Is This 12.8%-Yielding Dividend Stock a Bargain or a Trap?

Annaly Capital Management's (NYSE:NLY) dividend currently yields an eye-popping 12.8%. While a yield that high often seems like a trap, I think Annaly is a bargain right now.

Here's why I think income-focused investors should take a closer look at the mortgage REIT.

Image source: Getty Images.

The case for a trap

I wanted to start with the bear case because Annaly has at times been a dividend-yield trap. The REIT has cut its dividend several times throughout its history, including in early 2023 when it slashed its quarterly payment from $0.88 per share to $0.65 per share due to its declining earnings. I pulled the plug on my longtime investment in the mortgage REIT shortly after that cut because I got tired of seeing my income stream dwindle.

Annaly had to cut its dividend over the years due to changes in interest rates. The REIT invests in residential mortgages and mortgage servicing rights (MSR) using leverage. It typically borrows short-term and invests long-term, aiming to cash in on the spread between short- and long-term rates (short-term rates tend to be lower than long-term rates). However, changes in interest rates impact both sides of its balance sheet. Rising rates increase its borrowing costs while falling rates enable borrowers to refinance at lower rates, forcing Annaly to reinvest the proceeds at lower rates.

The case for a bargain

While falling earnings impacted Annaly's dividend in the past, the REIT has turned things around over the last several quarters. Its earnings available for distribution (EAD) rose from a low of $0.64 per share in the first quarter of 2024 to $0.79 per share in the second quarter of this year. This earnings improvement has enabled the REIT to raise its dividend twice over the past 18 months. It hiked the payment from $0.65 per share to $0.70 per share in the first quarter of 2025, and then to $0.75 per share in the second quarter of 2026.

Annaly has generated $3.02 of EAD over the past 12 months, easily covering the $2.85 per share it paid in dividends. Its EAD has now covered its dividend for nine straight quarters. With its stock recently below $22.50 a share, Annaly trades at a bargain price of 7.5 times earnings.

While interest rates have started to tick up this year due to elevated inflation, Annaly has built a much more durable portfolio over the past few years by diversifying across three investment strategies (Agency MBS, residential credit, and MSR). CEO David Finkelstein commented in the second-quarter earnings report that, "Looking ahead, we see meaningful opportunities across all three of our investment strategies and believe our scale, liquidity, and disciplined capital allocation position us to continue delivering compelling risk-adjusted returns across market cycles." Its diversification provides it with the flexibility to focus on the best opportunities. For example, it grew its Agency MBS portfolio by $3 billion in the second quarter by capitalizing on higher mortgage rates, while maintaining the size of its residential credit and MSR portfolios.

Annaly's a bargain if you're looking for a big-time yield

I think Annaly has shifted from a trap to a bargain over the past few years. Its earnings are rising, enabling it to begin rebuilding its dividend. While the REIT has a higher risk profile, it's an enticing option for investors seeking a lucrative income stream.

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.