We recently published a list of 10 extreme dividend stocks with upside potential. In this article, we take a look at how Vale SA (NYSE:VALE) compares to other extremely high dividend stocks with upside potential.

Investors often prefer high-yield stocks because they provide immediate gains. However, dividend growth stocks offer greater long-term benefits, such as increasing earnings, appreciation, and lower volatility. While many investors are attracted to the immediate returns of high-yield stocks, caution should be taken with excessively high yields as they may indicate underlying financial difficulties. Analysts recommend being careful when investing in very high yields. However, the stock market is a little unpredictable – past performance is not a reliable indicator of future results. While dividend growth stocks have produced high returns in the past, high dividend yield stocks have also performed well and produced robust returns. This is due to the inherent volatility of the stock market – what works at one time may not be as effective later, and the timing of success is often uncertain.

Also read: The 10 best dividend stocks with over 9% yield according to analysts

Yin Chen and Roni Israelov in their study Income Illusions: Questioning the Story of High Yield Stockspublished in the March 2024 Journal of Asset Management, divided stocks into high-dividend and low-dividend categories based on their median dividend yield from the previous year. They examined how dividends affected investment returns under different scenarios. Their research spanned January 1964 to December 2021 and included the 1,500 largest U.S. stocks. The high-dividend portfolio beat expectations on both return and risk, delivering an average annual return of 13.8% with volatility of 15.6%. In contrast, the low-dividend portfolio delivered a lower return of 11.8% but with significantly higher volatility of 21.9%. This resulted in a 3.6% difference in the average annual growth rate. In addition, the high-dividend portfolio experienced smaller declines during market corrections. Despite the overall better performance of high-dividend stocks over the entire observation period, investing in a long-short portfolio resulted in an annual loss of almost 1% from 2003 to 2021, with the best returns occurring between 1983 and 2002.

Studies like these can confuse investors, who often believe that high-dividend stocks are inherently risky. But that’s not always the case. When investing in high-dividend stocks, it’s important to evaluate several key metrics, such as payout ratios and debt levels. High-dividend stocks typically pay out a significant portion of their free cash flow as dividends, resulting in a high payout ratio. They may also fund those dividends with debt, leading to higher leverage and higher risk. These factors can make high-dividend stocks more vulnerable to dividend cuts during tough times, which can reduce earnings and potentially lead to significant share price declines.

The story continues

If payout ratios, debt levels and fundamental metrics are a good fit, investing in high-dividend stocks may not be a bad choice. Analysts have supported these stocks, although it depends on the specific market conditions. Brian Belski, chief investment strategist at BMO, has noted that “indiscriminately selling” high-dividend stocks presents a potential opportunity for investors. He pointed out that high-dividend stocks have underperformed the broader market in only two periods over the past thirty years: during the tech bubble and during the pandemic. Belski opined that such abnormal underperformance often signals an inflection point, after which these stocks typically experience a strong rebound thereafter. Historically, they have outperformed the broader market by over 20% on an annualized basis from trough to peak in relative annual returns for nearly a year, and continue to outperform nearly two years after the peak.

If this situation holds true and fundamentals remain solid, we would be interested in adding these stocks to our portfolios as well. Now let’s look at some of the best dividend stocks with upside potential.

Our methodology:

For this list, we looked for dividend stocks with a yield of over 7% (as of August 14). We then narrowed the selection by looking for stocks with the highest upside potential according to analysts. Among these stocks, we selected companies with relatively stable dividend histories. However, many of the companies on the list do not have a consistent dividend payout due to their exceptionally high yields. Many of the companies listed below belong to the REIT and energy sectors, as these industries are generally known for their high yields. The stocks are sorted in ascending order of their upside potential (as of August 14).

At Insider Monkey, we’re obsessed with the stocks hedge funds invest in. The reason is simple: Our research shows we can outperform the market by mimicking the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks each quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points. (Further details can be found here).

Aerial view of a massive iron ore mine showing the mineral deposits of the company’s Ferrous Minerals division.

Vale SA (NYSE:VALE)

Upside potential on August 14: 51.33%

Dividend yield as of August 14: 12.10%

Vale SA (NYSE:VALE), a Brazilian multinational mining company, tops our list of the best dividend stocks. The company’s performance remained robust in the second quarter of 2024, partly due to changes in the leadership team. Shaun Usmar was appointed as the new CEO to lead the copper and nickel business, bringing with him extensive mining experience and strategic knowledge.

Vale SA’s (NYSE:VALE) operating performance has been strong in every quarter. In its Iron Ore Solutions segment, the company achieved record production in the second quarter since 2018. As part of its strategic objective to become the preferred supplier of low carbon steel, the company is making progress on large growth projects such as Vargem Grande and Capanema, which are expected to add 30 million tonnes of capacity over the next twelve months. In addition, the company is pleased to announce a new partnership as part of its Mega Hubs strategy, further strengthening its position as a competitive supplier of direct reduction products. In the second quarter of 2024, the company generated revenues of over US$9.9 billion, representing 3% growth over the same period last year.

Vale SA (NYSE:VALE) has always remained true to its commitment to shareholders. During the quarter, the company allocated $114 million for its fourth buyback program. As of July 26, this buyback program was 22% complete, with 33.1 million shares repurchased. In addition, $1.6 billion in capital interest is scheduled to be paid in September 2024, in line with the company’s minimum dividend policy, which will be applied to the first half of 2024 results. The stock supports a dividend yield of 12.10% (as of August 14).

Total value 1st place on our list of extreme dividend stocks with upside potential. While we recognize VALE’s potential as an investment, we believe some highly undervalued dividend stocks promise higher returns and do so in a shorter time frame. If you’re looking for a highly undervalued dividend stock that’s more promising than VALE but trades at less than 7 times earnings and yields nearly 10%, read our report on the dirt cheap dividend stock.

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Disclosure: None. This article was originally published on Insider Monkey.