This article is aimed at providing you with a portfolio with elevated dividend yield coupled with capital appreciation potential. I used a stock screener to short-list mortgage REITs for which the analysts have a consensus mean recommendation of buy. The specific criteria are as follows:
- Each of the mortgage REITs under consideration must have a dividend yield of over 10%.
- Each of the mortgage REITs must have buy or better consensus recommendation from the analyst covering it.
Using the above criteria and the stock screener, I arrived at the following mortgage REITs:
- America Capital Agency (NASDAQ:AGNC)
- Armour Residential (NYSE:ARR)
- New York Mortgage Trust (NASDAQ:NYMT)
The remaining investment thesis will discuss the portfolio returns and the associated risks. It will also touch upon the individual stocks briefly.
The portfolio is designed keeping in mind the prevailing ultra low interest rate environment, where the yield hungry investors have little opportunities to enhance their regular income. In an environment where the 10-year Treasuries are yielding 1.86%, this portfolio is yielding 15.1% in dividends coupled with 5.2% capital appreciation potential. Overall, the portfolio offers 20.26% in total returns. The portfolio's beta of 0.76 represents relatively low risk associated to the investment in this portfolio.
Capital Appreciation Potential
American Capital Agency
Mortgage REITs have been under tremendous pressure since the launch of QE3. However, American Capital Agency has been able to outmaneuver the Fed's efforts. American Capital Agency's management is known for its superior MBS selection, which has led to a 21 bps expansion in its net interest rate spread during the fourth quarter of 2012. American Capital is also known to experience one of the lowest CPRs during such challenging times, when its peers are experiencing accelerated prepayments.
Therefore, analysts have a consensus outperform recommendation for American Capital Agency. They have a price target of $33.76 for the stock which is currently exchanging hands at $31.91. This represents an upside of 6%. American Capital is currently trading in line with its book value while yielding 15.7% in dividends.
Armour Residential, like American Capital Agency, is exclusively invested in Agency MBS. Armour Residential is considered to have an investment portfolio with MBS having high prepayment protection. Still, its prepayment speed increased 1.1% to 14.1%, sequentially. During the most recent quarter, its net interest rate spread compressed 27 bps over the prior quarter.
Armour Residential is trading at 11% discount to its book value and yielding 14.4%. The stock presents around 9% upside potential. Therefore, analysts rate the stock as outperform. Four of the ten analysts covering the stock have a hold rating while the rest recommend that investors buy the stock.
New York Mortgage Trust
New York Mortgage invests primarily in the distressed market securities. It also has investments in agency interest only securities, agency adjustable rate mortgage backed securities, non-agency residential MBS and agency RMBS consisting of ARM and hybrid adjustable-rate RMBS, multi-family CMBS and distressed residential single family loans. Therefore, you can expect complete diversification from its investment portfolio.
Four analysts out of the total seven covering the stock have a buy rating for New York Mortgage while the rest recommend their investor hold it. The stock is currently trading at a premium of 9% to its book value and yielding 15.25%. Investors can expect the stock price to appreciate by 1%.
I recommend you to buy the above low risk portfolio to benefit from its capital appreciation and elevated dividend yield.