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You’ve likely never heard of it…
This company doesn’t sell a physical product. It doesn’t have storefronts. And it doesn’t have a massive headquarters in a glass building in Manhattan.
This normal-looking building in Vero Beach houses the company with the highest-yielding stock in the United States.
As I just said, I’d be surprised if you’ve heard of ARMOUR Residential REIT (NYSE: ARR). This real-estate investment trust is small — the current market cap is just $600 million. But right now it is paying a dividend of $0.11 per share every month. At recent prices, that comes out to a yield of 18.6% per year. That’s the highest yield I’ve found on a stock with a market cap of more than $500 million.
So how can any company pay a yield of nearly 20% per share?
ARMOUR is a REIT, but it doesn’t own real estate like most do. It is what’s known as a mortgage REIT. The company owns a portfolio of mortgage-backed securities either issued or backed by Fannie Mae and Freddie Mac.
Essentially, the company’s business model is to raise money at low rates and invest in higher-yielding pools of mortgages. The REIT’s profit is essentially the difference between those two interest rates.
But isn’t it risky? After all, we’ve seen the headlines about the housing troubles. Poor-performing mortgage-backed securities are what led to the housing bubble popping nearly four years ago.
ARMOUR — like most mortgage REITs — invests only in securities backed by Fannie or Freddie. These government-sponsored enterprises (GSE) have the backing of the federal government. This means the securities backed by Fannie and Freddie in turn also have federal backing. Thus, the mortgage-backed securities carry almost no default risk.
But this doesn’t mean the yields on mortgage REITs are guaranteed by any means.
Remember, a stock’s dividend yield can change two ways — either the dividend payment changes or the stock’s price changes. And that’s where there is trouble with many mortgage REITs.
With interest rates falling, the REITs are being forced to settle for far lower yields on their mortgage investments. As mortgage rates fall, so does their income. Mortgage REITs may continue to struggle if rates for new and refinanced mortgages continue to remain low, which at this point, seems likely.
Already, many mortgage REITs have had to cut dividends. In fact, ARMOUR cut its dividend 8% from $0.12 per share each month to $0.11 just a few months ago.
But there could be more cuts on the horizon. Since the start of the year, ARR has announced additional share offerings of 66 million shares. Meanwhile, the share count has risen from 7 million shares to 85 million during the past 18 months.
Risks to Consider: While selling new shares gives the REIT access to cheap capital to invest in more securities, it also dilutes the share base dramatically. At this point, I think the abnormally high yield is the market’s way of saying it doesn’t believe the current dividend can be sustained with the flood of new shares.
Action to Take –> In other words, the 18.6% yield looks nice on paper, but I personally wouldn’t buy it right now.
– Amy CalistriSource: StreetAuthority
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