Big dividend yields are hard to ignore, so it's understandable if dividend investors seeing Annaly Capital Management's (NLY -0.32%) huge 17% yield on online quote services did a double take. There's one big problem: The dividend backing that yield won't last. Here's what you need to know and why Annaly probably isn't the best dividend stock for you.
Mortgage REITs are a complex business
Annaly is a real estate investment trust (REIT), but it doesn't own any property. It is what's known as a mortgage REIT. What it owns are collections of mortgages that are grouped together into assets that trade like bonds, generally called collateralized mortgage obligations (CMOs) or something similar. It is in a very different business than your traditional property-owning REITs.
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A key problem is that CMOs trade on the open market based on supply and demand. That means that the underlying value of the company's portfolio, which is in effect the underlying value of the company, can change from day to day. Factors that can impact the value of the portfolio include interest rate changes and the condition of the housing market. Rising rates, like the U.S. is facing today, generally reduce the value of existing CMOs. Rising rates can also lead to an increase in loan defaults. Weak housing markets also create headwinds, since demand for housing is low and thus demand for mortgages is low.
To put a figure on all of this, Annaly's book value per share (effectively the value of its portfolio) fell from $31.88 at the end of 2021 to $20.79 at the end of 2022. That's clearly not a good trend.
Annaly's dividend will be cut
It also helps explain why the management announced that the dividend was going to be cut during Annaly's fourth-quarter 2022 earnings conference call. Simply put, the big yield that investors are being presented by online quote services is based on old data. When the first-quarter dividend is finally announced, it will most likely be lower than the current $0.88 per share per quarter. You can almost expect a dividend cut.
This isn't an uncommon occurrence at Annaly. Its dividend has been heading lower for at least a decade. And yet, throughout this span, the yield has remained near or above the 10% mark. Stock prices and dividend yields go in opposite directions. So, every time the company lowered its dividend the stock fell. And that keeps the dividend yield at a high level.
Step back and think about that for one second. If you are a long-term dividend investor trying to live off of the income your nest egg generates, this is a terrible outcome. Not only do you suffer a reduction in the dividends you are collecting, but you also get the added hit of a loss of capital. History suggests that the huge yield on offer from Annaly is not going to lead to a positive outcome for most investors.
There are better options than Annaly
Mortgage REITs are complex, and most investors looking for a reliable income stream should avoid them, instead focusing on traditional property-owning REITs, like Federal Realty or Realty Income, which have long histories of regular dividend increases backing their yields. That's not to suggest that Annaly is a bad company -- that's not inherently true -- but it certainly won't be a particularly great dividend stock for most investors.
