The Weekly Dividend

I almost always drive above the speed limit. I prefer my iced tea Long Island style. I love the movie Swordfish. I order my baked potatoes fully loaded. And yet, despite my spry youthfulness and daring lifestyle, I am a painfully boring investor.

I like stocks so dull, so lackluster, that even my grandmother asks if I'm investing too conservatively ... with her money. Sure, I'll dabble in growth from time to time, but ultimately, I just can't stray from established brands, bountiful cash flows, and plump dividends.

Each week, I'll tap into my deep dividend devotion to bring you Fools the latest dividend news, inside insights, and the occasional look forward. Expect interviews with dividend gurus, reader mailbag Q&A's, and guest writers in the weeks to come. But for now, let's kick things off with a look at one of the bumpier areas of dividend investing.

Volatility, thy name is mortgage REIT
Fools might find it odd that despite my love of consistent cash flows, I own shares in mortgage REIT Annaly Capital Management (NYSE:NLY). Annaly's often painfully volatile share price and dividend payments stem directly from its creative business model. Unlike most REITs, such as Vornado Realty (NYSE:VNO) or American Financial Realty (NYSE:AFR), which invest directly into properties, Annaly instead invests shareholders' money in mortgage-backed securities, or MBS. Using that investment as collateral, the company borrows a substantial amount of additional funds in the short-term repurchase markets, which it then uses to purchase additional MBS.

The firm makes its money by using that leverage to amplify its "spread" -- the difference between its cost of borrowing and the return on its longer-duration investments. As the spread widens, or as the yield curve grows steeper, Annaly's profits typically rise substantially. When the spread contracts or shrinks -- typically, when the yield curve flattens or inverts -- Annaly's earnings and share price hit the skids. Hard. Need further details and explanation on Annaly's strategy and results? Check out the company's super-useful website.

The importance of the interest rate spread to the firm's health is readily apparent:

Now, while we're not looking at an especially strong correlation between changes in spreads and dividends, it's still unmistakably there. The differential between the two factors largely comes from the directions of interest rate shifts, mortgage prepayments by borrowers as interest rates shift downward, and the dividends Annaly itself receives from its now wholly owned asset-management subsidiary, FIDAC.

Annaly's Q1 dividend
On Tuesday, Annaly announced a first-quarter dividend of $0.20 a share. This payout is a slight bump above the $0.19 payout in the fourth quarter; more significantly, it's the fifth consecutive quarter featuring a dividend hike. It sounds lovely, but don't be fooled -- the company hasn't always provided shareholders with such seemingly smooth sailing. Witness the shifts in Annaly's quarterly payouts over the past 10 quarters:

Whoa, Nelly! With a share price bound tightly to its dividend payments, and a $0.15-per-quarter standard deviation on the dividend, it's no surprise that Annaly's share price bucks like a bronco.

Still, despite the inherent risks in the firm's business model, and the volatility in both Annaly's payouts and share price, I don't currently plan to unload my shares. Given the current shakiness in the housing and subprime lending markets, I doubt the Fed will raise short-term interest rates anytime soon. Such a move would harm Annaly by most likely exacerbating the currently inverted yield curve. That said, while inflationary fears may prevent the Fed from lowering rates in the short term, I expect interest rate spreads will eventually expand back toward historical norms.

When they do, I'll be waiting with my shares -- and their expanding dividends. Of course, should I be wrong, and further distortions in the yield curve await ... well, look out.

Dividend school
Perhaps you're wondering why I didn't mention Annaly's yield above. Nothing slides by you, Astute Dividend Lover! I temporarily ducked the issue because there are a couple of ways in which to express Annaly's yield.

The first approach would be a trailing-12-month measure, whereby you simply add up the payouts from the last four announced dividends, then divide that sum by the current share price. Presto! You've calculated a 4.4% dividend yield for Annaly. But such an approach extrapolates from some fairly dated reference points. Given the swings and volatility in Annaly's payouts, would you really want to factor a more than nine-month-old dividend into your estimations? Me neither.

This leads to the simpler -- and I believe, more accurate -- estimate of future payouts. Multiply the most recently announced quarterly dividend by four (the number of payment periods in the calendar year), then divide that result by the current share price. Such an approach results in a yield of about 5.3%, nearly a full percentage point higher than the trailing-12-month approach.

Which approach works best? While I'm inclined to trust the latter as a better gauge of Annaly's current outlook, neither is a particularly accurate estimate of payouts to come. If you'd like to learn how to forecast the future dividends of Annaly -- and other firms that are, thankfully, much easier to understand -- stay tuned for future installments.

More dividend divinations:

• 6 High-Risk Dividend Stocks
• Dividend Stocks That Deliver
• The Dividend Dilemma

Up for a further dose of dividend divinity? Check out a free 30-day trial to James Early's Motley Fool Income Investor newsletter.

Foolish editor Joe Magyer owns shares in Annaly, an Income Investor selection. American Financial Realty is also an Income Investor pick. Joe's dog, Warner, loves peanut butter. As always, Joe's holdings and CAPS profile are available for your viewing pleasure. The Motley Fool has a disclosure policy.