Income investors tend to flock to high-yield stocks, lured in by their huge dividend payments. Far too often, though, the risks of these investments outweigh the potential rewards. When it comes to AGNC Investment's (AGNC 0.10%) massive 12.6% yield, most investors should tread with caution, and conservative ones should probably avoid it. Here's why.
Too complex for most
A property-owning real estate investment trust (REIT) is fairly simple to understand. Such companies buy physical properties, lease them to tenants, and collect fairly steady streams of rent. At least 90% of any REIT's taxable income must be passed on to investors via dividends each year.
But mortgage REITs don't function like this.
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At the core, a mortgage REIT owns collections of mortgages that have been pooled together to trade like bonds -- these assets are usually called something like collateralized mortgage obligations (CMOs). These REITs generally employ leverage, with the portfolio of mortgages acting as collateral. The goal is to earn more than the cost of the leverage, leading to enhanced returns. The problem is that the values of CMOs rise and fall based on interest rates, the supply and demand of the assets, and other factors. If the underlying value of the portfolio falls too far, it can lead to a margin call. During the 2007-to-2009 Great Recession, a number of mortgage REITs ended up in bankruptcy.
That isn't to suggest that AGNC is in such a position today, because it's not. However, a margin call is a worst-case scenario that investors need to consider. Needless to say, any dividends a mortgage REIT is paying will end either before that point or very shortly after it. The key takeaway here is that mortgage REITs are complicated and can be risky, so you need to fully understand what you're buying. If you are a conservative dividend investor or someone who doesn't want to spend a lot of time tracking your investments, mREITs are not a good choice for you, even if their dividend yields are alluringly high. Resist the temptation.
A tough time
As far as AGNC goes, the REIT cut its dividend by 25% in 2020 to $0.12 per share per month. It has maintained the payout at that level ever since. Its yield today is 12.6%. By comparison, the average REIT -- using Vanguard Real Estate Index ETF as a proxy -- yields 3.5%. There's a reason for the wide discrepancy.
For example, AGNC reported that in 2022 it offered investors a "-28.4% economic return on tangible common equity for the year." So, yes investors collected a $1.44 per share in dividends, but the mortgage REIT's book value per share fell by $5.91, or 37.5%, year over year. That helps explain why the stock price fell by more than 30% in 2022.
Meanwhile, the REIT bought back 4.7 million shares at an average price of $10.78 per share. But it sold 56 million shares at an average price of $9.39 per share. When you net those two facts out, it doesn't sound like this activity was a win for investors.
All in, 2022 was not a particularly great year for AGNC, and while its investors may have collected big dividends, their total return (assuming the reinvestment of dividends) was still negative 21%. This is the type of volatility that is normal for mortgage REITs, especially during turbulent financial periods. In fairness, AGNC's tangible book value rose by just over 8% in the fourth quarter, but that, too, just shows how swiftly things change. If you end up on the wrong side of these changes, you could find yourself hurting.
Still a tough market
Rising interest rates have been taking a toll on the housing and mortgage markets, and generating serious headwinds for AGNC too. Interest rate trends are still going in a troubling direction, so there's no reason to expect AGNC's business to suddenly turn around. And given the inherent complexity here, most investors will likely be better off putting their money elsewhere. That's not meant to disparage AGNC in any way, but to highlight that the risk/reward balance here is both complex and seemingly tilted in the wrong direction for investors right now.
