- When your income can double itself in a short time, that's exciting.
- More income means more possibilities are within reach.
- Two picks that you don't want to miss out on.
- Looking for a portfolio of ideas like this one? Members of High Dividend Opportunities get exclusive access to our model portfolio. Learn More »
Co-produced with Treading Softly
I love to get two items for the price of one. I'm not a big spender or shopper, but getting two for the price of one is great. Assuming the store hasn't jacked up its prices prior to holding the sale, I get double the value for what I'm paying. That's a great temporary win!
But imagine for a moment if I could flip this on its head.
What if... I could have my income double instead? Earning twice as much would be amazing.
I love a good sale, especially one that lets me double the buying power of my money. How much more so would I love the ability to have twice the money to buy with? This would enable me to buy more of whatever I want, instead of just what is on sale at the moment.
What would you do with twice the income? Perhaps you'd give more to a cause you believe in, or help loved ones turn their dreams and passions into a reality. Perhaps you'd eat at that restaurant you've always wanted to try, but couldn’t justify splurging on.
The ability to double your income is an exciting prospect. Today we're going to look at two picks with a combined average yield of 9.5%, which if reinvested for just under 8 years would double their income production.
Twice the income by reinvesting them for 8 years. Twice as nice. Twice as many opportunities to investigate.
Let's dive right into these picks.
Pick #1: NLY - Yield 10.6%
Agency mREITs pulled back in June, and we have been getting a lot of questions about them. The sell-off started when AGNC Investment Corp. (AGNC) reported a decline in book value. Annaly (NLY) reported that book value declined to $8.37, while earnings remained elevated at $0.30/share despite leverage being only 5.8x, lower than it has been in several years. NLY's dividend payout ratio is only 73%, in a sector where 98-100% payout ratios are routine.
Like AGNC, NLY is storing up capital, waiting for an opportunity to leverage up and buy a lot of MBS. Additionally, NLY has sold its commercial credit business, which will close by the end of the quarter, providing it with more cash.
The reason book values are going down is that agency mortgage-backed securities (MBS) saw prices decline. They have since rallied strongly.
Source: MBS Dashboard
Agency mREITs like NLY hedge against these declines and protect book value by shorting U.S. Treasuries. Treasuries and MBS prices are usually highly correlated, so by shorting Treasuries, when prices go down, NLY would profit from the short position to offset losses on its holdings. In June, we saw a divergence; Treasuries remained strong with yields declining (meaning prices were going up) while MBS dipped and remained below the 50-day moving average.
Despite inflation news, the yield curve got flatter.
U.S. 10-Year Treasury real-time quotes (US10Y)
As a reminder, NLY profits from a steeper yield curve. We are not concerned about these rate movements for two reasons:
First, while Treasuries and MBS are highly correlated over time, it is not uncommon for them to diverge over short periods. Over the course of a month or even a quarter, it is fairly common to see the prices move in opposite directions. There is no reason to panic when they do so. Eventually, one will move to meet the other. Active traders might seek to profit from these movements by moving in and out, but we prefer to collect the dividends and buy the dips.
Second, lower MBS prices mean higher yields on new investments for NLY. Agency MBS prices have been high, which is one of the main reasons NLY allowed its leverage levels to decline to multi-year lows. For NLY to leverage back up, MBS prices need to come down. NLY has a lot of liquidity to take advantage of price drops and "average down". Declining MBS prices will lead to higher cash flow from new investments, which means higher earnings per share. If book value drops a bit to provide an opportunity for a higher dividend in the future, we can live with that!
In the longer term, Treasury rates will inevitably rise. We can't predict precisely when, but it will happen. When it does, NLY has obtained hedges at fantastic prices, and the gains from those hedges will substantially offset declining MBS prices.
This pullback is an opportunity to add more NLY at prices very close to book value. If you don't have a full position, now is the time to top off before NLY raises its dividend.
Pick #2: CSWC - Yield 8.4%
Capital Southwest Corp. (CSWC) is a BDC (business development company) that has pulled back from recent highs. If you missed adding before the last run-up, now is the time to add it to your portfolio. CSWC just announced its third dividend increase this year.
The macro-environment remains very strong for BDCs. CSWC lends to middle-market companies, the kind of businesses that run successful regional businesses. During periods of economic growth, these small- to medium-sized businesses often expand or are bought out by competitors. CSWC benefits from the opportunity to lend, providing capital for expansion. It also benefits when a portfolio company is acquired, frequently holding an equity position that will be bought in the transaction.
CSWC is a very well-run BDC with a quality portfolio. It has a strong track record to back it up. It has outperformed the vast majority of BDCs over the longer term, including Main Street Capital (MAIN), one of the most respected BDCs.
We love CSWC for its high-quality portfolio, internalized and high-quality management, and strong insider ownership at 15%. With CSWC, we also gain a hedge against inflation since 90% of the loan portfolio is floating rate. In the near term, CSWC will continue to enjoy numerous growth opportunities and it recently received an SBIC license to operate as a "Small Business Investment Company", expanding its borrowing and investment options.
BDCs, in general, have a lot of tailwinds, and CSWC is well-positioned to capitalize on them. We're taking advantage of the recent pullback to average up and add more.
These two picks are seeing prime environments to perform strongly. If you have the ability to set them aside and reinvest in them for 8 years, you will double their income output to your account.
Even better is that CSWC has raised its dividend three times in 2021 so far, and we expect even more dividend increases looking forward. This will help your dividend income stream double even faster. We also expect a dividend increase from NLY in 2021. More money as you wait on your income to double.
These two picks would make a great addition to an income portfolio. I suggest having at least 40 individual picks to make up a great portfolio. This allows you to benefit from diversification without making your portfolio so large that you cannot easily adapt to market conditions.
What would you do with twice the income? For many, it would make retirement living and finances so much easier. This is why we invest for income. We want income now to enjoy our lives and reinvest to grow our income stream. Many people have low-yield, or no-yield portfolios and they could easily double their income by moving into an immediate income portfolio. If you have a few years before retirement, you have the ability to double that income again through reinvestment and holding great securities like the picks above.
That's something to be excited about. It's even more exciting than a two-for-one sale, and those are hard to beat.
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This article was written by
Rida Morwa is a former investment and commercial Banker, with over 35 years of experience. He has been advising individual and institutional clients on high-yield investment strategies since 1991.Rida Morwa leads the investing group High Dividend Opportunities where he teams up with some of Seeking Alpha's top income investing analysts. The service focuses on sustainable income through a variety of high yield investments with a targeted safe +9% yield. Features include: model portfolio with buy/sell alerts, preferred and baby bond portfolios for more conservative investors, vibrant and active chat with access to the service’s leaders, dividend and portfolio trackers, and regular market updates. The service philosophy focuses on community, education, and the belief that nobody should invest alone. Lean More.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of NLY, AGNC, CSWC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Treading Softly, Beyond Saving, PendragonY, and Preferred Stock Trader all are supporting contributors for High Dividend Opportunities. Any recommendation posted in this article is not indefinite. We closely monitor all of our positions. We issue Buy and Sell alerts on our recommendations, which are exclusive to our members.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.