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Is it really even worth it anymore? All of the volatility, all of the fear you are experiencing? If it is not overtly plain to see, one of the most painful sectors to have been holding stocks over the last quarters has been the Mortgage Real Estate Investment Trusts (mREITs). There are several reasons for the selloff, some warranted, others overblown. For reasons why the stocks have sold off and what I think they future holds in store for the sector in the short, medium and long-term, please feel free to look over my numerous articles on the sector. In this article I really want to talk to those who are asking about the power of holding popular names in the sector over the long haul and what the dividends can do for us over time. Many have felt painful capital losses of late. Many question if it is really is worth it. I'll be honest, the sector has not been for the weak stomached investors with all of the anxiety of capital losses and dividend cuts. But I maintain that although the cycle of these stocks fluctuates with interest rate movements, as do their dividends and share prices, timing buys and pyramiding down to lower cost base whilst harnessing the power of the dividend can deliver ultimate returns. It simply requires patience, strong will and an illustration. A number of you have requested I look into the Annaly Captial (NYSE:NLY) situation after examining hypothetical purchases of American Capital Agency (NASDAQ:AGNC) in a highly controversial prior article.

Before delving into the meat of the analysis, I must reiterate that there are two approaches to owning high yielding stocks. The first approach is to buy shares and collect income coming in from the dividends. In this strategy an investor buys a set number of shares in a company, perhaps adding to the position on dips, and uses the cash for whatever needs may arise. Many retirees often utilize this approach. The second approach is to reinvest dividends allowing more shares to be accumulated over time and thus compound the investment. Most if not all brokerages will allow reinvestment of dividends. This strategy works best in tax favored accounts such as IRAs or ESA's, but can still be used in a taxable account (however the tax man will eat into your profits). In the case of NLY, I know many who started getting involved in in the late 1990's, the mid 2000's and most recently in the last few years.

What I would like to ultimately have you take away from this article is recognizing the power of dividend reinvestment, as well as understanding why timing your buys is so critical (and by extension trying to lower your cost basis) if you plan to be in NLY for the long haul. Therefore, I will present two analyses, one in which a hypothetical investor timed their buy perfectly at the low of 2005, and another who also bought in 2005 but when the share price was much higher. Table one below illustrates an example with a $10,000 investment made at the beginning of the summer of 2010.

Table 1. Dividend History And Illustration of Compounded Reinvestment Of A $10,000 Purchase of Annaly Capital Shares On November 10, 2005.

Ex-Dividend Date

Dividend Paid

Dividend ($)

Price of Shares ($)*

Number of Shares Reinvested**

Total Number of Shares

Purchase Date Nov 10th 2005 ($10,000 investment)

10.90

N/A

917.4312

12/28/2005

1/27/2006

0.10

12.71

7.2182

924.6494

3/29/2006

4/27/2006

0.11

12.88

7.8969

932.5462

6/28/2006

7/27/2006

0.13

12.34

9.8242

942.3705

9/27/2006

10/27/2006

0.14

13.05

10.1097

952.4802

12/27/2006

1/26/2007

0.19

13.77

13.1424

965.6226

3/29/2007

4/26/2007

0.20

16.08

12.0102

977.6328

6/28/2007

7/27/2007

0.24

14.45

16.2375

993.8703

9/27/2007

10/29/2007

0.26

17.74

14.5663

1008.4366

12/27/2007

1/28/2008

0.34

19.05

17.9983

1026.4350

3/26/2008

4/29/2008

0.48

17.10

28.8122

1055.2472

6/25/2008

7/29/2008

0.55

14.05

41.3086

1096.5558

9/16/2008

10/29/2008

0.55

13.01

46.3571

1142.9129

12/26/2008

1/29/2009

0.50

15.93

35.8730

1178.7859

3/26/2009

4/29/2009

0.50

13.88

42.4635

1221.2493

6/25/2009

7/29/2009

0.60

16.65

44.0090

1265.2583

9/29/2009

10/29/2009

0.69

17.21

50.7280

1315.9863

12/24/2009

1/28/2010

0.75

17.45

56.5610

1372.5473

3/30/2010

4/28/2010

0.65

17.01

52.4489

1424.9962

6/25/2010

7/29/2010

0.68

17.44

55.5618

1480.5580

9/30/2010

10/28/2010

0.68

17.59

57.2359

1537.7939

12/23/2010

1/27/2011

0.64

17.89

55.0133

1592.8072

3/29/2011

4/27/2011

0.62

17.75

55.6361

1648.4433

6/28/2011

7/28/2011

0.65

17.39

61.6152

1710.0585

9/28/2011

10/27/2011

0.60

16.92

60.6404

1770.6988

12/27/2011

1/26/2012

0.57

16.87

59.8280

1830.5268

3/28/2012

4/26/2012

0.55

16.27

61.8801

1892.4070

6/27/2012

7/26/2012

0.55

17.48

59.5437

1951.9506

9/27/2012

10/29/2012

0.50

15.80

61.7706

2013.7212

12/26/2012

1/29/2013

0.45

14.88

60.8988

2074.6201

3/27/2013

4/29/2013

0.45

15.77

59.1997

2133.8198

6/27/2013

7/29/2013

0.40

11.95

71.4249

2205.2447

*Share Price At Open **Based On Reinvesting At Opening Share Price

In table one, I lay out a hypothetical example of a $10,000 investment in NLY on November 10, 2005 when shares were trading at $10.90. This $10,000 purchase would have been good for over 917 shares (please note I am not including broker commissions being deducted from the $10,000 purchase). After buying the stock, the first ex-dividend date would have been a month later. A dividend of $0.10 would have been paid on January 27, 2006. An investor could collect the income of $91.74 or could take the funds and reinvest shares. Below I illustrate using one or the other approaches over the course of dividends paid until the present day (9/4/13).

Collecting Income

If we were simply collecting income, and we add up all of the dividends we have been paid, we would have made $14.32 in dividends per share since the investment. Based on the initial 917+ share purchase, we would have collected a total of $13,137 in dividends, which is $3,137 above our initial investment, plus we still have the principal (at a slight gain from the current $11.60 price at the time of this writing). Just counting dividends paid (assuming no gains or losses to principal), we have a 131.4% gain. Factor in a sale at $11.60 for another $10,642 (a gain of $642) and we actually have a 137.8% gain.

Reinvesting The Dividends

Now let us assume the first dividend pain in January 2006 was reinvested at the open of trading when the dividend was paid when shares were at $12.71. Here another 7.21 shares would have been acquired, raising the total shares held to over 924. Repeating this process over a seven and a half year, period up to the most recent dividend paid in July 2013 of $0.40, would result in the same individual now possessing over 2,205 shares. If this was a stock that paid no dividend, we would have a very disappointing gain over such a long period; we may have just kept up with inflation. However, due to the power of dividend reinvestment, our 2,205 shares can now be sold at $11.60 each for a total of $25,580.84, less any broker commissions. Our initial investment was $10,000. Therefore, we have made over $15,500 or a 156% gain.

If This Was A Stock That Did Not Pay Dividends

If this was a stock that paid no dividend, we would have a very disappointing gain over such a long period; we may have just kept up with inflation with a measly gain of 7%.

Wait A Minute

Now you may be asking yourself, "wait a minute, I thought compounding was so strong that it would absolutely obliterate returns compared to simply collecting the dividend!?!?" In this rare case we only made an extra $2,400 by reinvesting dividends. Still this $2,400 is a difference of an additional 18% in gains missed. But this difference could be a lot greater. It was only because the hypothetical investor was extremely lucky and timed his buy at the bottom in 2005 and NLY share prices have plummeted back to these levels along the cycle. Thus the investor who reinvested only did moderately better. But what if the shares were trading around $15.00 in instead? Well, the income investor would still have their $13,137 in dividends and then an additional $3761 in capital gains, for a total return of 168%. The dividend reinvestor? His 2,205 shares are now worth $33,708, a gain of $23,708 or 237%.

What If An Investor Bought Toward The High of 2005?

To highlight the importance of timing your buys correctly, but to also highlight the potential power of dividend reinvestment over income collection, I ran the numbers again utilizing different assumptions (table 2). In this simulation, I assumed a second hypothetical investor, who was attracted to NLY's yield, made a $10,000 purchase of NLY near the highs of the year in 2005 on June 20th for $20.00. As a side note, in just five months time in 2005, NLY lost nearly 50% of its share value; a situation very similar to what is happening here in 2013. Therefore, a $10,000 investment would have generated a buy of only 500 shares in June of 2005 (compared to 917+ in November 2005). Catching the first dividend (ex-dividend June 28, 2005) and reinvesting up until the most recent dividend paid in July 2013 would result in owning approximately 1242.5 shares. These shares can be sold today at $11.60 each for a total of $14,413.17, less broker commissions. This translates to a 44.1% gain.

Table 2. Complete Dividend History And Illustration of Compounded Reinvestment Of A $10,000 Purchase of Annaly Capital Shares On June 20, 2005.

Ex-Dividend Date

Dividend Paid

Dividend ($)

Price of Shares ($)*

Number of Shares Reinvested**

Total Number of Shares

Purchase Date June 10th 2005 ($10,000 investment)

20.00

N/A

500.0000

6/28/2005

7/28/2005

0.36

16.20

11.1111

511.1111

9/26/2005

10/27/2005

0.13

11.45

5.8030

516.9141

12/28/2005

1/27/2006

0.10

12.71

4.0670

520.9811

3/29/2006

4/27/2006

0.11

12.88

4.4494

525.4305

6/28/2006

7/27/2006

0.13

12.34

5.5353

530.9658

9/27/2006

10/27/2006

0.14

13.05

5.6962

536.6620

12/27/2006

1/26/2007

0.19

13.77

7.4049

544.0669

3/29/2007

4/26/2007

0.20

16.08

6.7670

550.8339

6/28/2007

7/27/2007

0.24

14.45

9.1488

559.9827

9/27/2007

10/29/2007

0.26

17.74

8.2072

568.1899

12/27/2007

1/28/2008

0.34

19.05

10.1409

578.3308

3/26/2008

4/29/2008

0.48

17.10

16.2338

594.5647

6/25/2008

7/29/2008

0.55

14.05

23.2748

617.8394

9/16/2008

10/29/2008

0.55

13.01

26.1193

643.9587

12/26/2008

1/29/2009

0.50

15.93

20.2121

664.1709

3/26/2009

4/29/2009

0.50

13.88

23.9255

688.0963

6/25/2009

7/29/2009

0.60

16.65

24.7963

712.8926

9/29/2009

10/29/2009

0.69

17.21

28.5820

741.4746

12/24/2009

1/28/2010

0.75

17.45

31.8685

773.3431

3/30/2010

4/28/2010

0.65

17.01

29.5516

802.8947

6/25/2010

7/29/2010

0.68

17.44

31.3055

834.2002

9/30/2010

10/28/2010

0.68

17.59

32.2488

866.4490

12/23/2010

1/27/2011

0.64

17.89

30.9965

897.4455

3/29/2011

4/27/2011

0.62

17.75

31.3474

928.7929

6/28/2011

7/28/2011

0.65

17.39

34.7162

963.5092

9/28/2011

10/27/2011

0.60

16.92

34.1670

997.6762

12/27/2011

1/26/2012

0.57

16.87

33.7093

1031.3854

3/28/2012

4/26/2012

0.55

16.27

34.8655

1066.2509

6/27/2012

7/26/2012

0.55

17.48

33.5491

1099.8000

9/27/2012

10/29/2012

0.50

15.80

34.8038

1134.6038

12/26/2012

1/29/2013

0.45

14.88

34.3126

1168.9164

3/27/2013

4/29/2013

0.45

15.77

33.3553

1202.2717

6/27/2013

7/29/2013

0.40

11.95

40.2434

1242.5151

*Share Price At Open **Based On Reinvesting At Opening Share Price

But what about the income investor who bought shares at $20.00 and didn't reinvest? This individual would have been paid $14.81 in dividends, but the absolute income from these dividends is far less than the hypothetical investor who purchased their shares at $10.90 in November 2005. The buyer at $20.00 a share would have been paid $7,405 in dividends. The 500 shares still held can be sold at a price of $11.60 for $5,800. Thus, the total return on the original $10,000 investment is $3,205, or a gain of just 32% over eight years. Compare this with the investor who bought at $10.90, who has a return of 131%. Clearly timing is everything in the dividends investing world. Also note, that the hypothetical buyer who reinvested dividends when making a $10,000 investment at $20.00 would have made an additional $1,208 ($4,413 in profit versus $3,205 in profit). This is a difference of 37.7% more profit being made had dividends been reinvested.

What If Share Prices Rebounded in Scenario 2?

A final note. If the shares were currently trading at $20.00 in the second scenario instead of $11.60, the income investor could sell them for $10,000, thereby having a profit of 74% ($7,405 in dividends) over 8 years. Not too bad. The investor who bought at $20.00 and hung tough through all of the swings while reinvesting dividends? If shares were back to their original $20.00, they could be sold for $24,850, a gain of $14,850 (148%), or more than double the income investor. This highlights the power of reinvesting dividends, but also highlights the critical nature of timing your buys efficiently.

Limitations of the Models

These models have a few notable assumptions. First, I utilized the opening price on the day the dividend was paid to calculate the number of shares purchased with said dividend. Ideally we would want to have exact data for such reinvestments, however certain brokers may reinvest at different prices. A different result may be obtained depending on the actual prices utilized. However, in no way is this method a large overestimation of the actual gains. It may even be an underestimation. The other assumptions are that the investor never added to or reduced positions over time, never hedged positions, traded around positions, reinvested dividends in other companies etc. In reality, investors will do a mix of all of these things. However, the illustration still shows how strong the power of reinvested dividends can be relative to not reinvesting. Further, the model also clearly shows the importance of timing your entry into high dividend paying stocks, and by extension, makes an argument for lowering one's cost basis (to maximize the effect of capital gains or minimize the effect of potential losses).

Conclusion

For those who are in the red with their investments in NLY, keep reinvesting dividends. You must be patient, as the hypothetical investor at $20.00 in 2005. NLY doesn't get over $20.00 a share often. Income investors who are down can simply collect income, however if the shares need to be sold at a loss from where they were bought, it could have a serious impact on total returns. Remember, right now, those who haven't hit that sell button have not lost anything. Everything is unrealized. It may take time for the macro environment to return to a highly favorable situation like we have had from 2010-2012, possibly a decade. However, not reinvesting dividends will result in missed opportunities for compounding one's investment throughout time. For those who are down on their initial investment right now, this simple analysis suggests that time is on your side, even if the dividends fluctuate badly overtime. It highlights the importance of timing one's buy, as well as makes a strong case for reinvesting dividends. In my opinion, significant gains can be made overtime in tax favored accounts, so long as investors can stomach the volatility in share prices and dividends paid. NLY had been in the game a long time, and I don't see them going out of business any time soon. It's a long-term winner among mREITs.

Source: Annaly Capital: Feeling Like It's Just Not Worth It Anymore?