The Market's Hottest Dividend Sector Gets More Great News

This article is part of our Rising Stars Portfolios series.

For a company, it's gotta be hard to do well when other companies are faltering. But that's exactly what the players in the high-yielding mortgage REIT sector do: kick butt when other companies feel the hurt. And there's more good news for these mREITs -- unemployment is up.

Late last week, it was reported that unemployment climbed to 9.2%. The number of net new jobs came to just 18,000 for the month, well below even the most dour analyst predictions. It was the weakest hiring report since May 2010. The poor showing throws into doubt analysts' claims about a second-half recovery, but it's nevertheless good news for mortgage REITs, which thrive in tough conditions like these. With unemployment so high, the Federal Reserve cannot credibly raise interest rates, keeping the cost of funding low for these REITs.

Such conditions are allowing Annaly Capital (NYSE: NLY  ) and Chimera Investment (NYSE: CIM  ) to pay out huge yields, around 14%. And that's part of the reason I purchased Annaly in my Special Situations portfolio, as a hedge against some other consumer names I own.

This segment of the market has seen more than its fair share of IPOs this year. New entrants are looking to raise more than $2 billion in capital to invest in mortgage REITs -- the market's hottest dividend sector. But already-public players have been taking their hats in hand to investors this year, too. Annaly, American Capital Agency (Nasdaq: AGNC  ) , and Invesco Mortgage Capital (NYSE: IVR  ) have performed secondary offerings recently. And that's on top of billions in new shares issued by American Capital Agency, Hatteras Financial (NYSE: HTS  ) , Annaly, and Chimera over the past few years.

These dividends look quite tempting:

Company

Leverage

Yield

Annaly 632% 14.0%
Chimera 176% 14.8%
American Capital Agency 662% 18.5%
Invesco Mortgage 370% 17.6%
Hatteras Financial 610% 13.7%
Two Harbors Investment (NYSE: TWO  ) 382% 14.6%
Cypress Sharpridge (NYSE: CYS  ) 554% 18.3%

Source: Capital IQ, a division of Standard & Poor's.

As I explained in a previous article: "Mortgage REITs make their money by borrowing at short-term rates and buying long-dated mortgages, and pocketing the spread between the two. They then lever up their balance sheet in order to exploit that spread. … Those yields trounce most of what you can find in traditional REITs."

And besides the unemployment report, other economic indicators or political obstacles continue to make mortgage REITs look attractive. The budget impasse will ensure that any government stimulus will be modest, and any attempt at near-term fiscal austerity will hurt the economy, making the situation relatively more attractive for mortgage REITs. Moreover, with plenty of excess capacity, businesses are loath to invest.

So while the bad news keeps on coming for the broader economy, it's almost all good news for mortgage REITs. And that's why I've decided to add even more Annaly to my own portfolio, as I explain here.

This article is part of our Rising Stars Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).

Jim Royal, Ph.D., owns shares of Annaly. The Fool owns shares of Annaly Capital and Chimera. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 12, 2011, at 10:32 AM, dbtheonly wrote:

    NLY announced a sale of 120 million shares @ $17.70. I'd expect to see the price drop to that point. Unless you have some sort of special access, I'd advise waiting a few days before adding NLY.

  • Report this Comment On July 12, 2011, at 10:41 AM, timlash wrote:

    Since I've read about 100 stories purporting a mad dash of investors to dividend stocks, I'm puzzled as to why the price of these mREIT stocks have not experienced a run-up and subsequent decline of their yields. How can this discrepancy be explained?

  • Report this Comment On July 12, 2011, at 6:12 PM, TT4N wrote:

    Investing in MREITs sure beats a 0% compounded never savings account :-)

  • Report this Comment On July 12, 2011, at 7:03 PM, SKenny89 wrote:

    Timlash: Because they continue to leverage in order to eithe increase profits or maintain current yields by offering more shares, which in turn dilutes and depreciates their share prices in accordance with the # of shares newly issued. Also as you probably already know , they are required by law to give back 90% of their profits to shareholders through dividends, which leaves little room for retained profits and subsequent appreciations in share prices. Purely an income play w/ little to no growth at current conditions.

  • Report this Comment On July 12, 2011, at 7:16 PM, SKenny89 wrote:

    However, regardless of interest rate risk (as rates increase, their profits and prices will eventually decrease) I'll take their current high yields as I currently hold shares of TWO, CIM, and AGNC in a small DRIP account.

  • Report this Comment On July 14, 2011, at 9:50 AM, timlash wrote:

    SKenny69: Couldn't it be argued (especially by NLY management) that since the proceeds from these periodic share sales are utilized to buy more assets upon which they can generate more above average returns that these sales do not fully dilute existing shareholders, but rather increase the size of the pie so that more people can benefit? Their current leverage ratios (~80% of assets) are below those they carried as recently as 2006 (~90%).

    My own disclosure: I bought NLY in 2008 @13 and sold about a year ago @17 on speculation of rising interest rates. Still waiting for rates, pining over the divis I gave up but closely following NLY.

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