With short-term interest rates as low as they have been in years, it’s not surprising that investors are looking for a better yield on their investments. The current environment has made mortgage REITs very popular because of their high-yields. However, there is one company in this space that looks like the best overall play. Invesco Mortgage Capital Inc (NYSE:IVR) might not be the most well known name in this space, but I would argue this is one of the best REIT values around.
Many high yields aren’t worth the paper they are printed on
There are many choices when it comes to high-yielding companies. According to the Fool.com CAPS Screener, there are 444 companies rated by the CAPS community with yields of at least 5%, and more than 80 that have yields of better than 10%. Invesco Mortgage certainly makes this list, and other mREITS like Hatteras Financial Corp. (NYSE:HTS), Annaly Capital Management, Inc. (NYSE:NLY), and American Capital Agency Corp. (NASDAQ:AGNC) are also among these ultra high-yield stocks.
However, investors need to be very careful when they tread among the 10% yielders. Companies like General Electric Company (NYSE:GE), BB&T Corporation (NYSE:BBT), Telefonica S.A. (ADR) (NYSE:TEF), and Frontier Communications Corp (NASDAQ:FTR) are all companies that at one point yielded better than 10% before their dividends were cut. A current high yield means virtually nothing, instead investors need to look at the company’s future earnings and cash flow to determine if their yield will survive.
The good news for mREITs is the Federal Reserve is expected to keep short-term interest rates low for the foreseeable future. The bad news is this same entity is keeping longer-term rates artificially low with their bond buying program. In the end, mREITs are still able to do well, but just not as well as they did in the past. Smart investors need to ignore trailing yields and look at what should be expected from these companies in the next year or so.
Separating the contenders from the pretenders
While no mREIT is expected to grow earnings at a terrific rate over the next year or so, there are differences between companies. For instance, Invesco and Hatteras Financial Corp. (NYSE:HTS) are expected to post earnings growth of 4.02% and 4.3% next year, while Annaly Capital Management, Inc. (NYSE:NLY) and American Capital Agency Corp. (NASDAQ:AGNC) are expected to see growth of 2.38% and 2.97%, respectively. While this doesn’t sound like a big difference, a 1% change in earnings is multiplied because of each company’s use of leverage.
Since mREITs are required to pay 90% of their earnings in distributions, the companies with higher growth rates, in theory would pay better dividends. With the second highest growth rate of the bunch, that’s one positive factor working in Invesco’s favor.
A second way to differentiate between these companies is by looking at their book value compared to the current stock price. While Hatteras Financial Corp. (NYSE:HTS) and Annaly Capital Management, Inc. (NYSE:NLY) both sell at discounts to their book value, their forward yields are also expected to be lower than the other two (more on yields in a minute). At current prices, American Capital Agency Corp. (NASDAQ:AGNC) actually sells at about a 2.6% premium to book value, whereas Invesco sells for about its book value. This is another point in Invesco’s column.
What will they pay?
The key reason most investors are interested in these companies is their yield. However, many analysts make the huge mistake of quoting trailing yield. Since mREITs pay 90% of their earnings, what they paid in the past is useless information. Like trying to drive down the highway looking backward, investors relying on trailing yields are in for a negative surprise.
Instead, figuring out what each company might pay in the future makes much more sense. If we multiply each company’s projected EPS times 90%, we should get the potential forward yield of each company.
This is where the rubber meets the road so to say. Based on estimates, Annaly Capital Management, Inc. (NYSE:NLY)’s forward yield would be about 8.1%, followed by Hatteras at 9.1%. American Capital Agency Corp. (NASDAQ:AGNC) should yield 11.52%, and Invesco should yield 11.22%.
While it looks like American Capital might be the slightly better value, we have to look at the overall picture. Invesco has a stronger expected growth rate, and sells for about equal to book value, whereas American Capital Agency Corp. (NASDAQ:AGNC) sells at a 2.6% premium to book. With their yields separated by just 0.3%, I would suggest the 1% better earnings growth expected at Invesco is the tie-breaker.
With shares of Invesco selling for a forward P/E of just 8, they seem like an outstanding value even if the company saw no earnings growth. For investors looking for a good dividend, Invesco is arguably one of the best high-yielders in the market today.
The article An 11% Yield With Potential Growth originally appeared on Fool.com and is written by Chad Henage.
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