It can't be said enough times: A high yield isn't sufficient to make a stock a buy. A perfect case in point is Annaly Capital(NYSE: NLY), which has a massive 13.2% dividend yield.
If you're trying to live off the income your portfolio generates, this real estate investment trust (REIT) would be a terrible choice for your portfolio. But there's also a unique type of investor who might find it appealing.
One chart tells all you need to know about Annaly
Dividend investors are attracted to high yields like moths are attracted to flames. If you don't take the time to understand what you're buying, the outcome could be the same -- singed wings.
That's because, sometimes, a high yield is a sign that Wall Street is justifiably worried that the dividend being paid isn't sustainable. That's the story with Annaly and a quick graph will help explain it all.
The first line to look at on the above chart is the orange one, which tracks Annaly's dividend yield over the past decade. Notice that it has always offered a high yield, usually over 10%. Sometimes, including today, it's well above 10%.
To be fair, Annaly is a REIT that's designed to pass income on to investors. Therefore, a high yield shouldn't be shocking. But a yield this high, when the average REIT's yield is just about 4%, is a bit too far out of line. It should cause you to question what's going on.
That's where the purple and blue lines come in. The blue line is the dividend, which has trended steadily lower. The purple line is the stock price, which has tracked the dividend lower.
Dividend yield is a simple math equation, dividing the annualized dividend by the stock price. The only way to keep the yield high when the dividend is falling is to also lower the stock price. And that's exactly what has happened here.
If you're a dividend investor trying to maximize the income your portfolio generates to supplement Social Security in retirement, owning Annaly would have been a disaster. You would have ended up with less income and capital losses. Given that history, it's hard to suggest that Annaly is anything but a sell for most investors who would be looking at it.
A unique investment for a unique investor
But Annaly really isn't made for the average dividend investor. It's a total-return investment that's most appropriate for institutional investors with a focus on asset allocation.
Annaly is a mortgage REIT, which means it owns mortgages that have been pooled into bond-like securities. It's a direct way to add mortgage exposure to a broadly diversified portfolio. The income part of the story is kind of secondary to this focus.
The chart above helps explain why. The stock price has declined along with the dividend over time, which is terrible for anyone using the income to pay for living expenses. But if those dividends were reinvested, the return achieved here would go from down around 50% to up around 50% over the past decade.
That's not the type of math that most dividend investors would look at, but it's exactly how insurance companies, pension funds, and endowments usually look at performance.
It all depends on who you are
Investing is very personal, but some stories are universal. When it comes to dividend investing, most small investors will want to focus on reliable companies with businesses that can support a growing dividend.
That's not what Annaly is built to do, so most investors will probably want to pass on its shockingly high yield. But that doesn't mean Annaly isn't appropriate for some investors. It's just a very select group that will appreciate the mortgage exposure it provides to those focused on asset allocation.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
