Is Annaly Capital Management Ultra High Yield Stock a Buy?

Despite a whopping 12.6% dividend yield, Annaly Capital Management (NLY 1.27%) it should not be viewed as an income stock. This should beg the question, “How could a high-yield real estate investment trust (REIT), which is basically designed to pass income on to investors, not be an income stock?” There’s a lot to understand before you consider buying this niche REIT.

What does Annaly Capital Management do?

As mentioned, Annaly Capital Management is a REIT, a corporate structure that was designed to provide investors with small institutional real estate investment income. In fact, REITs avoid taxation at the corporate level as long as they pass on at least 90% of their taxable income to shareholders through dividends. (Dividends from REITs are taxed at an investor’s ordinary income tax rate.)

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So it makes sense that dividends are an important part of how Annaly Capital delivers returns to shareholders. However, it is not a traditional REIT that owns properties. It holds mortgages that have been bundled into bond-like securities, which are usually called something like a collateralized debt obligation (CDO). While physical property will typically trade hands infrequently, mortgage bonds trade throughout the day. Thus, their prices can be quite volatile.

The list of factors that can affect the price of a mortgage bond includes investor sentiment, interest rates, mortgage repayment rates, housing market dynamics and the year the mortgage bond was created. There are a lot of complex factors involved that are hard to track unless you closely follow and analyze the industry. Additionally, mortgage REITs like Annaly generally use leverage in an effort to boost yields. And that increases the risk.

NLY data by YCharts

In short, if you’re looking for a simple REIT with hopes of collecting a reliable income stream, you shouldn’t be looking at Annaly. The proof is in the numbers. Annaly’s dividend peaked in the first quarter of 2010 at a quarterly rate of $3 per share (adjusted for a 1:4 reverse split in 2022). In Q2 2024, it was $0.65 per share, after being reduced in Q2 2023. Furthermore, since the company went public in late 1997, the stock has lost more of half the value. For a middle-income investor using their dividends to pay for living expenses, that would translate into less income and less capital, a double whammy.

Annaly Capital is not a bad investment…for the right investor

So it’s pretty clear that Annaly Capital is a risky option for investors hoping to live off dividend income. It’s just not reliable in that regard, which would remain true even if it increased its dividend. Prior to the 2010 peak, the dividend went through several dividend increase and decrease cycles. And yet there is one statistic that will be of great interest to some investors.

According to the company, the stock has given investors a total return of 855% since its initial public offering (IPO). How does that number come up given that the stock price is down about 50% since the IPO? The answer comes from dividends, which total return figures assume will be reinvested. Quite simply, the dividend is so high that it more than makes up for the share price decline. And thus the additional shares purchased lead to a solid total return over time.

That’s not how most small investors think about dividends. However, this is how institutional investors using an asset allocation model would think about dividends and investing in general. So Annaly is a decent way to get mortgage exposure as long as all dividends are reinvested. Entities such as insurance companies and pension funds may find it a very useful tool.

So is Annaly Capital Management a buy?

For most investors, however, Annaly Capital will not be a great investment choice. Ultra-high yield just isn’t the deal it seems when you dig into the details. However, that doesn’t mean Annaly is a bad investment. It just means that it is only suitable for a select group of investors, especially those using an asset allocation model.