Due to the current and ongoing low-interest rate environment of cash, CDs and Treasuries, many investors are expecting higher yielding options to supplement fixed income portfolios. One well liked alternative
currently offering some of the maximum dividends among publicly traded equities are agency mortgage REITs.
Among residential mortgage REITs, some have residential mortgage backed securities insured by federal firms, while others own RMBS's without agency guarantee. Agency mortgage REITs should have portfolios completely composed of residential mortgage backed securities insured by federal firms.
An agency RMBS is like a U.S. Treasury, with some distinctions. Government agencies make mortgages and then release a mortgage backed security. These firm RMBSs come with an agency backing and an implied U.S. government support. When borrowers default on agency-backed loans, the firms make payments and/or takeover the defaulting commitments. Prepayment buying of loans often has an unpredictable effect upon a REIT's quarterly income, its yield and asset valuation, but prepayment is much more preferable to a factual default.
Against Stock Market History:
Even though a handful of mortgage REITs appear to be going against stock market history, stocks with dividend yields between 14% and 15% are not secure investments. Over time investors targeting these high yields end up losing an excess of what they had earned. It is time to take a narrow look at Annaly's (NLY) numbers, along with its competitors, to see if its dividend can be maintained.
Annaly has a business model which generates capital by means of short term loans, generally 30 days, and spends that money on government sponsored, mortgage backed securities. This provides the firm's assets with an added measure of security, as the assets are backed by the U.S. government and are understood to be safe, resembling Treasury bonds. This makes the company different from other real estate investment trusts that invest in physical real estate with the further measure of risk.
The most significant variable in determining the firm's profits are the interest rate expenses incurred in borrowing the capital it requires. The other is the return it gets on the securities it buys. I believe this second variable is causing the firm some concern at the moment. The margin, or the profit Annaly generates, is the difference between these two variables-- known as the yield curve. The firm profits when the return on its investment goes beyond the interest it pays on the money it borrows. This is a very low risk business model, and due to the low risk, anticipated returns are normally not that significant.
Looking at Annaly's dividend history, it paid $0.57 per share in January 2012. Its dividend has varied in the past and has paid as high as $0.75 a share in January 2010.
In February 2012, common dividends declared for the quarters ending December 2011, December 2010, and September 2011 were $0.57, $0.64, and $0.60 a common share. The company pays dividends
based on its existing estimate of taxable earnings per common share, not GAAP earnings. Taxable and GAAP earnings will normally differ because of items such as non-taxable unrealized and realized gains and losses, differences in premium amortization, discount accretion, and non-deductible general and administrative costs. While I believe the potential value of a 14% dividend is worth an investment in this company, it does not have the stability some investors are seeking from lower paying dividend stocks.
Annaly Capital Management currently pays an annual dividend of $2.28 per share, which accounts for a dividend yield of 14.13%. The company also has a five year anticipated PEG ratio of 2.82, which makes the stock pricey when compared to competitors. The five year earnings estimate on the stock is just 2%, which is considerably lower than its competitors.
Equity Residential (EQR) is the Annaly's closest rival, and it pays an annual dividend of $2.27 per share that amounts to a dividend yield of 3.79%. Equity Residential as well has a five year anticipated PEG ratio of 2.07, with a five year earnings expansion estimate of 7%.
Another competitor is Boston Properties (BXP), which distributes an
annual dividend of $2.20 per share with a dividend yield of 2.08%. Boston Properties as well has a five year expected PEG ratio of 3.71 with a five year earnings growth estimate of 5.2%.
Simon Property Group (SPG), another competitor in this market, pays an annual dividend of $3.80 per share with a dividend yield of 2.68%. Simon Property Group also has a five year projected PEG ratio of 2.51, with a five year earnings expansion estimate of 5.8%.
Another competitor is Vornado Realty Trust (VNO), which distributes an annual dividend of $2.76 per share that equates to a dividend yield of 3.29%. Vornado Realty Trust has a five year estimated PEG ratio
of 1.19 with a five year earnings growth projection of 5.5%.
When looking at these indicators, Annaly is not performing that well compared to its nearest rivals. Not only is it more expensive, but the anticipated growth going forward does not even come close to competitors.
Owners, be Attentive! Hold the Stock
If you hold the stock currently for the long term, my best advice would be to hold on to it and wait it out, maybe picking up more if the price drops. If you are considering purchasing this stock, now is probably not the best time.
I recommend waiting for the firm's margins to contract, further driving the stock price lower and steadily buying in at timed intervals. The real threat to Annaly is the economic downturn, in addition to quality competitors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.