Catch a Falling NovaStar?

Mortgage REIT NovaStar Financial (NYSE: NFI  ) reported quarterly earnings last Friday, and it was a decidedly mixed bag. Net earnings were down significantly year over year, in spite of a larger portfolio of managed assets. Of course, considering NovaStar's business model, that's a natural result of the rising federal interest rate. An inverted yield curve can sure put a hurting on purely financial businesses like NovaStar, Monmouth Capital (NYSE: MONM  ) , or even Citibank (NYSE: C  ) . And with its focus on subprime mortgages -- loans to individuals with low credit scores -- NovaStar may be riskier than most REITs.

I'm a NovaStar shareholder, having bought the stock on the promise of a 17% dividend yield with what looked like solid backing. Today, all sorts of metrics are down from last year, some at alarming rates, and my investment is feeling a little shaky. Adjusted for dividends, I'm up 4.3% in 14 months' time, which is a far cry from the 17% free ride I was hoping for.

It's so easy to get drawn in by the promise of juicy dividends. But if it was just a matter of finding the highest possible yields, we'd all just invest in Terra Nitrogen (NYSE: TNH  ) or Elron Electronic Industries (Nasdaq: ELRN  ) -- with their 18% and 31% current yields, respectively -- and then just sit back and collect the payments until our dying day. But it's not that simple. Elron paid out gains from a sale of businesses as a one-time dividend, and that's not expected to happen again anytime soon. Terra makes fertilizers out of natural gas and has a really hard time financing its dividend from current income when oil and gas prices are high.

For its part, NovaStar is one of the many companies that keeps popping up in connection with naked short-selling. If (Nasdaq: OSTK  ) CEO Patrick Byrne's personal crusade against the illegal practice has any merit, then his company, Novastar, Netflix (Nasdaq: NFLX  ) , True Religion (Nasdaq: TRLG  ) , and NetEase (Nasdaq: NTES  ) -- among many others -- may have had their stock prices artificially depressed, some of them for years. Of NovaStar's float, 34% is still shorted, so either there's something fishy going on, or a very large portion of the market is seeing substantial dangers ahead for this stock.

What to do, what to do .... Hold and hope that the housing bubble doesn't pop while the naked shorting demons turn out to be real? Or cash out at a tiny profit and not look back? The Fool says I need to think about it for at least 10 days now, so I'll go soul-searching in the meantime. As for the rest of you, due diligence is in order. Mathew Emmert's Income Investor newsletter is a great place to learn more about safe dividends, and you can take it for a free 30-day spin today.

Fooling right along:

Netflix is a Motley Fool Stock Advisor selection, and NetEase is a Rule Breaker pick. Overstock is a former Stock Advisor recommendation.

Fool contributorAnders Bylundis a shareholder in NovaStar, Netflix, and True Religion, but holds no other position in any of the companies discussed here. He also used to own some stock. No, he doesn't go by the Reg SHO list when screening for investments. You can check outAnders' holdingsif you like. Foolishdisclosureis never nude.

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