Annaly Capital has a huge 13% dividend yield, but don’t buy it for the yield because the stock may end up letting you down in the long run.
Annaly Capital (NLY 0.96%) is one of those stocks that looks like it is a great choice for a specific type of investor, but is really intended for investors with a different approach. In this case, the ultra high yield of 13% screams dividend stock. But in reality, this mortgage real estate investment trust (REIT) isn’t a reliable dividend payer. Here’s a deeper dive into the buy, sell, or hold call for this niche dividend payer.
The Sell thesis
Given the ultra high and alluring dividend yield here, it is probably best to start with the list of people that shouldn’t buy Annaly. Sadly, despite a 13% dividend yield, dividend investors who are trying to live off of the income their portfolios generate should avoid the company. It would be awfully nice if a stock could provide you with a yield that’s notably above the 10% return that most investors expect from the broader market without having to take a trade-off somewhere, but that just isn’t the case.
NLY data by YCharts.
Start with the quarterly dividend, which is the orange line in the chart above. Look at how volatile it has been over time. It simply isn’t reliable. If you need your dividend income to pay for living expenses, you want a consistent, and hopefully growing, dividend over time. One that goes up and down won’t cut it. Then there’s the stock price, which is the purple line. It tends to rise and fall with the dividend, which makes sense.
However, look at the steady dividend and stock price declines over the last decade or so. Owning Annaly would have left income investors with a smaller income stream and a smaller nest egg. It is hard to imagine a worse outcome.
The Hold thesis
Annaly Capital really isn’t an income investment, despite it being a real estate investment trust (REIT). REITs are designed to pass income on to shareholders, but in Annaly’s case there’s a subtle, but important, twist. This REIT is looking to provide exposure to the mortgage sector for asset allocation investors. Dividends are important, but income isn’t the real goal, total return is the target.
NLY data by YCharts.
That’s highlighted in the graph above, which looks at the percentage change of the stock price, the dividend, and the total return over time. The key is that total return assumes dividend reinvestment, which is not something that income investors are likely to be doing. But if you are interested in having mortgage exposure within an asset allocation framework, you likely would reinvest dividends.
Asset allocation is normally the purview of large institutional investors (like pension funds). Some small investors use this approach, too, but it isn’t a common tactic for income investors. However, if you are using asset allocation (and dividend reinvestment) you should feel comfortable holding onto Annaly over the long term. Over time, reinvesting the outsized dividends has more than made up for the decline in the value of the stock.
The Buy thesis
Is Annaly Capital worth buying right now? This is where things get a little tricky. The answer is probably, but long-term income investors shouldn’t get excited by a period of strong performance. Rising rates are bad for bonds, which are basically what Annaly invests in (technically, it owns mortgages that have been pooled together into bond-like securities). Bond prices adjust quickly to interest rate changes because the prices of bonds rise and fall so that their yield matches whatever the current market rate happens to be. Over the past decade, there have been dividend cuts and stock price declines, while interest rates have risen.
On the flip side, falling interest rates are good for bonds as the price rises to match the current market rate. It appears that the Federal Reserve has shifted from a bias toward raising rates to a bias toward cutting rates. Annaly’s stock price will probably be pretty strong since it has risen over the past year, as long as rates keep trending lower. Essentially, the value of the portfolio it owns has increased thanks to expectations of lower rates.
If you expect to see rates continue to fall, it is probably worth buying Annaly — with the caveat that the dividend variability isn’t going to change, which remains true even if the dividend gets increased in the near term. In other words, if you are looking at total return, Annaly could be a good addition to your portfolio, but it is still a stock to avoid if you need a reliable income stream.
Annaly is a complex investment
Mortgage REITs like Annaly Capital are not easy to understand. However, one thing is pretty easy to see if you take the time to examine this ultra-high-yield stock’s dividend history — it is not a reliable income stock. It is all about total return, which it does a solid job of providing while giving investors exposure to the mortgage sector. So, if you are thinking of buying Annaly, make sure you buy it for its intended purpose.