There are a handful of high-dividend stocks that most income investors are familiar with, such as mortgage REIT Annaly Capital Management (NYSE:NLY) and business development company Prospect Capital Corporation (NASDAQ:PSEC). While I have a generally favorable opinion of both companies, one of the best things you can do if you like investing in ultra-high dividend stocks is to spread your money over several companies.
High-paying stocks like these tend to be rather volatile, and one of the best ways to combat this is through diversification. That way, if any one of them has say, a bad quarter, or needs to chop its dividend, your overall portfolio won't suffer too much.
With that in mind, here are three of my favorite lesser-known high dividend stocks you could add to your high-dividend portfolio.
A different kind of mortgage REIT
Most REITs that invest in mortgages generally borrow several times the value of their assets to buy agency-backed mortgages, and pocket the spread between the cost to borrow money and the interest rate paid by the mortgages.
The main problem with this is that the high use of leverage leaves these companies very susceptible to fluctuations in interest rates.
However, PennyMac Mortgage Investment Trust (NYSE:PMT) is a somewhat different type of mortgage REIT. Instead of using high leverage ratios to achieve double-digit returns, PennyMac mainly invests in distressed mortgages, which generally pay higher rates and can be purchased at a discount.
Unlike the other mortgage REITs, most of which have leverage ratios in the five-to-one to seven-to-one range, PennyMac uses just 1.8:1 leverage.
And don't let the thought of "distressed mortgages" alarm you. Compared with other mortgage REITs, PennyMac has delivered consistent performance, and has produced an average return on equity of more than 15% (annualized) over the past 10 quarters.
In fact, the company has actually raised its dividend by 11% since 2012, a rarity in the sector, and currently pays an 11.3% annualized yield. The dividend should be easily sustained, as the current $0.61 quarterly payout is well below the $0.69 in earnings the company brought in during the last quarter.
Smaller BDCs can be a good fit for you as well
With a market capitalization of about $2 billion, Apollo Investment Corp (NASDAQ:AINV) isn't exactly small, but it does pale in comparison with sector leaders Prospect and Ares Capital Corp.
Apollo makes its money by funding the debt of other companies, mostly small- or medium-sized, and currently has the debt of more than 115 businesses in its portfolio including that of such household names as BJ's Wholesale Club, Del Monte, and Molycorp. And, the businesses Apollo invests in operate in 37 different industries.
So, while the individual holdings of BDCs are of a relatively high level of risk (that's why they need Apollo's funding), the diversity of the portfolio means that if one or two of the company's investments don't perform well, it wouldn't hurt the bottom line too much.
Apollo currently pays a dividend of about 9.6%, or $0.80 per year, which should be pretty safe going forward. The company is expected to earn at least $0.90 per share in both 2015 and 2016.
Closed-end funds: the third variety of ultra-high dividend stock
A closed-end fund raises a pre-determined amount of capital for the purposes of investing in a particular industry, geographical area, or sector. And, many of these funds are geared toward producing income.
For example, the BlackRock International Growth & Income Trust (NYSE:BGY) is one of the largest closed-end funds. As the name implies, it invests most (at least 80%) of its assets in equity securities of non-U.S. companies, for the main purpose of producing income. In order to maximize income, the fund can invest in these securities directly, or through the use of derivatives.
Many of the fund's holdings are companies most investors are at least somewhat familiar with. The top five holdings are Roche Holding, Novartis, Baidu, Anheuser-Busch Inbev, and Imperial Tobacco.
This particular fund currently pays a pretty nice 9.2% annual dividend yield on a monthly basis, and currently trades for about a 7% discount to the value of its assets.
And there are plenty of others to choose from. For a list of some of the largest, the ISE High Income Index is a good place to start; it lists 30 closed-end funds that all pay excellent dividends.
It's all about variety
High-dividend stocks can be an excellent way to build wealth in your portfolio, but you don't want to put all of your eggs in one basket -- the best way to invest in high-dividend stocks is to spread your money around. Over the long term, that's a good way to achieve the kind of results you want, without being too susceptible to any one company's performance.
Matthew Frankel owns shares of Annaly Capital Management, PennyMac Mortgage Investment Trust, and Prospect Capital. The Motley Fool recommends Apollo Investment.. 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.
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