As investors grow older -- and wiser -- they increasingly accept that it's tough to consistently beat the market. Rather, investing veterans grow increasingly satisfied with merely mirroring the market's long-term gains. If this sounds like you, that's perfectly fine.
If you've got a nagging itch to at least try to beat a broad-based benchmark like the Dow Jones Industrial Average (^DJI 0.40%), however, here's an idea to consider: real estate investment trust Annaly Capital Management (NLY 1.02%). With its dividend yield now standing at an incredible 14.4%, your dividend income alone on Annaly has the potential to drive market-beating gains.
Just bear in mind that this high-yielding pick comes packed with plenty of caveats.
Annaly Capital Management is a most curious kind of company
As was noted, Annaly Capital Management is a real estate investment trust, or REIT for short. These instruments trade like ordinary stocks, although they're actually a tax-advantaged means of investing in rental real estate. While you'll pay taxes on your REIT's dividend payments, as long as the REIT passes along the bulk of its profit to shareholders, that income isn't also taxed before it reaches you.
Annaly is a bird of a slightly different feather, though. While it qualifies as a REIT, it doesn't actually own physical real estate. Rather, it owns mortgages bundled into so-called mortgage-backed securities. Annaly Capital assumes the risk of defaults on these loans, but also reaps the benefit of the interest paid with these loans' underlying mortgage payments. It also purchases these mortgage-backed securities on a leveraged basis, meaning it buys them with borrowed money to bolster the returns they generate.
In simpler terms, Annaly Capital Management is something of a mortgage loan speculator.
And that's been problematic for Annaly shares of late, which are down about 15% this year. The REIT's price has been more than halved since its mid-2021 peak, as demand for new mortgage loans has tapered off. Rampant inflation and the streak of interest rate increases it's spurred is also a threat to Annaly Capital's business. Mostly, though, the specter of economic weakness and the resulting delinquencies and defaults on loans is worrisome. They hurt the value of mortgage-backed securities, and even more so when they're purchased using leverage the way Annaly does.
The thing is, the market may be pricing in a calamity that just isn't in the cards.
Healthier than it's getting credit for
For the record, yes, concerns about the health of the economy and the mortgage market are legitimate. The Conference Board estimates the U.S. gross domestic product (GDP) growth rate will slide from a subpar 2.2% in 2023 to only 0.8% next year. Meanwhile, the nation's credit card delinquency rate now stands at a multi-year high of 2.77% on record-high balances, according to the Federal Reserve. On a global basis, the International Monetary Fund (IMF) says the world's economy is just "limping along." These data points paint a troubling picture.
But take a closer look at the economic rhetoric, and specifically, take a look at the current state of the U.S. mortgage market.
Regarding the economy, expectations for a soft landing that steers clear of a recession are on the rise. Indeed, even though IMF chief economist Pierre-Olivier Gourinchas says the world's economic growth is merely tepid at this time, he believes the U.S.'s "remarkable strength" leaves it particularly well positioned to ease its way out of an economic funk.
On the mortgage front, curiously, borrowers are specifically not struggling to continue making these payments. Perhaps they're highly motivated to keep their ultra-low interest rates in place. The Fed reports that single-family residential mortgages on U.S. homes continue to fall, reaching a multi-year low of 1.72% during the second quarter of this year.
Maybe Annaly Capital Management isn't in the trouble most investors seem to think it could be.
In this vein, the REIT has continued paying the new, lower quarterly dividend it established at the onset of this year. It's also continuing to earn more than it's dishing out in dividends during this time.
Weigh the actual risk with the likely reward
To be clear, Annaly Capital is hardly a risk-free investment here.
Although mortgages may hold up just fine while the domestic economy fights its way back from the brink of serious economic weakness, that prospect is far from ironclad. Something unforeseeable could happen in the future, driving Annaly shares even lower. Something could also happen that forces the REIT to dial back its dividend payment yet again.
Annaly Capital Management shares have also been a subpar long-term performer, with much of its weakness being spurred by habitual dividend cuts.
Data source: YCharts
Weigh the plausible risk against the probable reward. You're stepping into a real estate investment trust paying out a dividend equal to more than 14% of its share price. Even if another dividend cut is in the cards, you're still doing well.
Moreover, this stock's long-term decline and inconsistent dividend reflect an unforgiving environment that's been tricky for mortgage REIT managers. Namely, interest rates have been unusually low since 2009, following the subprime mortgage meltdown the year before. With interest rates poised to remain near their current multi-year highs at the same time the mortgage loan market is close to stabilizing, however, profitably managing a portfolio of mortgage-backed securities should get easier. That's something the market doesn't seem to be acknowledging at all, at least not yet.
This might help you make the decision: Despite the REIT's lousy performance of late, the analyst community's current consensus price target still stands at $22 per share. That's more than 20% above Annaly Capital Management's present price.
