Annaly Capital Management (NLY -0.64%) takes the title of an ultra-high-dividend stock to a whole new level. The mortgage real estate investment trust, which invests in mortgages and mortgage-backed securities (MBSs), has a dividend yield of more than 16% -- about 11 times higher than the current yield on the S&P 500.
With a yield as high as this, investors may be wondering what's driving Annaly's double-digit yield and how risky an investment is the stock today. Let's take a closer look and see.
Mortgage REITs generally pay a higher yield
Mortgage REITs historically pay a much higher dividend yield than other dividend-paying stocks. That's because their business model carries more risk.
Mortgage REITs originate, invest, and/or service mortgages earning money from the interest collected on the loans or fees charged for servicing loans for other companies. Most mortgage REITs bundle their investments into securities, trading them like bonds to increase their returns or gain more liquidity.
This makes them susceptible to things like interest rate swings and fluctuations in the bond and stock market, which can hurt their asset values or earnings. To compensate for the risk of the industry, mortgage REITs pay higher dividend yields.
According to the National Association of Real Estate Investment Trusts (NAREIT), publicly traded mortgage REITs averaged a 10% dividend yield during the past six years. The average yield for stocks in the S&P 500 during that same period was about 1%, while equity REITs averaged a yield of roughly 3.8%.
Other factors are at play
Mortgage REITs are facing increased challenges in today's economy thanks to rising interest rates. Mortgage REITs rely heavily on short-term borrowing to fund the acquisition of new mortgages. When the short-term cost of borrowing is low, as it was after the global pandemic, business booms. But this year, the Federal Reserve has raised short-term interest rates six times. In turn, it's reduced how much money Annaly makes from the interest collected on loans after its cost of borrowing (net interest spread).
Annaly Capital Management is also battling decreased demand for government-backed mortgages after the U.S. government ended its quantitative easing program earlier this year. Bonds are also paying higher returns than MBSs right now, making them less attractive and pushing down the value of Annaly's assets.
Is Annaly's dividend worth the risk?
Unfortunately for Annaly, these headwinds are far from over. The Fed has emphasized its hawkish stance on rising interest rates to tame inflation in the coming year. And demand for real estate loans continues to fall in a slowing economic environment.
A dividend yield of more than 16% definitely helps offset some of the risks the stock carries, but I personally feel it's not enough. Annaly has significantly underperformed the market historically, costing investors a lot of money over the past 10 years. In that time, its share price has dropped by 62%, while its dividend has decreased by 51%.
Ultra-high dividend yields are nice, but they rarely are sustainable. I'd rather collect a somewhat lower rate for 10 to 20 years than collect a higher rate for a shorter period. Fortunately, there are plenty of high-paying dividend stocks that offer a lot more reliability for investors today.
