2 high yielding stocks to buy Hand Over Fist and 1 to avoid

If you see a stock with a dividend yield that exceeds 14%, you should know right away that it needs to dig deeper. This is usually a sign that Wall Street views the investment as risky, which is why most investors would probably be better off avoiding AGNC Investments (NASDAQ: AGNC). But you will probably find Real estate income (NYSE: O) and WP Carey (NYSE: WPC)both with yields just above 5%, much more attractive. Here’s why smaller is better.

The problem with AGNC Investment

Over time, AGNC Investment has done a pretty good job of meeting its goals. The problem is that the goal is total return, not income. As a real estate investment trust (REIT), income is an important component of total return, but the real benefit of the income stream comes from the reinvestment of dividends. The chart below is complex but highlights the important themes.

The share price (purple line) has eroded over time. The dividend (orange line) rose initially but has been in a long decline. If you were to use the dividends you received to pay for living expenses, you will now be left with less income (especially from the high end) and less capital. However, if you reinvested the dividends, the total return is more than 500% since the company’s initial public offering (blue line).

So this isn’t really an income stock; is a total return stock aimed at investors seeking exposure to mortgage securities (which is what AGNC invests in). Income investors should avoid this and look for stocks with stronger histories of returning value through dividends.

Two net lease REITs to consider: Realty Income and WP Carey

Net lease REITs own single-tenant properties for which the tenant is responsible for the majority of property-level operating costs. Although any individual property carries high risk, in a large portfolio the risk tends to be quite low. Realty Income is the largest net leasing REIT, and WP Carey is the second largest.

They also share other similarities, especially on the diversification front. Both companies operate in the US and Europe. And both portfolios include commercial and industrial properties. Each of these REITs has also divested its office assets, which is where a big divergence comes into play.

Realty Income was able to spin off its offices without cutting its dividend. It has now increased its dividend annually for nearly 30 years. Add in an investment-grade balance sheet and size to act as an industry consolidator, and even the most conservative income investors will likely find the stock appealing. The yield is around 5.1%, which is considerably higher than the 1.3% offered by S&P 500 index and about 3.9% of the average REIT.

A dividend cut came with the WP Carey office spinoff, which was due to the relatively large size of its investment in the property class and its smaller size as a company. (Actual earnings are more than four times that of WP Carey.) But WP Carey immediately returned to increasing its dividend after the cut, meaning the cut is probably better viewed as a reset. So while the REIT has tarnished its dividend history, it still prioritizes rewarding dividend investors for sticking around.

The dividend yield, meanwhile, is 5.8%, so you’re getting paid more to accept the perceived uncertainty here. Those with a slightly higher risk tolerance will probably be happy to get the extra return.

Lower return, but also lower risk

There’s no denying that AGNC Investment has a much more attractive dividend yield than Realty Income or WP Carey. But its dividend history suggests it’s best avoided by investors trying to live off the income generated by their portfolios. Real estate income is a much better option for conservative investors, even after a recent rise in prices. Meanwhile, WP Carey comes with a bit more risk given the dividend reset, but for those willing to look past a few downsides, the extra yield could be worth it.

Should you invest $1,000 in Real Estate Income right now?

Before buying shares in Real Estate Income, consider the following:

The Motley Fool Stock Advisor the analyst team has just identified what they think they are 10 best stocks for investors to buy now… and Real Estate Income was not one of them. The 10 stocks that made the cut could produce monster returns in the coming years.

Consider when Nvidia made this list on April 15, 2005… if you invested $1,000 at the time of our recommendation, you would have $720,542!*

Stock advisor provides investors with an easy-to-follow blueprint for success, including portfolio construction guidance, regular updates from analysts, and two new stock picks every month. The Stock advisor the service has more than four times return of the S&P 500 since 2002*.

See the 10 stocks »

*The stock advisor returns starting August 26, 2024

Reuben Gregg Brewer has positions in Realty Income and WP Carey. The Motley Fool has positions and recommends Realty Income. The Motley Fool has a disclosure policy.

2 High-Yield Stocks to Buy Hand Over Fist and 1 to Avoid was originally published by The Motley Fool