Dividend stocks have been all the rage over the past few years. Given abysmal bond yields coupled with the perceived safety of dividend stocks relative to growth stocks, some have even gone so far as to predict a dividend bubble.
As my colleague Morgan Housel noted earlier this year: "starved of yield with interest rates near 0%, investors are tripping over themselves to get dividends these days." It's for this reason that S&P 500 stocks with the highest dividend payout paradoxically began last year with the highest P/E ratios.
But for the smartest investors, it's not the current yield that matters, but rather the future yield. Take Bank of America (NYSE:BAC), which currently pays out only $0.01 per share a quarter in dividends. Assuming the nation's second largest bank by assets ultimately earns between $30 and $40 billion a year, which I believe it will, that payout could easily reach $0.25 over the next five to 10 years, equating to a yield on original investment of more than 8%.
The question, then, is not what a stock is currently yielding, but rather whether the dividend payout will increase with time. With this in mind, I've taken a look at some of the most popular dividend stocks in the financial industry to see whether or not they are likely to increase their dividend payouts in 2013. Up today is Annaly Capital Management (NYSE:NLY), the pioneering, and largest, mortgage REIT in the country.
The magic 8-ball says: "Outlook not so good"
The probability that Annaly will raise its dividend this year is slim to none. The reason? Like other participants in the mortgage REIT space, including American Capital Agency (NASDAQ:AGNC) and ARMOUR Residential (NYSE:ARR), Annaly is fighting against powerful headwinds originating at the Federal Reserve.
Over the last few years, the Fed has moved aggressively to drive down long-term interest rates generally, and mortgage rates in particular. It doubled down this past September by announcing a third round of quantitative easing under which it's committed to buying $40 billion in mortgage-backed securities a month until the unemployment situation improves "substantially."
The impact of these policies, and QE3 in particular, in the mortgage REIT space has been impossible to ignore. In Annaly's case, as you can see in the chart below, thanks to the increased competition for MBSes, its yield on earning assets has plummeted, going from 3.71% in the third quarter of 2011 to 2.54% in the third quarter of last year, a 32% decline. Over the same time period, meanwhile, its cost of funds decreased by only 7%, going from 1.63% down to 1.52%. This confluence of rates has cut Annaly's interest rate spread in half, from 2.08% in September of 2011 to 1.02% in the same month last year.
One of the reasons Annaly has been hit so hard is because of a particular aspect of its portfolio. Namely, its portfolio has a significantly higher constant prepayment rate than any of its competitors. As I discussed in depth here, this metric measures the proportion of an mREIT's holdings that are prepaid every year. In a decreasing interest rate environment like the present one, in turn, a higher CPR is a bad thing, as the mortgages purchased to replace the prepaid ones will almost necessarily yield less than existing assets. By means of comparison, the following table illustrates how Annaly's CPR stacks up against its peers in the industry.
Once all of these factors are taken into consideration, it should be no surprise that Annaly has had to cut its dividend substantially over the last few years. At the height of its profitability in the fourth quarter of 2009, Annaly paid out $0.75 per share. In the third quarter of this year, alternatively, it distributed only $0.50 a share. And given the ongoing and cumulative impact of the Fed's policies, there's every reason to believe this trend will continue. It's for these reasons, in turn, that I don't think Annaly will raise its dividend this year.
John Maxfield owns shares of Bank of America. The Motley Fool owns shares of Bank of America and Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.