There’s more than one way to beat the market with dividend stocks. People who have a long time frame before they need to tap into their savings like to buy shares of growing companies that can quickly increase their dividend payments.
There’s nothing necessarily wrong with dividend growth stocks, but what if you insist on significant dividend payouts from the start? The first thing to know about standout dividend yields is that they tend to be high because most investors believe the underlying company can’t generate enough cash to meet its obligations.
For those of you who insist on chasing ultra-high rates, there are a few names that a major investment bank thinks they are buying right now. Jason Steward, an analyst at Janney Montgomery Scott, recently began reporting on AGNC investment (NASDAQ: AGNC) And Annaly Capital (NYSE: NLY) with purchase ratings.
Both companies are real estate investment trusts (REITs) that invest in mortgage-backed securities rather than real estate. At recent prices, AGNC Capital and Annaly Capital offer mind-boggling dividend yields of 14.7% and 13% respectively.
AGNC investment
As a mortgage REIT, AGNC Investment makes its living on the margin between the interest received from its mortgage-backed securities and the interest paid on shorter-term debt.
Mortgage spreads, or the difference between the 30-year mortgage rate and the 10-year government bonds, are larger than normal. After noting that mortgage spreads are the primary driver of mortgage REIT book value, Steward initiated coverage of AGNC Investment with a buy rating.
Steward provided a fair value estimate of approximately 6% above AGNC Investment’s recent share price. Of course, with a dividend yield of 14.7%, the share price doesn’t need to rise to generate market gains for patient investors.
AGNC investors don’t have to worry much about mortgage defaults. About $62.2 billion of the $63.3 billion portfolio is tied up in securities backed by a government agency in the event of default.
Before investing in AGNC, assuming it can maintain its dividend forever, it’s important to realize that the company uses the mortgage-backed securities in its portfolio to secure relatively low-interest loans.
If the Federal Reserve, through no fault of the company itself, stops supplying demand for mortgage-backed securities, the value of AGNC’s portfolio could decline significantly. This means that a collapse in the overall market for mortgage-backed securities could force the company to sell off large portions of its portfolio at high sales prices to appease lenders.
Before you buy shares of this stock, you should know that investors who bought AGNC Investment 10 years ago have only gained 36%, and that’s only if they reinvested all their dividends. Most income-seeking investors should avoid these risky stocks.
Annaly Capital
Steward also began covering Annaly Capital with a buy rating and a fair value estimate of $21. This is a larger mortgage REIT than AGNC Investment. At the end of March, Annaly’s investment portfolio rose to $87.5 billion, of which $63.5 billion is tied up in agency-backed securities.
Annaly Capital’s dividend offers a yield of 13.1% at recent prices. This is significantly lower than AGNC Investment because Annaly seems more stable. The observed stability comes from significant revenue streams outside the portfolio of agency-guaranteed mortgage securities.
Annaly Capital invests in mortgage servicing rights, assets that increase in value when the Federal Reserve increases interest rates. Annaly also has approximately $2.7 billion in residential mortgages directly on its books.
Annaly Capital is arguably more stable than AGNC Investment, but it is still too risky for most investors. The company reports negative net interest margins, which is unsustainable.
Investors who bought Annaly Capital ten years ago saw their principal value fall by more than half. Those who reinvested their dividends have gained just 40.6% over the past decade.
If Annaly can’t quickly turn around its agency-backed portfolio of higher-yielding assets, investors who buy the stock now can expect a dividend cut and another decade of unsatisfactory returns. Most income-seeking investors also want to avoid these risky stocks.
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Cory Renauer 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.
2 Ultra-High Yield Dividend Stocks That One Wall Street Analyst Says Are Smart Stocks to Buy Now Originally published by The Motley Fool
