High-yield dividend stocks have a rich history of delivering market-beating returns. In fact, the notion that high-yield dividend stocks (those with yields of 4% or greater) generally outperform other types of equities was a central theme in Charles H. Dow's 1920 iconic, posthumous publication, "Scientific Stock Speculation."
Surprisingly, though, the core reason these equities tend to generate outsized returns has more to do with their underlying value propositions, rather than their appeal as top-tier passive-income vehicles. Keeping with this theme, empirical studies have shown that the magnitude of a stock's dividend yield has little to do with its ability to beat the broader markets over the long run.
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By contrast, these same studies show that a dividend stock's "earnings yield" is far more important from a return-on-investment standpoint. Earnings yield is calculated as the most recent 12-month earnings divided by share price x 100.
This lesser-known valuation metric provides the company's earnings per share expressed as a percentage of each dollar invested in the stock. In everyday use, money managers often compare a company's earnings yield to the 10-year Treasury yield to understand whether its stock is undervalued or overvalued, in comparison to a so-called "risk-free" asset.
How does this valuation metric tie into high-yield dividend stocks? The big picture is that high-yield dividend stocks frequently sport earnings yields far greater than the 10-year Treasury bond yield (indicating they're undervalued). What this means is that investors are actually orienting their portfolios toward value -- instead of simply chasing above-average passive-income opportunities -- when they load up on stocks with elevated payouts.
In technical terms, this capital allocation strategy is known as the "value tilt." Below are two real-world examples of billionaire money managers employing the value tilt through the purchase of stocks with elevated dividend yields.
NRG Energy: 4.87% dividend yield
NRG Energy(NYSE: NRG) is an integrated power company that operates primarily out of Houston, Texas. Bridgewater Associates, a hedge fund run by billionaire Raymond Dalio, has steadily been nibbling at this high-yield utilities stock since the first quarter of 2022, according to the fund's 13F filings with the Securities and Exchange Commission. In the fourth quarter of 2022, Bridgewater Associates kept buying NRG, increasing its stake in the Texas energy company by a whopping 325%.
What does NRG stock offer, apart from its elevated dividend yield? Texas is forecast to be one of the fastest-growing energy markets in the U.S. over the balance of the current decade. That fact bodes well for NRG's long-term growth trajectory.
Moreover, NRG's three-year-long reorganization effort, which played out over the course of 2017 to 2020, drastically improved its balance sheet, free-cash-flow outlook, and financial flexibility. It ultimately culminated in the company expanding into other high-growth areas, such as its $5.2 billion acquisition of Vivint Smart Home.
On the valuation side, the Texas power giant's 15.4% earnings yield compares rather favorably to the current 3.46% yield of the 10-year Treasury, implying that its stock might be significantly undervalued at current levels.
This singular valuation metric doesn't necessarily mean NRG stock is a table-pounding buy. But when viewed in the broader context of its healthy long-term outlook, it's easy to see why Raymond Dalio's hedge fund kept hitting the buy button on this high-yield dividend stock throughout 2022.
Pioneer Natural Resources: 13.9% dividend yield
Pioneer Natural Resources(NYSE: PXD) is a Texas-based oil and gas company that uses a fixed-plus-variable dividend framework to return cash directly to shareholders. As things stand now, Pioneer sports one of the highest trailing-12-month dividend yields in the benchmark S&P 500. In addition, Pioneer has also been using its strong free cash flow to aggressively buy back its stock in recent times.
The oil and gas company's shares, in turn, have attracted a significant amount of institutional buying over the past several quarters. Billionaire Kenneth Griffin's hedge fund Citadel Advisors, for instance, bought another 588,550 shares of the oil company in the fourth quarter of 2022.
Despite this flurry of institutional buying, Pioneer's shares have been under heavy pressure in 2023 -- down 15.8% so far this year -- due to falling oil prices at the onset of the year. The one clear upside to this double-digit downturn is that Pioneer's stock is now in bargain territory.
With an earnings yield of 15.9% at current levels, the oil company's shares are arguably dirt cheap right now. Bottom line: Pioneer's recent weakness may represent a compelling entry point for value-oriented investors, especially if oil prices rebound later this year in response to rising demand from China.
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George Budwell has no position in any of the stocks mentioned. The Motley Fool recommends Pioneer Natural Resources. The Motley Fool has a disclosure policy.
