Despite a gigantic 12.6% dividend yield, Annaly Capital Management (NYSE: NLY) shouldn't be looked at as an income stock. That should bring up 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 noted, Annaly Capital Management is a REIT, a corporate structure that was designed to give small investors income generated from institutional-level real estate investment. In fact, REITs avoid corporate-level taxation as long as they pass at least 90% of their taxable income on to shareholders via dividends. (Dividends from REITs are taxed at an investor's regular income tax rate.)

So it makes complete sense that dividends are a big piece of the way Annaly Capital provides returns to shareholders. However, it is not a traditional property-owning REIT. It owns mortgages that have been pooled together into bond-like securities, which are usually called something like a collateralized debt obligation (CDO). Whereas a physical property will usually trade hands infrequently, mortgage bonds trade all day. Thus, their prices can be fairly volatile.

The list of factors that can affect a mortgage bond's price include investor sentiment, interest rates, mortgage repayment rates, property market dynamics, and the year in which the mortgage bond was created. There are a lot of complex factors involved that are hard to track unless you are closely watching and analyzing the industry. On top of that, mortgage REITs like Annaly generally employ leverage in an effort to enhance returns. That also increases risk.

In short, if you are looking for a simple REIT with the hope of collecting a reliable income stream, you should not 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 the second quarter of 2024 it was $0.65 per share, after being cut in the second quarter of 2023. Further, since the company went public in late 1997, the shares have lost more than half of their value. For an average 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 is fairly clear that Annaly Capital is a risky option for investors hoping to live off of their dividend income. It just isn't reliable in that regard, a fact that would remain true even if it increased its dividend. Before the 2010 peak, the dividend went through multiple cycles of dividend increases and dividend decreases. And yet there's one statistic that will interest some investors very much.

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

This is not how most small investors think about dividends. However, it is how institutional investors using an asset allocation model would think about dividends and investing in general. So Annaly is a decent way to gain exposure to mortgages as long as all of the dividends are reinvested. Entities like insurance companies and pension funds could find it a very useful tool.

So, is Annaly Capital Management a buy?

For most investors, however, Annaly Capital won't be a great investment choice. The ultra-high yield just isn't the deal it seems like when you dig into the details. However, that doesn't mean that Annaly is a bad investment. It just means that it is only appropriate for a select group of investors, notably those using an asset allocation model.

Should you invest $1,000 in Annaly Capital Management right now?

Before you buy stock in Annaly Capital Management, consider this:

The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and Annaly Capital Management wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.

Consider when Nvidia made this list on April 15, 2005... if you invested $1,000 at the time of our recommendation, you’d have $743,952!*

Stock Advisor provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. The Stock Advisor service has more than quadrupled the return of S&P 500 since 2002*.

See the 10 stocks »

*Stock Advisor returns as of September 23, 2024

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Is Ultra-High-Yield Annaly Capital Management Stock a Buy? was originally published by The Motley Fool