Mortgage real estate investment trust (REIT) Annaly Capital Management (NLY 0.19%) has long offered investors a double-digit-percentage dividend yield. It's now sitting at a huge 18% -- even higher than usual -- as the company's recent 1-for-4 reverse stock split seems to have upset investors a little bit. Normally, stock splits aren't particularly meaningful events, but in this case, Wall Street's concern may be appropriate.
What a stock split does
The most important thing to know about stock splits is that they don't actually change anything about the underlying value of a company, nor about the relative sizes of the slices of it that each shareholder owns. The only things that change after a split are the number of shares each investor owns and the price of those shares. For example, if you owned a stock that was trading for $100 and it split 2 for 1, you'd end up with two shares worth $50 each. Effectively, the same thing. A reverse split works in the opposite direction, so a $50-per-share stock that splits 1 for 2 would leave you with one share of stock worth $100. Again, there's no change in the value of your holding, nor in your ownership stake in the company.
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Still, investors often read into stock splits. Regular stock splits are viewed as positives. Reverse splits are generally seen as negatives. It's probably not appropriate to give much weight to a stock split, but a reverse split really can be a sign of trouble.
Most major exchanges -- like the New York Stock Exchange or the NASDAQ, for example -- have minimum share price requirements. If a stock trades below, say, $1 per share, for too long, the company will get a warning from the exchange that it is at imminent risk of being delisted. That's bad for a company, because it can limit its ability to raise capital. Most often, reverse splits are done to increase the price of a stock so it can avoid being delisted.
As such, a reverse split can be a warning sign. It suggests that investors aren't interested in providing the company with the capital it needs, often because the business is struggling.
But Annaly wasn't at risk of being delisted. So, at first blush, there doesn't seem to be a problem here.
Still a problem
However, once you dig into the mortgage REIT's history and learn the reason for its reverse stock, split, you'll find cause to worry. For starters, in the news release announcing it, management noted that "...the Company believes the reverse stock split will make the common stock more attractive to a broader range of investors..." That's normally a reason companies offer when they want to perform a regular split, because it lowers the price of the stock. But how would a higher price achieve the same result for Annaly?
The answer is that some institutional investors, like insurance companies and pension funds, have minimum share price rules for the companies they hold. It appears that Annaly needed to boost its stock price so its shares could continue to be owned by institutional investors. That's not necessarily bad, until you look at what got the REIT to this point.
Its quarterly dividend payout has been on a downward trend over the past decade. That has dragged the price of the stock down along with it. For income investors, that's a terrible outcome. The yield, which remained high because of the falling price, may have somewhat hidden the trend for those who didn't dig a little deeper. However, if retail investors are less likely to be interested in Annaly due to its falling dividend and stock price, then it becomes more important for the REIT to make nice to institutional types. And to do that, it needs a higher ticker price.
Most will be better off elsewhere
A complicating factor here is that Annaly is a mortgage REIT, which is a unique niche in the REIT space. In fact, Annaly is generally considered a well-run mortgage REIT. However, given its track record, its reverse split is yet another warning sign that dividend investors should probably look elsewhere. Its yield is attractive, but the risk/reward trade-off just won't be worth it for anyone who cares about dividend consistency.
