Published: February 26, 2010

Some interesting stocks appeared on my stock screener this morning...

As a full-time dividend stock analyst, I screen the market every day for high-yield stocks. I'm looking for the income investor's holy grail: a strong company, with sound finances, paying a sustainable 15% dividend yield.

It's mostly a fool's errand.

Stocks have high yields because no one wants them. The yield climbs because the stock price has collapsed or the dividend payment is about to collapse... or both.

Most of the time, my screens usually return rotten sneakers, soiled diapers, and an occasional rusting supermarket cart... But this morning, I screened the market for stocks paying over 15%... and I found this collection of high-quality companies...
 
All these stocks are mortgage REITs – or, as we call them in DailyWealth, "virtual banks." These are not junk companies...

For one thing, virtual banks are safe investments. They only invest in securities issued by Fannie Mae and Freddie Mac. On Wall Street, they call these investments "agency mortgage backed securities" or "agency MBS." Fannie and Freddie are government agencies, and their MBS are fully backed by the U.S. government.

And right now, the companies that buy agency MBS – these virtual banks – are trading at all-time cheap valuations...

The price-to-book ratio is one of the most important metrics for valuing virtual banks. Any time you pay more than one times book value, you're paying a premium over the liquidation value of the assets. These stocks generate returns on equity of over 12%. You'd expect to pay a large premium over book value for their stocks.

But as you can see above, most virtual banks are trading at tiny – or nonexistent – premiums. Take Annaly as an example. It is the largest and most respected virtual bank in America. Over the past 13 years, Annaly's price-to-book ratio has swung between 0.97 and 1.64. It's at 1.01 right now, only 4% above its all-time low.
Also, virtual banks are generating extraordinary dividends at the moment. Annaly just paid out $0.75 per share. That's the largest quarterly dividend in its 13-year history... And based on yesterday's share price, it adds up to a 17% annual yield.

So should you buy Annaly and its virtual bank peers today? In a word, no...

For one thing, the Fed is about to end its support of the agency MBS market...

In November 2008, the Fed announced it would purchase $1.25 trillion in agency MBS in a program to support the housing market. The Fed has completed 96% of this program. It'll buy another $50 billion in MBS over the next four weeks to complete the program and then stop buying MBS.

Investors are afraid the end of Fed purchases could cause agency MBS prices to fall suddenly. Virtual banks own giant pools of these securities. If MBS prices fall, virtual banks will decline in value. Book values and dividend payments will fall.

This fear is the reason the virtual-bank stocks have all fallen 15%-20% over the last month and are now trading at such attractive valuations. I doubt MBS prices will collapse. The market has had months to anticipate this news. But I don't want to take the risk.

Another concern is the downtrend. Except for Annaly, the charts of virtual banks are all showing nasty drops. Take this chart of Hatteras as an example. Shares haven't yet found a floor.

Steve and I will keep an eye on this situation and let you know when the right time comes to get back in to virtual banks. In the meantime, you should keep away.

-- Tom Dyson
Editor
Daily Wealth

Note: This article originally appeared on Daily Wealth.