The S&P 500 currently has a 1.4% dividend yield. That's not very attractive for most income-seeking investors. The good news is that they have a lot of higher-yielding options. Many companies offer dividends yielding more than four times the S&P 500.
However, investors must tread carefully when investing in stocks with ultra-high dividend yields since not all those payouts are sustainable. One that's more questionable is the monster yield offered by industrial giant 3M(NYSE: MMM). On the other hand, the big-time payouts of Enbridge(NYSE: ENB) and Clearway Energy (NYSE: CWEN.A)(NYSE: CWEN) seem very sustainable. Here's why income-focused investors should buy those two hand over fist while avoiding 3M for now.
A reset after the spin?
3M currently yields 5.8%, one of the highest yields in the S&P 500. On the one hand, the industrial company can easily afford that payout. Last year, it generated $6.3 billion in adjusted free cash flow (up 30% from 2022), easily covering its $3.3 billion in dividends. The company used the excess free cash flow to strengthen its already solid balance sheet. Net debt declined by 17% to $10 billion.
However, there are concerns about the dividend's future. While 3M has a long history of dividend increases, that could end in 2024. The company agreed to settle two multi-billion-dollar legal claims last year. One way it plans to fund those settlements is to spin off its healthcare business into a new company called Solventum, which should occur next month. 3M will get a cash distribution from that business and retain a 19.9% stake it intends to monetize over the next five years. This transaction will give the company some money to fund its legal settlements.
The concern is that the company's healthcare unit contributes more than a quarter of its revenue and operating income, which could mean 3M might need to reset its dividend following the spinoff to reflect its lower earnings and to fund its legal settlements. That potential for a reduction is why income-focused investors should avoid 3M for now.
The fuel to continue increasing its dividend
Enbridge offers investors a higher dividend yield than 3M at 7.6%. The Canadian utility and pipeline company also has lots of visibility to grow that payout in the future, something it has done for 29 straight years.
The company generates very stable cash flow (98% comes from predictable cost-of-service or contractual arrangements). Meanwhile, it only pays out 60% to 70% of its steady cash in dividends. That gives it a big cushion while enabling it to retain significant cash to fund expansion projects.
Enbridge has a massive backlog of energy infrastructure projects currently under construction, giving it lots of visibility into cash flow growth. On top of that, it's buying three high-quality natural gas utilities this year. These factors drive its view that it will grow its cash flow per share by at least 3% annually through 2026 and by 5% per year over the medium term. That should give Enbridge the fuel to grow its dividend by as much as 5% per year over the medium term.
A fully powered growth plan
Clearway Energy also offers a higher-yielding dividend (currently 7.6%), which it expects to continue growing. The clean energy infrastructure company anticipates increasing its payout toward the upper end of its 5% to 8% annual target range through 2026.
Two factors power that plan. First, the company generates very stable cash flow. It sells the power it produces under long-term contracts with utilities and large corporate buyers, which puts its payout on a strong foundation.
On top of that, the company cashed in on the value of its thermal business in 2022. It has been recycling that capital into higher-return renewable energy investments. Clearway has already secured the investments needed to support its dividend growth plan. The company has the line-of-sight to grow its cash available for distribution from $342 million last year to $435 million as those development projects come online over the next few years. Meanwhile, the company should have no problem continuing to grow its cash flow and dividend beyond 2026. It has several catalysts, including rising power prices, debt refinancing, and additional acquisitions.
Focus on the visible growth
While 3M has been a great dividend stock over the years, there's a lot of uncertainty about the payout's future. The company might decide to reset its dividend following its healthcare spinoff.
Income-focused investors should avoid 3M until there's more clarity about the payout's future. Instead, they should buy Enbridge and Clearway Energy. They offer higher-yielding payouts, which should continue growing over the next few years. Those features make them much more attractive income stocks these days.
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Matt DiLallo has positions in 3M, Clearway Energy, and Enbridge. The Motley Fool has positions in and recommends Enbridge. The Motley Fool recommends 3M. The Motley Fool has a disclosure policy.
