Far too often, investors believe they'll find a winning lottery ticket on Wall Street. Which is why stocks like Annaly Capital(NYSE: NLY) and its huge 13.5% dividend yield might have investors thinking that it will have them on a fast track to a seven figure portfolio. After all, the historical return of the stock market is around 10% or so, so 13.5%, compounded over time via dividend reinvestment, would be that much better. History suggests that an investment here won't work out as well as hoped.
This dividend record doesn't track
There's no question that Annaly's massive dividend yield is attractive, particularly when you consider that the S&P 500 Index is yielding a scant 1.4% and the average real estate investment trust (REIT) nearly 4%, using Vanguard Real Estate Index ETF(NYSEMKT: VNQ) as an industry proxy. But there's usually a reason why a stock has such an outsized yield and, in the case of Annaly, it is important to understand the dividend back story.
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It isn't hard to explain the problem here, Annaly has a long history of cutting its dividend. The stock price tracks along with the dividend. Over the past decade, the dividend and the stock have both headed steadily lower. That combination has resulted in a yield that has been elevated, often well over 10%, the entire time. But for an investor, the end result has been less dividend income and less capital. This is not an outcome that will get dividend investors into the millionaire club.
Now, to be fair, reinvesting the dividends over the past decade had a material and positive effect on return. As the chart below shows, the stock declined by roughly 50% over the past 10 years. But if you reinvested the dividends, that total return achieved would have been positive 50%. That's a huge difference and shows the power of dividend reinvestment and, effectively, compounding. But Annaly still isn't a millionaire maker when you compare its performance to, say, the S&P 500 Index, with a 150% stock only gain and a 210% total return over the same span.
So what's the point of Annaly?
Annaly is a mortgage REIT, which means it buys mortgages that have been pooled into what are often called collateralized mortgage obligations (CMOs), or something similar. There's nothing wrong with this, but it is a complex and unique approach in the REIT sector. It is very different from a property owning REIT, which buys physical assets and rents them out. You need to make sure you dig deeply into Annaly's business model before you even consider an investment here.
However, the bigger picture is around the purpose of Annaly. It is not really meant for small investors that want to live off of the income their portfolios generate. The dividend volatility is, perhaps, the clearest evidence of that. But the difference between total return and stock price return is another key factor here. Essentially, Annaly provides direct exposure to mortgage-backed securities for investors that are looking for such exposure. It isn't really meant to be an income investment, as are most property owning REITs.
What types of investors would want to own Annaly? Traditionally the list would include large, institutional investors like pension funds that focus on asset allocation. In this approach, the goal isn't to use dividend income for living expenses, so total return is more important (and assumes dividend reinvestment). Annaly is an adequate option for mortgage exposure if asset allocation is the primary focus. If you are like most small dividend focused investors, asset allocation probably isn't your primary goal.
Don't get distracted by the big yield
The problem for investors is that massive 13.5% dividend yield, which can cause an unfortunate emotional reaction. It makes people think that there's a chance to "get rich quick" and Annaly just isn't that simple a story. (Nothing is THAT simple a story.) If you want to get into the millionaire club, you are better off sticking to lower yielding stocks with more consistent dividend histories. And there are actually a lot of those in the REIT sector to choose from.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Specialized Funds-Vanguard Real Estate ETF. The Motley Fool has a disclosure policy.
