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Want $1,000 in Passive Income? Invest $5,000 in These 3 Dividend Stocks and Wait 4 Years

Motley Fool - Mon Oct 23, 2023

Oftentimes, stable and boring businesses can be great dividend stocks, especially during times of market volatility. After all, going with a company that has a track record of distributing cash to shareholders no matter the market cycle can be a sigh of relief when asset prices are slipping.

Midstream giant Oneok (NYSE: OKE) and chemical companies Dow (NYSE: DOW) and Huntsman(NYSE: HUN) each yield over 4%. By investing $5,000 in equal parts of each stock and waiting four years, investors can expect to earn at least $1,000 in passive dividend income. Here's what makes each of these quality companies worth a closer look.

A sunset over an industrial port terminal.

Image source: Getty Images.

After completing a major acquisition, Oneok is well-poised to fuel strong passive income for income investors

Scott Levine (Oneok): While there are plenty of dividend stocks for income investors to consider in pursuit of a more robust passive income stream, Oneok stands out as a particularly appealing choice at the moment. The midstream company has logged a consistent track record of rewarding shareholders via the dividend. From 2000 through 2023, the company has hiked its dividend at a compound annual growth rate of 12%.

The company has also recently completed an $18.8 billion acquisition of Magellan Midstream Partners, which has the company strongly positioned to continue the trend. With a juicy 5.5% dividend yield, Oneok is an energy stock that will appeal to income investors and value investors alike, considering it's sitting in the bargain bin.

Operating various midstream assets in the Rocky Mountains, Permian Basin, and throughout the Midwest, Oneok is a leading energy company specializing in the transportation, treatment, and storage of natural gas liquids.

Management expects the acquisition of Magellan to contribute 3% to 7% to its earnings per share in 2025 through 2027. Moreover, it anticipates the transaction will result in stronger free cash flow (FCF) -- with 20% accretion in FCF per share from 2024 through 2027.

Drilling down further into Oneok's stock, investors will find the current valuation to be another reason for its appeal. Currently, shares of Oneok are trading at about 12.5 times earnings, a notable discount to its five-year average price to earnings (P/E) of 20.3.

Dow's improvements have gone unnoticed by the market

Daniel Foelber (Dow): In today's high-interest-rate environment, it's important to find dividend stocks with strong balance sheets and the cash flow needed to support their payouts. Commodity chemical company Dow checks both those boxes.

What impresses me most about Dow is how quickly it has turned its balance sheet around. When Dow first spun off from DowDuPont in 2019, Dow had far more debt. But a few outperforming years have done wonders for Dow's balance sheet. Its total net long-term debt position is down 29.5% since the spin-off.

Dow will have a tough time growing if the broader economy slows down. But that's OK because the dividend is manageable, and the balance sheet is strong. Dow is a rare case where abstaining from dividend raises may actually be a good thing. Instead of getting into the habit of regularly hiking the dividend every year, Dow has kept its dividend at a consistent $0.70 per share since the spin-off.

The move makes a lot of sense, given that Dow has been able to pay down debt and has made some sizable buybacks over the last couple of years as well. After all, investors are already getting a 5.6% dividend yield from Dow. So, using excess cash flow in other ways is understandable.

High-quality cyclical dividend stocks like Dow offer investors a rare blend of income and growth. Even during uncertain times, Dow rewards shareholders with a large dividend. However, during an uptick in the business cycle, investors still get that dividend but also benefit from the upside potential of the broader economy.

The ideal cyclical company is one that pays an attractive dividend, has a strong balance sheet, and is an industry leader. Dow has these qualities in spades. And for that reason, it's a high-yield dividend stock worth considering now.

It is a challenging 2023, but the valuation is attractive now

Lee Samaha(Huntsman): I won't beat around the bush. You only have to look at Wall Street analyst estimates for a whopping 21.5% decline in revenue in 2023 to see Huntsman is facing a challenging year. The chemical company's polyurethanes, performance products, advanced materials, and textile effects are used in key end markets, including construction, industrials, transportation, coatings, and adhesives.

Demand is waning for two reasons. First, the slowdown in the economy is, as usual in a highly cyclical sector like chemicals, pressuring demand. Second, there's the accentuating factor that many customers are destocking from previously high inventory levels due to an inventory build stemming from the supply chain crisis in previous years.

Can it get worse? Definitely. Polymer prices have fallen sharply in recent weeks due to demand fears coming from economic weakness in Asia and notably in Europe caused by high energy prices pressuring its industrial sector.

That said, the company's trailing-12-month dividend payout of $167 million is easily covered by trailing FCF of $240 million, and Wall Street estimates $252 million for the full year. Moreover, history suggests Huntsman's end markets will return to growth at some point, and the unique phenomenon of excessive destocking caused by the supply chain crisis is unlikely to repeat.

Cautious investors will want to wait for Huntsman's third-quarter earnings report on Oct. 31 before buying in because the company clearly faces some near-term pressure. Still, the stock is trading on just 16.5 times its estimated FCF in 2023 -- a good valuation if the company passes through an earnings trough in 2023 as expected.

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Daniel Foelber has no position in any of the stocks mentioned. Lee Samaha has no position in any of the stocks mentioned. Scott Levine has no position in any of the stocks mentioned. The Motley Fool recommends Magellan Midstream Partners and ONEOK. The Motley Fool has a disclosure policy.

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