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Annaly Capital Management, Inc. (NLY), American Capital Agency Corp. (AGNC): Stocks for the Dividend Investor, Part 2; High Yield

In part one of this series I looked at some solid dividend paying stocks with a rich history that will provide a solid backbone to any portfolio. In this part I am going to look at the high yielding dividend stocks that offer above average returns but significantly higher risk.

Annaly Capital Management, Inc. (NYSE:NLY)

High yield comes with high risk by its very nature, and with the whole market bouncing around new highs every day dividend yields are being pushed to new lows, driving investors into higher risk assets that offer a higher yield.

The most popular of these high risk/high yield assets are mREITs, which use high levels of leverage to achieve high returns. I believe the best companies in the high yield mREIT sector are Annaly Capital Management, Inc. (NYSE:NLY), currently yielding 12.5%, and American Capital Agency Corp. (NASDAQ:AGNC)., currently yielding 18%.

Why are payouts so high?

I have written about how these mREITs manage to achieve such high yields many times before, so I wont go into to much detail here.

However, in summary, the payouts are so high because these mREITs rely on high levels of leverage or borrowing, usually through a repurchase agreement, which then allows the company to buy mortgage backed securities with up to 50% leverage. This high level of leverage gives the company a relatively high level of income per share, which it then distributes to shareholders, resulting in a high yield. A more in-depth run-down can be found here.

Are these high payouts secure?

Yes and no. The majority of these mREITs purchase agency mortgage securities, which are supposed to be high quality, and low credit risk. That said, the yields on these assets have fallen recently as the Federal Reserve purchases $85 billion in bonds per month, raising prices and depressing yields. This has forced these mREITs to look elsewhere for yield, namely lower credit-quality mortgage-backed securities, which offer a higher yield but with more credit risk. These higher risk assets are only limited to small sections of mREIT portfolio’s.

In respect to shareholder payouts, I believe these are set to continue falling as the Fed’s asset purchase program continues to drive down yields. Having said that, as I discuss below, shareholder payouts could be in for a boost in the future when the Fed starts to taper asset purchases.

What about Total Return?

As I say above, I believe that shareholder payouts from these two companies are set to continue falling as they have done during the past year, which will obviously depress share prices.

However, thanks to their high dividend payouts, despite falling share prices, investors in both Annaly Capital Management, Inc. (NYSE:NLY) and American Capital Agency Corp. (NASDAQ:AGNC) have seen their total return equal or beat that of the S&P 500.

Annaly Capital Management, Inc. (NYSE:NLY) total return

2010 2011 2012 2013 – So Far $1000 becomes
Dividends during year $2.65 $2.44 $2.05 $0.45
Share price YoY change -$0.77 -$1.89 -$2.93 $0.61
Total Return $1.88 $0.55 -$0.88 $1.06
10.7% 3.1% -5.5% 11.9% $1,206
S&P 500 14% -1.1% 12.7% 17 $1,486

American Capital Agency Corp. (NASDAQ:AGNC) total return

2010 2011 2012 2013 – So Far $1000 becomes
Dividends during year $5.60 $5.60 $3.75 $1.25
Share price YoY change $2.32 -$0.66 $2.68 -$0.35
Total Return $7.92 $4.94 -$0.88 $0.90
30% 38% 22.7% 3% $2,267
S&P 500 14% -1.1% 12.7% 17% $1,486

What about the Future?

Recent minutes of the Federal Open Market Committee meetings revealed that some members of the committee are worried about potential losses on the Fed’s massive holdings of MBS. To stem such losses, the committee might have to taper asset purchases early before a serious improvement in the labour market.

Now, here is the problem, any entity that holds such a large portion of the market, is bound to significantly affect the whole market when it comes to the point of selling. The Fed in particular will have to sell $1.5 trillion in MBS (27% of the market) into a shallow market, which will cause prices to fall. Falling prices will mean higher yields and the Fed will have to wind down its huge portfolio into a seller’s market.

When the Fed comes to selling, yields of mortgage-backed securities will rise and mREITs will gain from a higher income on their assets again.

A high yield company that is not a mREIT

While mREITs are defined by their high yield, when a non-leveraged, non-financial company has such a high dividend yield, the company and the yield look risky, especially when the company operates in the technology sector.

Windstream Corporation (NASDAQ:WIN). is one of the highest yielding stocks in the S&P 500. Currently yielding 11.4%, the company looks risky on the face of it paying out $1 per share in dividends during 2012 but only earning 28 cents per share. Having said that, Windstream Corporation (NASDAQ:WIN)’s cash flows appear to show that the company’s payout is well funded.
Metric 2012
Earnings-per-share $0.28
Dividend per share $1
Operating cash flow $1,780
Investing cash flow -$1,100
Dividends $588
Dividend cover by cash flow (operating-investing) 1.2x
Free cash flow $88.4

$US Millions

Windstream Corporation (NASDAQ:WIN)’s high dividend yield is not a worry as the payout is easily covered 1.2 times by the company’s operating cash flow, after the deduction of investing activities, indicating that the company could be a potential investment for a high yield seeking dividend investor.

Conclusion

Investors that are looking for extra yield can look to mREITs to provide them with a payout that is significantly above the market average. However, investors need to be aware that the Fed’s actions will have a serious knock on effect to their investments.

On the other hand, investors could look to Windstream Corporation (NASDAQ:WIN) to provide extra yield as the company’s payout is well covered by operating cash flow.

The article Stocks for the Dividend Investor, Part 2; High Yield originally appeared on Fool.com is written by Rupert Hargreaves.

Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
Rupert is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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