As I noted last week, for the past two years I have picked three income stocks that I believed would perform particularly well in the year to come. In both years, each trio outperformed the S&P 500 Index by a wide margin.

I don’t know if I can keep that streak alive this year, but I’m going to give it a try. There are two rules that limit the stocks to choose from; each company must be a current holding in the Personal Finance Income Portfolio, and the dividend yield for each one must be greater than the yield on the 10-year Treasury note.

Until recently, the second requirement was easy to meet. Two years ago, the yield on the 10-year Treasury note was around 1%. At the start of last year, it had doubled to 2% but was still lower than the yield on S&P 500 Index at that time.

However, the Fed’s aggressive rate hikes last year has pushed the T-note yield up to 3.5%. That eliminates eight of our Income Portfolio holdings, but still leaves 20 to choose from. After eliminating the six that I used over the past two years, I have fourteen that meet both of my requirements.

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Two years ago, I believed that value stocks with strong cash flows would rally strongly in 2021. Last year, I felt that rising commodity prices would be the key to capital appreciation. This year, I am focusing on businesses that recently restructured their balance sheets to improve their operating metrics as described below.

AT&T

Over the past three years, telecommunications giant AT&T (NYSE: T) has steadily lost value as its ill-fated attempts at diversification added debt to its balance sheet without a commiserate increase in profits. That motivated the company to divest its non-core businesses so it could focus primarily on 5G bandwidth.

The financial benefits of that decision are not yet visible in the company’s bottom line, but I believe that will change this year. Wall Street will have to see it to believe it, which could happen later this month when the company releases its fiscal 2022 full-year results and guidance for 2023.

To be sure, it will take several quarters until the full effect of AT&T’s investment in 5G starts to pay off in a big way. In the meantime, its most recently quarterly dividend of $0.2775 per share equates to a forward annual dividend yield of 6%.

Gladstone Capital

Provided the Fed’s rate hikes do not induce a deep recession, lenders should be able to widen their profit margins now that interest rates are no longer suppressed. That is especially true for a Business Development Company (BDC) such as Gladstone Capital (NSDQ: GLAD), which lends to a wide variety of small businesses.

Gladstone has generated remarkably consistent results despite the Fed’s unexpected hawkishness. On November 14, Gladstone releases its fiscal 2022 Q4 and year-end results (ended September 30) which included a 15.6% increase in total investment income compared to the previous quarter.

Despite that success, GLAD has been flat for the past year. Wall Street will need to see more proof that a recession won’t result in a spike in small business loan defaults before it will get back on the BDC train. Until then, investors will have to content themselves with GLAD’s 9% forward annual dividend yield.

Digital Realty Trust

At the heigh of the coronavirus pandemic two year ago, data center REIT (real estate investment trust) Digital Realty Trust (NYSE: DLR) was soaring. While workers were confined to their homes and everyone was shopping online, demand for cloud computing skyrocketed.

The company took advantage of its inflated stock value to use it as currency to acquire a large portfolio of properties in Europe. That transaction negatively impacted its balance sheet, both in terms of dilution of its equity and additional debt used to close that deal.

As both the pandemic and Digital Realty’s operating metrics began to fade, Wall Street abandoned DLR in favor of higher yielding REITs. But now that its share price is below what it was three years ago, DLR pays a forward annual dividend yield of nearly 5% and is poised for a strong rebound in 2023.

The average forward annual dividend yield for these three companies works out to roughly 6.7%, which is nearly twice the yield on the 10-year Treasury note. If they appreciate by an average of 10 – 15%, which I believe they will, that should be good enough to once again beat the S&P 500 Index this year on a total return (share price appreciation plus dividends paid) basis.

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