Question:
I heard you speaking recently on the show, about the high yields on some MLPs, and how it can be tricky, because some of the return is often return of capital. Also, red flags get raised when a dividend return is very high. Well, I was reading about AGNC, a REIT, and the dividend yield is at or near 15%. Is it a house of cards, ready to fall? How can a dividend return be that high, and be within logical bounds of safety, etc?
Answer:
When you see a dividend that high, that is generally an indication that people do not expect the dividend to continue. Most real estate investment trusts (REITs) pay 3% to 4%, depending on the type of REIT it is. American Capital Agency Corp. (NASDAQ: AGNC) is a mortgage REIT. They can pay a high dividend because the company is leveraged eight to one. They are borrowing short term at low rates to buy 30-year mortgages at higher interest rates. The company has 16% of capital. The bet is that they are supported by the payments on the mortgages. Thus, they are borrowing against them. Companies can also increase leverage through the use of derivatives and swaps. The more a company is leveraged, the more potential there is on the upside, but also the increased risk on the downside.
When interest rates increase—and we believe it is not “will they increase” but “when they increase”—the value of the mortgages AGNC holds will fall, and the cost of their borrowing will increase. This is a very precarious place to be. Initially, when interest rates increase, mortgage prepayments will fall. Long-term, rising interest rates will be a negative for the company.
AGNC has also cut their dividend in the past year. We recommend avoiding this stock.
At Henssler Financial we believe you should Live Ready, which means understanding if a dividend sounds too good to be true—it probably is. If you have questions regarding investments, the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166, or email at experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
