The Federal Reserve has kept a low interest rate policy since the financial crisis began in 2008, and that looks likely to continue for at least a couple more years as weakness in the global economy persists. Investors who cling to "safety" by parking cash in money market accounts are earning less than 1% per year, and if you factor in taxes and inflation, they could even be losing money.
Investors who are willing to accept some volatility and bear some risk could end up with nice gains over the next couple of years. For some investors, the solution to creating income has led them to junk bonds that yield about 7%, or mortgage REIT stocks like Chimera Investment Corporation (NYSE:CIM), which yields about 16%, and Annaly Capital Management (NYSE:NLY), which yields around 13%. Investing in these two names could provide gains of nearly 30% over the next two years, based on the dividend yield alone. This sure beats what money market investors will earn in the next couple of years.
However, the mortgage REIT sector is not without risk and companies in this industry often raise capital and sometimes lower the dividend payout, both of which can put pressure on the stock. While having a portion of your portfolio in the mortgage REIT sector could make sense, it's also important to be diversified and have other income stocks to balance out the risks.
Mortgage REIT companies borrow money at low rates and invest it in mortgage securities that generate higher rates of return. There are other companies that borrow at low rates and use that leverage in order to magnify returns for shareholders, and that is why this type of business model might be particularly interesting for investors who like mortgage REIT stocks. Here's a closer look at one company that also uses leverage to increase returns and that makes it particularly appealing for investors seeking income:
KKR Financial Holdings LLC, (KFN) is a specialty finance company that invests in a wide range of asset classes with the goal of generating both current income and capital appreciation. It generates revenues and profits by collecting dividend and interest income from investments, plus it realizes gains (and sometimes losses) from the sale of investments, a portion of which is then paid out to shareholders in the form of a quarterly dividend.
KKR Financial and its subsidiaries make corporate loans, and invest in high yield corporate bonds, distressed debt securities, stocks, and credit default swaps. It also holds royalty interests in oil and natural gas properties. Because of the types of investments the company makes, it could be particularly attractive to investors who like junk bonds, and mortgage REIT stocks. Here are three reasons to buy this stock on dips:
1) This stock has been trending up and it has risen from about $8 per share in June, to just over $9. However, the stock still looks undervalued and it trades below book value, which is $9.82 per share.
2) Company insiders tend to know their companies better than analysts or other investors, and that is why it can be smart to follow them when they buy shares. On August 8, 2012, Paul Hazen, a director purchased 63,737 shares for a transaction value of about $584,000. Just a day later, he bought another 46,263 shares in a transaction valued at about $423,000. That is about $1 million of insider buying, which is a very positive sign.
3) This stock not only pays a great yield, but it also has capital gains potential. A few weeks ago, analysts at Deutsche Bank (NYSE:DB) initiated coverage and set a buy rating with a $12.50 price target for KKR Financial shares.
While some investors are scared off by stocks that offer high yields, it can pay to look deeper and realize that if there is a reasonable explanation for the high yield, the stock should not necessarily be avoided. For this company, the high yield is reasonable and easy to explain, because it uses leverage just like many mortgage REIT companies. It's true that leverage increases risk, but when borrowed money is used to buy relatively stable assets or even assets that are trending higher like junk bonds, the risks can be well worth taking. This stock appears to have support at about $8.50 per share, so patient investors should try to buy on dips to that level.
Here are some key points for KFN:
- Current share price: $9.11
- The 52 week range is $6.68 to $9.54
- Earnings estimates for 2012: Not available on Yahoo
- Earnings estimates for 2013: Not available on Yahoo
- Annual dividend: 84 cents per share which yields 9.2%
Data is sourced from Yahoo Finance.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Disclaimer: No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.