This 12.5%-Yielding Dividend Stock is Hiking its Payment by Another 7.1%. Time to Buy?

Annaly Capital Management (NYSE: NLY) already offers a monster 12.7% dividend yield. That's more than 10 times higher than the S&P 500's 1.1% yield. It's now boosting that payout by another 7.1%.

Here's a look at how the real estate investment trust (REIT) focused on residential mortgages can afford its big-time yield and whether investors should buy it for income.

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Another raise

Annaly Capital Management recently declared its latest dividend. The mortgage REIT will pay $0.75 per share on July 31 to investors who hold shares as of June 30. That's a 7.1% raise from the $0.70 per share it paid last quarter. It will boost the REIT's forward dividend yield to 13.6% at its recent share price. In commenting on the increase, CEO David Finkelstein stated that it underscores "the strong performance of Annaly's diversified housing finance portfolio and our focus on driving shareholder value."

The dividend increase follows Annaly's steadily improving earnings. The company reported $0.76 per share of earnings available for distribution (EAD) during the first quarter. That was up from $0.74 per share last quarter and $0.72 per share in the prior year period. It's a continuation of the improvement in the REIT's earnings over the past few years:

Data source: Annaly Capital Management. Chart by the author.

With its earnings rising, ample investment opportunities in the current market environment, and a strong financial profile, Annaly now has the confidence to increase its dividend. It's the REIT's second raise in the past 18 months. However, the dividend remains well below its peak due to a series of cuts in prior years.

Diversification is paying dividends

Annaly's investment strategy differs from that of other residential mortgage REITs, such as AGNC Investment. Whereas AGNC Investment only invests in Agency MBS (mortgage-backed securities guaranteed against credit losses by government agencies such as Fannie Mae), Annaly also invests in residential credit (non-agency residential mortgage assets) and mortgage servicing rights (MSR).

That diversification gives it the flexibility to invest where it sees the best opportunities. For example, Annaly ended the first quarter with $92 billion in Agency investments, down marginally from the year-end level. The REIT opportunistically repositioned the portfolio during the quarter by rotating out of higher-yielding MBS and into lower-yielding MBS, which it expects will provide more durable cash flows. Meanwhile, it raised $510 million of equity during the quarter to capitalize on opportunities to grow its residential credit and MSR portfolios. It expanded its residential credit portfolio by 30% to $10.3 billion in the quarter, while its MSR portfolio grew by 9% to $4.2 billion. The company expects to continue growing these platforms.

A higher risk, higher reward income stock

Annaly Capital's diversification strategy is paying off. The REIT is capitalizing on opportunities to grow its residential credit and MSR portfolios, helping drive earnings growth. That's enabling the REIT to increase its dividend. While Annaly is a higher-risk income stock (it has cut its dividend many times in the past), it's a good option for more risk-tolerant investors looking to buy income.

Matt DiLallo 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.