Why a Higher Dividend Yield Doesn’t Tell the Entire Story

“We never stretch for yield.” – Warren Buffett

Annaly Capital Management (NLY) is a mortgage real estate investment trust company. They own real estate properties and pays out the majority of their earnings, around 90%, in the form of dividends to receive special tax treatment as a REIT.

The share price as of year-end 2010 was $17.92 and sported a dividend yield of 15.4%. This is the kind of yield that can attract investors in search of income and higher returns.

In 2011, NLY actually paid out $2.44 in dividends and finished the year with a share price of $15.96. You would have earned 13.6% in dividends based on the 2010 year end share price, which sounds great when taken at face value.

The only problem is you would have lost 10.9% on the stock price. On a total return basis investors netted only 2.7%.

The next year, the yield started out at roughly the same rate as the year before at around 15.3%. Actual dividends paid in 2012 came in at $2.17 while the share price ended the year at $14.04.

This equates to a total return of only 1.6% including dividends (13.6%) and the share price drop (-12.0%). Again, not a great return considering the S&P 500 gained 16%.

Using the trailing dividend payouts, 2013 started out with another enticing yield of 15.5%. Rising interest rates caused the payout to really drop last year with the company paying only $1.65 in dividends, or an 11.8% return of capital on the stock.

The share price also took a dive and finished 2013 at $9.97, losing 29.0% for a total return of -17.2%.

The total return to investors over three years was -13.7% even through each year the company started out showing a yield in excess of 15%. Also, the amount of dividend payments dropped over 30%.

There were a number of factors that caused the drop in share price and dividends paid, including the level of interest rates, the business model and even more attractive investment options elsewhere in the market.

Yet I’m sure there were investors who saw those huge 15% yields and thought it was a can’t-miss investment opportunity with little-to-no-risk involved because it was a dividend payment.

There are no fail safe investments offering 15% yields without taking on additional risks. Obviously, in the case of NLY, that meant that the share price was too high to justify those yields.

This doesn’t mean that it never makes sense to invest in higher yielding securities. You just need to align your risk tolerance with the stated yield.  In the years leading up to this underperformance, NLY was a great stock to own and made investors a ton of money.

Higher yield implies higher risk. That means sometimes you will be rewarded but other times you get will burned.  As always, what’s baked into the share price will matter much more than simply following a single measure such as dividend yield.



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