Finding high-yield dividend stocks is usually a difficult endeavor since a high yield is often a red flag that something is wrong and the market is beginning to price in a dividend cut. This is especially true when the company's competitors have lower yields.
But for a few types of companies, mainly real estate investment trusts (REITs) and master limited partnerships, a high dividend yield is not necessarily a sign of something wrong. Let's look at one such company, AGNC Investment (AGNC 0.14%).
Mortgage REITs buy real estate debt
AGNC Investment is a mortgage REIT, which is different from the typical REIT model, where a company builds commercial property and then rents it out. Mortgage REITs don't own properties, they own mortgages. If you recently refinanced your home, chances are your loan ended up begin owned by a mortgage REIT like AGNC Investment.
Image source: Getty Images.
The company concentrates on mortgages that are guaranteed by the U.S. government. This means that even if the borrower defaults on the mortgage, AGNC still gets paid. While this doesn't mean that it cannot lose money on an investment, it does mean that the biggest risk (i.e., credit risk) is off the table.
Spring of 2020 was rough on the mortgage REIT sector
The mortgage REIT sector did go through a stressful period at the beginning of the COVID-19 pandemic when liquidity dried up in the mortgage-backed securities market. Even though these securities are guaranteed by the government, their prices declined precipitously because every mortgage REIT was forced to de-leverage (or reduce debt). As these securities fell in price, AGNC's bankers required more cash collateral, which caused a self-reinforcing downward spiral.
AGNC, like every other mortgage REIT, cut its dividend, although it admitted in retrospect it probably wasn't necessary. Many mortgage REITs weren't so lucky as to escape with just a dividend cut; some ended up having to enter forbearance with their bankers. So while the company invests in government-backed mortgages, liquidity risk can spring up and cause issues, and these sorts of episodes happen. This is simply the reality of investing in financial stocks.
Why a dividend hike looks likely
As a REIT, AGNC doesn't pay corporate taxes, provided that it distributes the vast majority of its net earnings as dividends. This is why these stocks are generally highly favored with income investors. Take a look at the chart below, which shows AGNC's dividend yield over the past several years. The yield is at an all-time low -- a result of the stock's recovery from the COVID-19 related sell-off in spring of 2020 and caution on the part of management. Since mortgage REITs generally like to keep their dividend yield in a set range, AGNC is looking ripe for a dividend hike.
AGNC dividend yield data by YCharts.
AGNC cut its monthly dividend from $0.16 to $0.12 in April 2020 as a result of the COVID-19 crisis. Notwithstanding the forced selling of the spring of 2020, as a general rule, mortgage REITs generally trade right around book value per share. These stocks aren't likely to outperform in a bull market, but are more suitable to an income investor who is willing to accept periodic volatility.
Unlike the mortgage REITs that invested in non-guaranteed mortgage-backed securities, AGNC was never in danger of failing. The company has recouped its pre-COVID-19 book value per share. The next step is probably to recoup the pre-COVID-19 dividend.
