Dividend stocks can be an excellent source of passive income, which is why many income investors gravitate toward them. One popular dividend stock, with an ultra-high yield of 14%, is AGNC Investment Corp. (AGNC 0.97%).
However, having a high dividend yield doesn't always mean a stock will deliver for your portfolio. Read on to see how AGNC has performed for its investors over the past decade and whether it's right for your portfolio.
Why AGNC's dividend yield is so high
AGNC is a real estate investment trust (REIT), which means it isn't subject to federal or state income tax as long as it distributes 90% of its taxable income to shareholders. Because of this tax treatment, REITs tend to deliver big dividend yields to their investors.
AGNC is a mortgage REIT that invests primarily in agency mortgage-backed securities guaranteed by government agencies such as Fannie Mae or Freddie Mac. Mortgage-backed securities are bonds backed by a pool of mortgages, and investors like AGNC receive periodic payments similar to coupon payments on a bond. The company makes money on its net interest margin, which is the interest income it earns on its investments minus its funding costs.
Here's how much a $5,000 investment 10 years ago would be worth today
AGNC has been a good source of income through its high dividend. In the past decade, the REIT has had an average dividend yield of 12%. While this dividend is eye-popping, the stock price has fallen 52% in the same period, reducing the stock's total return to investors.
If you invested in AGNC Investment 10 years ago, your investment would've delivered a total return (with dividends reinvested) of 54%. In other words, your $5,000 investment would be worth $7,708 today. These returns pale compared to the SPDR S&P 500 ETF's total return of 224% during the same decade.
Data source: YCharts.
AGNC has faced these headwinds over the past year and a half
The fact that the government guarantees its mortgage-backed securities means AGNC faces less credit risk than other REITs. However, that doesn't mean it doesn't have other risks.
Mortgage rates aren't double digits, yet AGNC's dividend is, so how does the REIT do it? One word: leverage, and a lot of it. At the end of the first quarter, AGNC had a leverage ratio of 7.2 times its stockholders' equity. High leverage can magnify gains, but on the flip side, it can also magnify potential losses.
Also, mortgage REITs hold assets with long maturities while they fund their investments with short-term borrowings. Rising interest rates hurt mortgage REITs, increasing their funding costs while also lowering the value of the REIT's mortgage assets. As a result, mortgage REITs face significant interest rate and rollover risks.
These pressures have weighed on AGNC's business and valuation over the last year. While the REIT hedges its portfolio against interest rate changes, those hedges haven't quite offset losses on its mortgage portfolio. As a result, AGNC's book value per share has fallen from $15.75 at the end of 2021, before the Fed's rate hiking cycle, to $9.39 per share at the end of this year's second quarter.
Is it a buy?
AGNC can generate high dividend yields, but investors should know the other risks of investing in mortgage REITs. High leverage and rising interest rates can weigh on the book value, and the past year has seen the Fed raise interest rates at the fastest pace in decades.
There have been indications that the Federal Reserve will slow down or even pause its pace of rate hikes this year. According to CME Group's FedWatch tool, markets anticipate one more rate hike of 0.25% before the end of this year, with rate cuts expected in early 2024. If this is the case, AGNC will become a more appealing investment than in the past year and a half.
However, the stock still trades at a slight premium to its book value, and there is no guarantee the Fed will be so quick to stop or reduce its interest rates soon. That, coupled with its lackluster performance over the past decade, suggests income investors may be better looking elsewhere for dividend stocks that can deliver steady, solid returns over time.
