Once you retire, you begin to depend on your savings and investments to take the place of your salary when it comes to covering at least part of your costs of living. Many retirees look to dividend paying stocks as a source of cash they can get hold of without having to sell their holdings. As the economic hardship we faced in trying to combat the COVID pandemic so brutally reminded us, however, dividends are not guaranteed payments.
In addition, when companies slash their dividends, their stock prices often fall as well. That makes it extra important for retirees to look for companies that look capable of continuing to provide their dividends when times are tough. In that context, these three dividend stocks look ideal for retirees to consider as part of their strategy to generate cash in their retirement.
No. 1: A rock-solid insurance titan
Prudential Financial (NYSE: PRU) has a lot going for it when it comes to being worthy of consideration in a retiree's portfolio. High among its list of attributes is its dividend, which recently clocked in at a nearly 7.2% yield. That dividend is well covered by the company's operating cash flow, consuming less than $0.9 billion of the nearly $13.5 billion in cash from operations it generated in the first six months of this year.
In addition to that strong operating cash flow, Prudential Financial boasts over $65 billion in equity on its balance sheet, supported by over $400 billion in bonds. In the insurance business, a strong balance sheet is what allows an insurer to cover risks above and beyond what it already prices into its premiums. That $65 billion of equity means a lot can go wrong before Prudential is forced to cut its dividend.
Indeed, the company is so proud of its rock-solid foundation that it uses an actual rock -- the Rock of Gibraltar -- as its company symbol. Investors should note that Prudential Financial did cut its dividend during the financial crisis, but it quickly bounced back once that crisis passed. That's a testament to the priority the company puts on maintaining a strong balance sheet and its focus on its long term survivability, which should be comforting for investors with a long term horizon.
No. 2: An energy infrastructure giant that has cleaned up its balance sheet
Energy pipeline giant Kinder Morgan (NYSE: KMI) was forced to slash its dividend in late 2015 in order to protect its investment grade credit rating. Chastened by that experience, it spend the next couple years paying down debt, selling off less-productive assets, and largely self-funding its expansion plans from its freed up cash flows .
That far healthier balance sheet makes today's Kinder Morgan a much stronger company than it was five years ago. It's so much stronger, in fact, that it was able to increase its dividend by 5% in the midst of the COVID pandemic, even around the time oil was bottoming out at negative prices. While that increase was less than the company had originally projected for the year, that's really just a sign that it's serious about protecting its balance sheet and its long term viability.
Kinder Morgan's dividend currently offers investors a yield around 8.5%, and that yield is well covered by the company's operating cash flows. It does often pay out more than it reports as accounting earnings. That high earnings payout ratio is largely an artifact of the capital-intensive nature of the pipeline business. The company's investments in its infrastructure generate depreciation that keep earnings down despite its ability to generate cash.
No. 3: A health business that's much bigger than its name might suggest
You might know CVS Health (NYSE: CVS) from its nearly 10,000 retail stores. What you might not know, however, is that its front-of-store operations represent only around 7.5% of the company's total revenue. The vast majority of its cash is generated from its other operations, including pharmacy, health insurance, and long term care services. That makes CVS Health a bona fide healthcare titan, with its namesake stores more a gateway into its ecosystem than the core of its business.
That broad coverage of the healthcare market uniquely positions CVS Health to participate in multiple aspects of that industry. With America's population aging and with older people generally needing more healthcare services than younger ones, chances are good that it will be a growth industry for some time to come. That makes CVS Health, which trades at less than eight times its projected 2021 earnings, a reasonable potential value in today's market.
CVS currently pays a $0.50 per share per quarter dividend, which offers investors a yield of nearly 3.5% at recent prices. That healthy yield only consumes around a third of the company's earnings. That gives it room to potentially consider increasing its dividend again, something it had done fairly regularly until 2017. Even if it takes a little while before the company's management resumes increasing the dividend, however, the company's reasonable valuation and decent current yield makes it worth considering.
Use your dividends intelligently as a retiree
While these three dividend paying stocks are certainly worthwhile for retirees to consider, it's important to remember that dividends are not guaranteed payments. As a result, a good asset allocation practice is to not rely on stocks -- or stock dividends -- to cover costs you expect to have to pay within the next five years. Instead, use a bond ladder or other conservative asset allocation strategy to cover your near term costs, and leverage your dividends as a way to help replenish those assets as they get spent over time.
That way, you can keep the potential of getting the long term benefits of owning stocks while not exposing yourself to immediate hardship if something were to go wrong with your investment. As a retiree relying on your portfolio to cover your costs of living, that type of arrangement gives you a much better shot of riding out the next market crash.
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Chuck Saletta owns shares of CVS Health, Kinder Morgan, and Prudential Financial and has the following options: short June 2021 $18 puts on Kinder Morgan, short January 2022 $20 puts on Kinder Morgan, long January 2022 $20 calls on Kinder Morgan, short June 2021 $20 calls on Kinder Morgan, short March 2021 $75 puts on Prudential Financial, short March 2021 $100 calls on Prudential Financial, short January 2022 $100 puts on Prudential Financial, and long January 2022 $100 calls on Prudential Financial. Chuck also owns bonds issued by CVS Health. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.
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