It's tough to beat the market even with good growth stocks. Many investors would argue that beating the market with dividends alone is practically impossible. The S&P 500's long-term average annual gain of 10% is well above even the highest of dividend yields among familiar stocks, after all.
Every once in a while, however, unusual circumstances serve up unexpected opportunities.
Annaly Capital Management (NLY 1.02%) is one such opportunity. Although the organization's been forced to dial back its dividend payments for the past couple of years, the stock's lousy performance since all the way back to 2009 has pumped its dividend yield up to an incredible 13.9%.
If you can stomach the risk, this might be a prime entry point for a certain type of investor.
Annaly Capital Management, up close and personal
Don't sweat it if you've never heard of it. Most people haven't. It's not exactly in a mainstream business. Its market cap of $9.3 billion isn't exactly head-turning either. Moreover, the stock's poor long-term performance doesn't exactly keep it on anyone's radar. But if you believe good opportunities lie off the beaten path, Annaly Capital Management merits a look at this time.
Annaly is structured as a real estate investment trust, or REIT. In most cases, REITs simply hold revenue-bearing and rent-producing properties like apartment buildings, strip malls, hotels, and office buildings. REITs are also tax-advantaged investments since any profits from these properties that are passed along to investors aren't first taxed at the corporate level. That's why REITs tend to be seen first and foremost as income-producing holdings -- they boast better-than-average yields.
Even by REIT standards, though, Annaly Capital Management is a bird of a different feather. Rather than owning real estate, Annaly borrows money to purchase bundles of mortgage loans, collecting the difference between interest earned on those mortgages and the interest it pays on the money borrowed to buy them.
Most of the time, this business model is straightforward enough. However, intuitive investors suspecting the recent and rapid changes in interest rates were problematic for Annaly are 100% right. Because the yield curve has been inverted since mid-2022, the REIT's costs to borrow money have been greater than the interest payments being collected on the mortgage loans it's holding. Now ... read that previous sentence again.
10-2 Year Treasury Yield Spread data by YCharts
Indeed, even the unusually low interest rates we've seen since 2008 have made matters complicated for Annaly Capital Management. That's why shares have performed so poorly since then.
As the old adage goes, though, nothing lasts forever.
Much-needed change is finally brewing
On a technical (and GAAP) basis, Annaly Capital Management has unsurprisingly been losing money since the middle of 2022, when the mortgage interest rate yield curve first inverted.
That doesn't mean Annaly hasn't been able to continue funding dividend payments. There are earnings available to pass along to shareholders. In fact, on a non-GAAP basis, Annaly has earned more than twice what's it's needed to continue covering dividends over the course of the past couple of years.
Veteran investors know that all companies will eventually need to produce sustained GAAP profits if they want to survive. Doubts about this real estate investment trust's ability to do so again in the foreseeable future are arguably the chief reason its shares are still struggling.
While it's happening at a painfully slow pace, the inverted yield curve is de-inverting. As the domestic and global economies continue to stabilize without slipping into recession, look for long-term rates to fight their way back above short-term rates in the foreseeable future.
It's not just normalized interest rates on the verge of working back in Annaly Capital's favor again, either. Interest rates are stabilizing back near long-term norms not seen since before 2008.
Effective Federal Funds Rate data by YCharts
This matters as well.
See, although the spread between long-term and short-term interest rates is certainly a key aspect of the REIT's business, it's not the only one. Interest rates' absolute levels are a factor too. Much like banks' lending businesses, a REIT's profit margins are wider when all interest rates are. It makes for a more forgiving, higher-profit-margin environment in which to borrow money and buy bonds and other debt instruments ... like mortgage loans.
In this vein, Annaly has been seeing modest interest income improvements of late in step with the yield curve's recent trek back toward normalization.
Annaly is not for everyone, but certainly for someone
Is it something for everyone's portfolio? No. This is still a pretty speculative play, despite CEO David Finkelstein's comment during last quarter's earnings call that "it's not our recommendation to the Board to make an adjustment to the dividend." Things are always changing, and the REIT has certainly culled its dividend payments in the past. It's not only always possible that the dividend behind Annaly's 13.9% yield could be reduced, but that such a reduction would also drag the stock even lower.
If there's room for a little more risk in your portfolio, though -- or maybe a reason to generate above-average near-term income -- Annaly Capital Management's current yield is enormous. The problems that have plagued it for a few years now are finally starting to abate.
Just don't bet the whole farm on it.
