With interest rates still at extremely low numbers, many investors are returning to dividend yielding stocks to add an additional boost to their portfolio. Like many, I am often tempted by these high yielders, such as Annaly Capital Management (NLY). However, just like any stock, they should not be taken at face value alone.
In some cases a stock can be an accidental high yielder. This happens when the price of a stock falls while the dividend payout remains the same. Typically, when this occurs, the company will need to adjust the dividend accordingly if earnings do not return to previous levels. One reassuring thing about Annaly is the beta is only 0.23, making the stock's volatility very low. Barring any huge news, it is not likely that the price of the stock will suddenly venture too far in either direction. In addition to low volatility, Annaly is a real estate investment trust, meaning that the company is required to distribute 90% of taxable income to investors as dividends. The current yield of Annaly is 14%, which equates to a payout of $2.20 annually.
In the world of REITs, Annaly is not the only contributor. Between companies like CYS Investments (CYS), Capstead Mortgage (CMO), and Redwood Trust (RWT), investors have options to choose from. While Annaly Capital is arguably the most popular of the REITs, CYS Investments was the best in terms of profit for investors in 2011 with a dividend-adjusted return of 22.7%. The interesting thing about this is that before dividends, CYS returned only 3%. Even in 2012, mortgage REITs have outperformed the market. Many investors are on board with CYS. Recently, Nomura upgraded the stock to a Buy from Neutral. The stock has also been named a Top 10 REIT, according to a "DividendRank" report published by Dividend Channel. The stock's current price level, along with its attractive yield of about 15%, are all part of the reason the stock has seen a steady rise in price over the past six months.
Capstead Mortgage is another REIT that many investors are interested in. This stock, similar to CYS Investments, was also very profitable in 2011, with a dividend-adjusted return of 19.1% (according to Fool article linked above). Since October, this stock has also been on the rise with an increase in price of about 15%. Add an annual dividend yield of 13.10% and you would have a return just short of 30%. Part of the reason a stock like this is so profitable is due to the company's net margin on over 90%. Currently, the company is set to release its first quarter 2012 earnings following the close of trading on Wednesday, April 25th. Investors will be interested in these earnings as it will determine the amount of dividend to be issued from the company.
Not all REITs can produce profits like CYS, Capstead, and Annaly. Redwood Trust was actually one of the worst REITs in 2011. Adjusting the return to include dividends, Redwood saw a loss of 24.6%. Probably the biggest reason for this noticeable decline is how Redwood operates. Unlike most other REITs that strictly own a portfolio of loans, Redwood also owns a number of properties. To help fuel the business, Redwood sold bonds that are tied to $328 million in loans on March 28th. These bonds sold in high demand due to a shortage of these highly rated assets.
Economic news that makes dividend yielding stocks, REITs in particular, even more attractive is interest rates. The Federal Reserve announced that it will keep the federal funds lending rate near 0% through late 2014. Originally, it was projected these rates would end in the middle of 2013. This is not only great news for anyone looking to buy or refinance a home, but it is also great news for REITs as well. The low interest rates help keep the cost of doing business for REITs down as the companies borrow under the federal funds rate and lend at its own higher rate; the difference, or spread, being the profit. With the interest rate set to be low over the next couple of years, I would not be surprised to see some of these companies become a little more aggressive. For the companies that do, it is possible there will also be an increase in dividends.
If you are looking for the safer of the REITs, I would stick with Annaly Capital as a majority of its portfolio is invested in U.S. government backed securities (see previously linked Fool article), which are about as risk-free as you can get. An interesting ratio for Annaly is the price to book value which is currently at 0.98, trading for less than its tangible value as well as half the industry value of 2.2.
Value investors may consider this stock looking at this ratio coupled with the company's dividend yield. Over the past 5 years, Annaly had an average dividend yield of 8.5%. Considering that U.S. securities are well below that rate, the stock looks to be an attractive purchase. To further the bull pitch for the company, Annaly was also one of the 10 best performing mortgage REITs of 2011. Ultimately, with the interest rates remaining low, REITs like Annaly will be able to operate with lower costs over the next couple of years. As long as the companies are able to capitalize on their interest spreads, I see stocks like Annaly as a good investment for dividend investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.