Seeking Alpha
Profile| Send Message| ()  

Even in light of the down real estate market, income investors who are seeking high dividend yields could find a strong pick in Armour Residential REIT (ARR). Currently, REITs are very attractive - especially relative to the fixed income market overall.

According to Five Star Equities, one of the biggest reasons for this is that the sector as a whole has an above average dividend growth outlook. This is primarily due to the the ability of REITs to manage risks and produce higher returns by capitalizing on increased leverage, compared to other industries such as healthcare and technology. Given this, plus the 10% annual dividend growth expectation in this particular industry sector, investors could have a real winner by going with Armour for both the long- and the short-term.

In this article, I discuss why Armour Residential REIT is one of my all time favorites, along with why I think - based on its dividend yield and its future growth prospects - that it may very well be the next home run for investors who seek both growth and income.

REITs as An Industry Sector

So far this year, mortgage REITs (real estate investment trusts) have outperformed the market as investors continue flocking to the large dividends that these shares tend to produce. According to one analyst, the effective prepayment risk management that is practiced by REITs tends to generate higher returns due to these entities being able to run at a higher amount of leverage without the need to compromise their equity cushion.

Certainly, REITs offer some great benefits to investors, including steady income without the need to sell their position, cash flow no matter what the market direction, two potential sources of income - including both dividends and capital gains - and a great hedge against inflation.

However, even with all of the positives of investing in REITs, it's also important for investors to pay close attention to a couple of other aspects of these investments. First, while the payout ratios when considering an investment in REITs are not a huge issue due to the requirement for REITs to pay a bulk of their cash flow out as dividends, it is imperative to focus on the cash flow per share, as in many cases, this may even exceed the declared dividend per share.

Why Armour in the REIT Industry Sector?

Armour Residential REIT focuses mainly on residential mortgage backed securities that are either issued or guaranteed by U.S. government-chartered entities like Fannie Mae (OTCQB:FNMA) (the Federal National Mortgage Association) or Freddie Mac (OTCQB:FMCC) (the Federal Home Loan Mortgage Corporation), although some portion of the company's portfolio may also be invested in bonds or in unsecured notes that are issued by the U.S. Treasury.

The company is managed externally and is advised by Armour Residential Management LLC. This managing entity is affiliated with the company's executive officers. The firm uses a calendar tax year.

Earlier this year, Armour reported a second quarter monthly cash dividend on its common stock of $0.10 per share. The stock is currently trading at $6.75, well above its 12-month low of $5.40 and nearing its one year estimated target of $7.30, which some predict it could surpass by mid-year.

In early March, the company announced that it had priced an underwritten public offering of over 30 million shares of common stock. In addition, the firm granted the underwriters of this offering to purchase up to over 4.6 million additional shares of its common stock.

The current dividend paid out by Armour gives the company a dividend yield of just under 18% - an almost unheard of number in any industry sector - and especially given that the overall average yield of shares in the REIT sector stands at just over 5.5%.

Even competitors such as American Capital Agency (AGNC), currently yielding in excess of 17%, comes with a bigger share price at just under $30 per share, extremely close to its one year target estimate of just under $31 and far above its 52 week low of just over $22.

The bottom line though is that for my money, I would lean toward buying shares of Armour over any of its competitors. With the high dividend yield, coupled with the positive prospects for growth, even at over $7 per share, this REIT would be an extremely good buy.

How Long Can Armour Sustain Such a High Dividend Yield?

For those who are wondering just how long Armour's dividend yield can sustain, it is difficult to say. The company's share price continues to move up, however, and this is likely to slow somewhat as the year goes on.

Another positive factor with Armour, though, is the interest rate hedging strategy that was recently set up by the company's management. This should help protect the company and/or help it benefit it from a change in primarily long-term interest rates.

In Armour's case, the company has been set up to benefit from a 50 basis point rise in rates. And based on this, the company will be in a great position should rates go down. Yet, even if interest rates rise slightly, Armour will still be protected.

The Bottom Line

In looking at the REIT industry sector overall, there is an abundance of good news - even given the recently volatile real estate market. Those who are seeking income have always turned to real estate and related investments to a steady stream of cash flow - and now should be no different.

Armour Residential REIT shows a number of positive factors. An upward moving share price - yet still low enough though to pick up a large number of common shares - along with a dividend yield in the range of 18%, give Armour Residential REIT two perfect reasons to be on investors' buy list in the immediate term.

Source: Armour Residential REIT: Growth And Income For 2012