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This article discusses the potential for outsized returns through the reinvestment of monthly dividends for two companies – Armour Residential REIT (NYSE:ARR) and Prospect Capital Corporation (NASDAQ:PSEC). Based on the current market price and monthly dividend amounts for ARR and PSEC, my calculations indicate that in a two-year time frame, one can increase the number of shares owned by 46% and 33%, respectively, with zero capital appreciation. Those numbers increase to 159% for ARR and 105% for PSEC when extending the time frame out to five years.

Armour Residential REIT (ARR) is focused on investing in Agency residential mortgage-backed securities. Armour's residential mortgage-backed securities portfolio consists of hybrid adjustable-rate, adjustable-rate and fixed-rate residential mortgage-backed securities issued or guaranteed by the United States government-chartered entities. ARR makes its money based on the shape of the yield curve (borrows short term, lends long term). Given the current shape of the yield curve, and the recent announcement by the Federal Reserve to keep short-term rates at zero, ARR is well-positioned to maintain its robust yield. ARR currently features a dividend yielding 19+%, which is paid out monthly. In Q2 2011, a net interest spread of 2.36% (a metric used to gauge the earnings potential of a REIT) was reported. This number was comparable to, but slightly lower than, Annaly Capital’s (NYSE:NLY) net interest spread of 2.45%. It should be noted that ARR paid out 20.2 million in dividends for the quarter while only earning 18.6 million. The main culprit for the payout ratio exceeding 100% was due to the two secondary offerings performed during the quarter. I will be paying close attention to these numbers in their subsequent quarterly reports. Management’s recent announcement maintaining the Q3 dividends at 0.12 per month suggests that the dividend will be covered going forward.

Starting with an ARR share price of 7.51 and a monthly dividend of 0.12 per share, one can calculate the number of extra shares obtained via dividend reinvestment based on assumptions on stock price and dividend changes. In this simple example, I keep both the dividend and the share price constant, and calculate the number of additional shares accumulated by various time frames. By 2 and 5 years, respectively, the number of shares can be increased by 46% and 159% resulting in returns far in excess of the historical S&P return of 10% annualized. I would argue that my two-year scenario is a likely one given the recent Fed announcement and yield curve shape. The five-year scenario, however, is much less likely and has been constructed for more so for illustration purposes.

Prospect Capital Corporation (PSEC) is a financial services company that lends to and invests in middle market privately-held companies. The company is a closed-end investment company. The company invests primarily in senior and subordinated debt and equity of companies in need of capital for acquisitions, divestitures, growth, development, project financing and recapitalization. PSEC pays a monthly dividend which is currently yielding 14+%. It should be noted that PSEC currently pays out slightly more than it makes (based on a comparison of dividend to net investment income). However, the recent secondary offering and historic deal flows over 750 million year to date should push PSEC's annual net investment income above its annual dividend payout. I will be examining these numbers closely when they report Q2 earnings.

With that said, starting with a share price of 8.42 and a monthly dividend of 0.1013 per share, one can calculate the number of extra shares obtained via dividend reinvestment based on assumptions on stock price and dividend changes. As was the case with ARR, I keep both the dividend and the share price constant, and calculate the number of additional shares accumulated by various time frames. By 2 and 5 years, respectively, the number of shares can be increased by 33% and 105%. Like with ARR, I would argue that my two-year scenario is a likely one given the copious amount of new deals announced by PSEC. The five-year scenario, however, is much more speculative.

Reinvestment of the monthly dividends from both ARR and PSEC provide you with the potential to more than double your money in a five-year time span given their current yields and market conditions.

Disclosure: I am long PSEC, ARR.

Source: 2 Dividend Stocks With Potential to Double Within 5 Years