Shares of AGNC investment(NASDAQ: AGNC) have increased by almost 40% in the past year. But when you add the massive 14.5% dividend yield of mortgage real estate investment trusts (REITs) to the mix, the total return (which assumes dividend reinvestment) was an even more impressive 60%. That’s a huge total return and easily exceeds expectations. 42% total return from the S&P500 index. Is there more to come as AGNC Investment’s share price bounces near the $10 price point?
There are two important facts we can glean from the fact that AGNC Investment is a mortgage REIT. First, REITs are designed to pass income to shareholders in a tax-advantaged manner. A REIT can only remain a REIT if it distributes at least 90% of its taxable income as dividends. Dividends are therefore a very important piece of the puzzle at AGNC Investment. Secondly, AGNC invests in mortgages.
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AGNC chart
A real estate holding REIT is quite simple to understand. It buys a physical asset (a type of building) and rents it to a tenant, collecting rent along the way. That rent is used to finance dividends. A mortgage REIT purchases mortgage securities, often bond-like investments made up of mortgages combined into one interest-paying security. Very often, leverage is used in an attempt to improve returns.
All told, AGNC Investment’s cash flow is the difference between the interest it earns on its portfolio of mortgage securities and the costs it incurs in purchasing them (including management fees and interest charges). That is very different from owning a property.
AGNC Investment reports what amounts to an intrinsic value, which it calls tangible book value. Tangible book value, like NAV, is the value of AGNC Investment’s portfolio divided by the number of shares outstanding. At the end of the third quarter of 2024, tangible book value was $8.82 per share. However, the stock is trading closer to $10 per share.
For starters, mortgage REITs are fairly complex businesses. A lot of things can affect the price of a mortgage bond, including interest rates, housing market dynamics, mortgage repayment rates, and even the year a mortgage bond was created, among others. Unless you’re willing to take the time to learn about the mortgage REIT industry, you probably shouldn’t go near a REIT like AGNC Investment. And even if you take the time to understand the mortgage REIT sector, it will still be very difficult for you to follow AGNC Investment’s portfolio.
Then there is the high dividend yield of 14.5%. While it looks incredibly enticing, the returns appear to be prompting investors to assign AGNC Investment a value higher than the value of its actual asset portfolio (its tangible book value). So at almost $10 per share, investors are actually paying too much. It seems likely that tangible book value will act as an anchor for the stock price, which helps explain why the stock is currently bouncing at $10.
Ahead of the Federal Reserve’s 50 basis point rate cut, Wall Street predicted a remarkable turnaround in interest rates. But after that cut, the prospects have become less optimistic. Interest rates play a major role in how bonds are valued. If interest rate cuts do not occur as expected during AGNC Investment’s strong share price rise, a move above $10 seems more difficult to achieve.
AGNC chart
There’s another problem here. AGNC Investment’s dividend history has long been quite dismal, with a clear trend of cuts in the rearview mirror. This was accompanied by a falling share price. Trying to live off the income your portfolio generated would have been a terrible outcome. And it wouldn’t be worth the risk to buy this REIT now, even if you thought it could break above $10. There is clearly a very high risk that the dividend will not be reliable, given how unreliable it has been in the past.
Here’s the problem. While AGNC Investment is probably a bad choice for a dividend investor, it is not a bad mortgage investment. Reinvesting the huge dividend more than offsets the share price decline and results in solid total returns. That dividend boosted returns last year compared to the S&P 500 index. But a material increase in prices from here will likely require more rate cuts. That doesn’t seem to be what Wall Street currently expects.
If you’re a dividend investor, trying to get AGNC Investment’s huge returns is probably a risky mistake. Still, if you’re focused on total return, it can be an interesting way to add mortgage exposure to a diversified portfolio. However, it also seems like a risky venture to expect the stock price to rise sharply from here on out.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
Should You Buy an AGNC Investment (and the 14% Yield) While It’s Below $10? was originally published by The Motley Fool
