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In Part I, we examined seven REITs with yields as high as 19%; today, we are going to take a look at five REITs but before we go any further we would like to go over some key ratios that we feel are imperative; investors should get a handle on them before jumping into stocks that pay dividends.

Free cash flow yield is obtained by dividing free cash flow per share by the current price of each share. Generally lower ratios are associated with an unattractive investment and vice versa. Free cash flow takes into account capital expenditures and other ongoing costs associated with the day to day to functions of the business. In our view free cash flow yield is a better valuation metric then earnings yield because of the above factor

Levered free cash flow is the amount of cash available to stock holders after interest payments on debt are made. A company with a small amount of debt will only have to spend a modest amount of money on interest payments, which in turn means that there is more money to send to shareholders in the form of dividends and vice versa.

Operating cash flow is generally a better metric than earnings per share because a company can show positive net earnings and still not be able to properly service its debt; the cash flow is what pays the bills.

The payout ratio tells us what portion of the profit is being returned to investors. A pay out ratio over 100% indicates that the company is paying out more money to shareholders, then they are making; this situation cannot last forever. In general if the company has a high operating cash flow and access to capital markets, they can keep this going on for a while. As companies usually only pay the portion of the debt that is coming due and not the whole debt, this technique/trick can technically be employed to maintain the dividend for sometime. Individuals searching for other ideas might find this article to be of interest 5 Plays With Healthy Dividends As High As 8.7%.

Interest coverage is usually calculated by dividing the earnings before interest and taxes for a period of 1 year by the interest expenses for the same time period. This ratio informs you of a company's ability to make its interest payments on its outstanding debt. Lower interest coverage ratios indicate that there is a larger debt burden on the company and vice versa.

Debt to equity ratio is found by dividing the company's total amount of long-term debt (debts with interest rates that have a maturity longer than one year) by the total amount of equity. A debt to equity ratio of 0.5 tells us that the company is using 50 cents of liabilities in addition to each $1 dollar of shareholders equity in the business. There is no fixed ideal number as it depends on the industry the company is in. However, in general a ratio under 1 is acceptable and ideally it should be in the 0.5-0.6 ranges.

Current ratio is obtained by dividing the current assets by current liabilities. This ratio allows you to see if the company can pay its current debts without potentially jeopardising their future earnings. Ideally the company should have a ratio of 1 or higher.

Quick ratio or acid -test is obtained by adding cash and cash equivalents plus marketable securities and accounts receivable dividing them by current liabilities. It is a measure of a company's ability to use its quick assets (assets that can be sold of immediately at close to book value) to pay off its current liabilities immediately. A company with a quick ratio of less than 1 cannot pay back its current liabilities. Additional key metrics are addressed in this article 5 Dividend Champs With Yields As High As 17%.

Price to tangible book is obtained by dividing share price by tangible book value per share. The ratio gives investors some idea of whether they are paying too much for what would be left over if the company were to declare bankruptcy immediately. In general stocks that trade at higher price to tangible book value could leave investors facing a great percentage per share loss than those that trade at lower ratios. The price to tangible book value is theoretically the lowest possible price the stock would trade to.

Annaly Capital Management Inc (NYSE:NLY) is our favourite play on this list for the following reasons:

It has a five year dividend growth rate of 42%

It has a five dividend average of 12.4%

It has a ROE of 8.73%

It has decent interest coverage of 2.4

And a total 3 year returns of 60.74%

100 Invested in NLY for 10 years would have grown to 218, 250, and 00.

click to enlarge

Important facts investors should be aware in regards to investing and REITS

  1. Payout ratios are not that important when it comes to REITS as they are required by law to pay a majority of their cash flow as dividends. Payout ratios are calculated by dividing the dividend rate by the net income per share, and this is why the payout ratio for REITS is often higher than 100%. The more important ratio to focus on is the cash flow per share. If one focuses on the cash flow, one will see that in most cases, it exceeds the dividend declared per share.

Stock

Dividend Yield (%)

Market Cap

Forward P/E

EBITDA

Quarterly Revenue Growth

Beta

Revenue

Operating Cash flow

ARR

18.80

595.90M

5.91

61M

N/A

0.23

-18.98M

77.12M

NLY

13.30

16.63B

7.52

2.05B

N/A

0.30

1.39B

8.19B

ANH

12.70

885.53M

7.6

212M

24.50%

0.29

135.30M

-162.57M

PMT

11.30

494.76M

5.96

52.9M

203.00%

0.45

98.33M

-75.63M

GOOD

8.00

205.00M

60.42

22M

8.10%

0.82

42.74M

18.65M

ARMOUR Residential REIT Inc. (AMEX: ARR)

Industry : REITs

Net income

2009 = $-1.15 million

2010 = $6.54 million

2011=It stands at $-18.47 million and the losses could top the $-60 million mark.

Total cash flow from operating activities

2009 = $-2.61 million

2010 = $9.17 million

2011= it stands at $55.5 million and could top the $90 million mark.

Key Ratios

P/E Ratio = 6.6

P/E High - Last 5 Yrs = N.A.

P/E Low - Last 5 Yrs = N.A.

Price to Sales = 12.21

Price to Book = 1.04

Price to Tangible Book = 1.04

Price to Cash Flow = -86

Price to Free Cash Flow = 50.2

Quick Ratio = 0

Current Ratio = 0.1

LT Debt to Equity = 0

Total Debt to Equity = 9.09

Interest Coverage = N.A.

Inventory Turnover = N.A.

Asset Turnover = 0

ROE = -8.19%

Return on Assets = -0.74%

200 day moving average = 7.12

Current Ratio = 0.08

Total debt = 5.32B

Book value = 6.78

Qtrly Earnings Growth = N/A

Dividend yield 5 year average = 0%

Dividend rate = $ 1.32

Payout ratio = 135%

Dividend growth rate 3 year avg = 0%

Dividend growth rate 5 year avg =

Consecutive dividend increases = 0 years

Paying dividends since = 2010

Total return last 3 years = 9.47%

Total return last 5 years = N/A

Warning

Net income is on course to take a big hit in 2011 and the losses could top the $-60 million mark. However, operating cash flow is increasing so there is more than enough money to cover the dividend payment.

Annaly Capital Management Inc

Industry: REITs

Net income for the past three years

2008 = $346.18 million

2009 = $1.97 billion

2010 = $1.27 billion

2011= it stands at $820 million and could top the $1 billion mark.

Total cash flow from operating activities

2008 = $1.11 billion

2009 = $10.82 billion

2010 = $10.87 billion

2011= it stands at $2.62 billion

Key Ratios

P/E Ratio = 8.4

P/E High - Last 5 Yrs = N.A.

P/E Low - Last 5 Yrs = N.A.

Price to Sales = 7.3

Price to Book = 1.06

Price to Tangible Book = 1.06

Price to Cash Flow = 15.1

Price to Free Cash Flow = 2.6

Quick Ratio = N.A.

Current Ratio = N.A.

LT Debt to Equity = 0.04

Total Debt to Equity = 0.04

Interest Coverage = 2.4

Inventory Turnover = N.A.

Asset Turnover = 0

ROE = 8.73%

Return on Assets = 1.14%

200 day moving average = 16.81

Current Ratio = 0.06

Total debt = 90.50B

Book value = 16.22

Qtrly Earnings Growth = N/A

Dividend yield 5 year average = 12.4%

Dividend rate = $ 2.44

Payout ratio = 124%

Dividend growth rate 3 year avg = 6.17%

Dividend growth rate 5 year avg = 42.15%

Consecutive dividend increases = 4 years

Paying dividends since = 1997

Total return last 3 years = 60.74%

Total return last 5 years = 101.37%

Notes

Dividend has been cut from 60 cents to 57 cents, but we believe this is due to the fact that management is taking action now against the potential threat of higher rates. They already reduced their leverage in 2011 and will most likely reduce it even more in 2012. Currently, it has a leverage of roughly 5.5X down from roughly 6.5X.

While the Fed can control rates for a while, Europe is an example of what takes place once the public starts to lose faith in a country's ability to pay back its debt. The US is on track to meet the same fate in the not too very distant future. The chart patterns are already giving early signs that bonds are ready to correct rather strongly. NLY has one of the best management teams in the business. In the first article of this series, we listed AGNC as our favourite out of list of 7 REITS. NLY was not on that list but consider that 100K invested in NLY for four years would have grown to 141K and invested in AGNC for the same time period; it would have grown to 238K. Put in another way the gains AGNC achieved in 4 years would have taken over 10 years to achieve with NLY.

AGNC does use more leverage, and this could be detrimental if rates were to rise significantly. NLY is taking proactive action now. In the end, it comes down to risk tolerance. Investors looking for higher yields but willing to take on more risk can consider AGNC. While investors looking for above-average dividends with lower levels of risk should consider NLY.

Anworth Mortgage Asset Corp. (NYSE: ANH)

Industry : REITs

Net income for the past three years

2008 = $62.61 million

2009 = $130.24 million

2010 = $110.5 million

2011= it stands at $94 million and could top the $124 million mark.

Total cash flow from operating activities

2008 = $139.6 million

2009 = $211.77 million

2010 = $463.66 million

2011= It stands at $-79 million

Key Ratios

P/E Ratio = 7.3

P/E High - Last 5 Yrs = N.A.

P/E Low - Last 5 Yrs = N.A.

Price to Sales = 3.91

Price to Book = 0.96

Price to Tangible Book = 0.96

Price to Cash Flow = 7.7

Price to Free Cash Flow = -3.1

Quick Ratio = N.A.

Current Ratio = N.A.

LT Debt to Equity = 0.04

Total Debt to Equity = 0.04

Interest Coverage = 2.3

Inventory Turnover = N.A.

Asset Turnover = 0

ROE = 12.73%

Return on Assets = 1.56%

200 day moving average = 6.62

Current Ratio = 0.01

Total debt = 7.58B

Book value = 6.95

Qtrly Earnings Growth = 25.5%

Dividend yield 5 year average = 12.6%

Dividend rate = $ 0.94

Payout ratio = 104%

Dividend growth rate 3 year avg = -0.96%

Dividend growth rate 5 year avg = 66.52%

Consecutive dividend increases = 0 years

Paying dividends since = 1998

Total return last 3 years = 51.09%

Total return last 5 years = 18.72%

Warning

Dividend was cut from 23 cents to 21 cents. Cash flow from operating activities has turned negative in 2011 and this means that it is not generating enough money to cover the dividends. Out of the past 3 years this is the first time cash flow has turned negative. It also has a rather erratic dividend history. In our opinion only investors willing to take on a bit of extra risk should consider this play. If you open a position consider selling covered calls.

Pennymac Mortgage Investment T (NYSE: PMT)

Industry : REITs

Net income

2010 = $24.49 million

2011=it stands at $44 million and could top the $64 million mark.

Total cash flow from operating activities

2010 = $-22.79 million

2011= It stands at $-81.2 million and the losses could top the $-120 million mark.

Key Ratios

P/E Ratio = 8.5

P/E High - Last 5 Yrs = N.A.

P/E Low - Last 5 Yrs = N.A.

Price to Sales = 5.81

Price to Book = 0.93

Price to Tangible Book = 0.93

Price to Cash Flow = 9.3

Price to Free Cash Flow = -4.9

Quick Ratio = 1.4

Current Ratio = 1.4

LT Debt to Equity = 0

Total Debt to Equity = 1.1

Interest Coverage = 6.3

Inventory Turnover = N.A.

Asset Turnover = 0.1

ROE = N/A

Return on Assets = N/A

200 day moving average = 16.67

Current Ratio = 2.18

Total debt = 585.38M

Book value = 19.04

Qtrly Earnings Growth = 165.6%

Dividend yield 5 year average = 0%

Dividend rate = $ 1.84

Payout ratio = 84%

Dividend growth rate 3 year avg = 0%

Dividend growth rate 5 year avg =

Consecutive dividend increases = 1 years

Paying dividends since = 2010

Total return last 3 years = N/A

Warning

Net income is rising but operating cash flow is on course to decrease even more in 2011. This is not a good sign for such a young REIT. A negative operating cash flow indicates that the company does not have enough money to cover the dividend. As this is on course to take place for the second year in a row, we feel that only speculators should consider this play.

Gladstone Commercial Corp (NASDAQ: GOOD)

Industry: REITs

Net income for the past three years

2008 = $4.92 million

2009 = $4.61 million

2010 = $4.93 million

2011= It stands at $4.4 million and could top the $6.19 million mark.

Total cash flow from operating activities

2008 = $17.58 million

2009 = $17.02 million

2010 = $18.12 million

2011= It stands at $14.3 million and could top the $19 million mark.

Key Ratios

P/E Ratio = 144.1

P/E High - Last 5 Yrs = 270.2

P/E Low - Last 5 Yrs = 60.5

Price to Sales = 4.79

Price to Book = 1.47

Price to Tangible Book = 1.91

Price to Cash Flow = 156.3

Price to Free Cash Flow = -10.8

Quick Ratio = N.A.

Current Ratio = N.A.

LT Debt to Equity = 1.98

Total Debt to Equity = 1.98

Interest Coverage = 1.3

Inventory Turnover = N.A.

Asset Turnover = 0.1

ROE = 4.3%

Return on Assets = 3.41%

200 day moving average = 16.78

Current Ratio = 10.55

Total debt = 275.11M

Book value = 12.73

Qtrly Earnings Growth = -13.8%

Dividend yield 5 year average = 10.4%

Dividend rate = $ 1.50

Payout ratio = 115%

Dividend growth rate 5 year avg = 1.14%

Consecutive dividend increases = 0 years

Paying dividends since = 2003

Total return last 3 years = 160.89%

Total return last 5 years = 30.3%

Notes

Net income and operating cash flow are on course to rise for the third year in a row. Total cash flow generated from operating activities has been enough to cover the dividends for from 2008-2010 and it should be enough to meet the dividend payments for 2011.

Conclusion

We issued two targets for the SPX over eight week ago. The first target fell in the 1305-1325 ranges. For the second target, we stated that the SPX could trade as high as 1340; on Friday, it traded as high as 1345 surpassing our target by 5 points. The markets are rather overbought and in our opinion long term dividend, investors would be wise to wait for a pullback before committing large sums of money to this market. After this pull back the markets are expected to mount a rather strong counter rally.

All charts sourced from dividata.com

Source: The Highest Paying REITs With Yields As High As 18.8%: Part II