The S&P 500's dividend yield is currently around 1.2%. So, when a stock like Annaly Capital Management (NLY +2.38%) offers a yield more than 10 times above that level, it seems like something is off.
However, that's not the case with this real estate investment trust (REIT). It must legally pay out 90% of its taxable income in dividends to remain in compliance with IRS regulations.
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A monster yield from the real estate sector
Annaly Capital Management is a mortgage REIT. It invests in Agency mortgage-backed securities (mortgage pools guaranteed against credit losses by government agencies, such as Fannie Mae), non-agency residential mortgages, and mortgage servicing rights. These mortgage investments typically yield low-risk, fixed-rate returns in the low to mid-single digits. Through the use of leverage, Annaly can earn higher returns, currently in the double digits across all three strategies.
The mortgage REIT reported $0.73 per share of earnings available for distribution (EAD) in the third quarter, up from $0.66 per share in the year-ago period. That easily covered its $0.70 per share dividend payment. Its EAD was $0.73 per share in the second quarter and $0.72 per share in the prior two quarters. The improvement in EAD over the past year enabled Annaly Capital Management to hike its dividend payment earlier this year from its previous level of $0.65 per share.
As long as Annaly's EAD remains above the current dividend level, it will be able to maintain the payment rate. However, its EAD can fluctuate based on interest rates and market conditions. In 2022, Annaly's EAD was between $0.89 and $1.22 per share, which enabled it to pay a quarterly dividend of $0.88 per share.
Annaly has a legal requirement to pay out nearly all of its taxable net income in dividends, which is why it has such a high yield. However, that payout will fluctuate with its earnings, which is something investors need to consider before buying shares for income.
