Should You Buy Annaly Capital Management Stock Right Now?

Many investors look to invest in dividend-paying stocks. If you're one of them, real estate investment trusts (REITs) provide an excellent way to do so. That's because, legally, they have to pay out at least 90% of their taxable income as dividends.

Most people think of REITs investing in various properties, like offices, retail space, apartment buildings, and data centers. But REITs can also invest in mortgages. These are called mortgage REITs (mREITs)

Annaly Capital Management (NYSE: NLY) is an mREIT. The stock offers a tempting 12.8% dividend yield. While that merits attention, should you buy the stock?

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Understanding the business

Annaly Capital Management primarily invests in agency mortgage-backed securities (MBS). These typically account for the high-80% range of its portfolio. It also holds non-agency residential mortgage loans and mortgage servicing rights (they service a pool of residential mortgage loans in exchange for a portion of the interest payments).

These pools of mortgages packaged together have guarantees by agencies like Fannie Mae, Freddie Mac, and Ginnie Mae. That provides a high level of confidence that Annaly won't have defaults that affect the regular payments.

If that seems like a low-risk investment strategy, Annaly tries to juice the returns through borrowing, or leverage. It had leverage under generally accepted accounting principles (GAAP) of 7.1 times equity as of Sept. 30.

Typically, Annaly finances its purchases with short-term debt. While leverage can boost returns, higher leverage also raises the company's risk. That includes changing economic conditions and interest rates changing (i.e., the spread between short- and long-term yields narrowing).

Recent results

Annaly Capital Management's results have shown steady improvement. Its third-quarter earnings available for distribution (EAD) grew to $0.73 a share. That's 10.6% higher than a year ago.

EAD is a key performance indicator (KPI) since it measures how much money the company has to pay dividends. It's calculated by making adjustments for certain items, such as non-recurring and noncash expenses, to its GAAP net income.

Another KPI is annualized EAD return on equity, which was 14.7%. A year ago, it was about 13%.

Volatile dividends

Annaly Capital Management's shares presently have a very high 12.8% dividend yield as of Nov. 7. By comparison, the S&P 500 index yields 1.2%.

It currently pays a $0.70 quarterly dividend. Last quarter's EAD covered the payout.

However, it's important to note that Annaly's results fluctuate based on interest rates. Hence, its dividend payments change, up and down, too. For instance, quarterly dividends were $0.88 in 2022 before dropping to $0.65 the following year.

Putting it together

For those looking for sure and steadily increasing dividends, Annaly Capital Management's stock isn't a good fit. Personally, there's too much risk involved in the company's results and dividends for me to invest.

After all, while the Federal Reserve cutting interest rates could benefit Annaly, it also depends on how long-term yields change. And future rate cuts aren't a sure thing. Even the Federal Reserve, after cutting short-term rates at its last meeting, indicated that reductions aren't guaranteed at its next meeting. If the central bank isn't sure what action it will take, how can investors know?

That's a lot of uncertainty, and the economy faces heightened risk, including persistent inflation, increased layoffs, and the prolonged government shutdown that has resulted in a lack of economic data being released.

Hence, despite the high dividend yield, I'd pass on the shares.

Lawrence Rothman 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.