the world’s largest and most successful mining companies. With a market capitalization approaching $100 billion, the U.K.-headquartered Rio Tinto offers exposure to precious metals like gold, base metals like copper and aluminum, and rarer products like lithium and diamonds. From its corporate office in London, Rio Tinto oversees operations around the world.

The past year has been kind to Rio Tinto, as its profits have more than doubled from 2020 levels. Higher prices for the commodities it produces allowed Rio Tinto to boost its earnings, and it shared its bounty with shareholders. Like many U.K. companies, Rio Tinto typically  pays two dividends per year, and March’s payment of $4.79 per share combined with the recently declared August dividend of $2.67 per share add up to a yield of more than 12.5% at recent prices.

The risk, of course, is that Rio Tinto could see profits decline if commodity markets become weak. That’s something that every mining stock has to deal with, but when dividend yields get especially high, the potential for a double-hit from a dividend cut and subsequent share-price declines becomes particularly troubling.

That said, Rio Tinto stock isn’t priced for the good times to last forever. With shares fetching just over 10 times trailing earnings, it appears that Rio Tinto shareholders are keeping their future expectations in check — particularly those who’ve gotten burned before by cyclical swings in the natural resources space.

A big jump in oil prices benefits BP Prudhoe Bay

BP Prudhoe Bay has seen an even bigger pop in its prospects. Unlike Rio Tinto, BP Prudhoe Bay has seen a massive gain in its share price, which has nearly quadrupled year to date in 2022.

The key to understanding BP Prudhoe Bay lies in its royalty trust structure. The dividend payouts that the company makes are directly tied to the proceeds of the sale of the oil and other energy products it pulls out of the ground. When oil prices plunged in the immediate aftermath of the COVID-19 pandemic, BP Prudhoe Bay went more than a year without paying any dividend at all.

With the rebound in oil, though, BP Prudhoe Bay has returned to impressive dividend prominence. The royalty trust has paid out a total of $3.14 per share in the past 12 months, working out to a trailing yield of nearly 19%. The most recent quarterly payout of $1.405 per share implies an even higher annualized yield of more than 33%.

As long as oil prices remain near current levels, BP Prudhoe Bay’s prospects to keep making healthy payouts look good. However, investors risk the stock losing nearly all of its value as well as dividends coming to a halt if oil falls back to its levels early in the pandemic.

The better dividend stock investment

Moreover, BP Prudhoe Bay has the additional challenge that as a royalty trust, its fortunes are tied to an asset that’s gradually getting depleted. In the long run, the trust’s value will fall to zero regardless of what oil prices do, simply because production levels will likely keep dropping.

That makes Rio Tinto a somewhat safer dividend stock, but investors still need to be aware of the cyclical factors at play. High yields could persist for a while, but eventually, the business cycle will bring the natural resources sector back down to earth and potentially hurt those investors who got in near the top.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Leave a Reply

Your email address will not be published. Required fields are marked *