Bull markets generally lead to extreme investor enthusiasm. With some Wall Street commentators saying we are now back in bull territory, long-term investors should probably take a step back and temper their excitement. Constant vigilance is a much better way to approach investing. And right now, dividend investors eyeing AGNC Investment's (AGNC 0.97%) massive 13.8% dividend yield should tread with caution. It might not be the bargain you hope it is.
The business is the story
AGNC is a mortgage real estate investment trust (REIT). This is vastly different from property-owning REITs, which are fairly simple to understand using kitchen table finance. Basically, you buy a property and rent it out. Mortgage REITs buy mortgages that have been cobbled together into bond-like securities, often called collateralized mortgage obligations (CMO). CMOs are usually backed by a lot of individual mortgage loans, with each loan having its own risk/reward profile. To complicate things, mortgage REITs generally use leverage, often backed by the value of the CMOs it owns, in an attempt to enhance returns.
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A lot can go wrong. For example, CMOs trade regularly, so the value of the portfolio will rise and fall, much like the value of your stock portfolio. Add in the leverage, which can help improve returns but can also exacerbate losses, and a mortgage REIT's value (which is essentially the value of the portfolio it owns) can be highly volatile over time. There are multiple hard-to-predict factors involved in CMO market prices. For example, interest rates, housing market dynamics, and mortgage payment trends can all play a role in the value being assigned to a CMO. Even the year a CMO was created can be an important trait to consider. It is highly unlikely that an individual investor will be able to track what's going on with a mortgage REIT's portfolio.
To be fair, even with property-owning REITs, investors are trusting that management will do the right thing for shareholders. That's really true of any stock you buy. However, mortgage REITs are particularly complex investments, and only the most active investors should probably own them. For example, insurance companies and pension funds might find mortgage REITs a good portfolio fit, with diversification and total return (which assumes dividend reinvestment) driving the decision process.
We can do it, or can we?
Here's the problem, mortgage REITs tend to offer investors very large dividend yields. AGNC's 13.8% yield is just one of many examples in the space. A double-digit yield can be like a siren's song to dividend investors looking to maximize the income their portfolios generate as they try to live off of the income stream their portfolios create. The history here suggests caution is in order.
Over the past decade, AGNC's dividend payment has trended steadily lower. And yet, at the same time, the dividend yield has generally remained near or above 10%. Since price and yield move in opposite directions, the only way for that to have happened is for the stock to have trended steadily lower, as well -- which is exactly what has happened.
AGNC Dividend Per Share (Quarterly) data by YCharts.
So dividend investors lured in by a huge yield, perhaps thinking they have found a bargain, have ended up with less dividend income and capital losses. That's a terrible outcome. But take a closer look at the chart above; most of the dividend cuts have come when the dividend yield has been around where it is today.
That doesn't mean the dividend will be cut. In fact, management has gone on record stating that it is "very comfortable" with where the dividend is right now. However, it looks like investors are again worried that the dividend isn't going to be sustainable. If history is any guide, they have a reason to be worried.
Getting burned twice
The question for dividend investors is whether or not the risk of a dividend cut is worth the reward of the high yield. For conservative investors, that answer is most likely going to be no. And even more active and aggressive investors should think carefully about AGNC. A dividend cut is likely to be accompanied by a lower stock price, meaning that you open yourself up to a terrible double whammy if you are wrong about the sustainability of this REIT's dividend.
