A $20 AGNC Share Bought at Its 2008 IPO Has Paid $51 in Dividends. The Stock Trades Near $9.

At first glance, AGNC (NASDAQ: AGNC) might seem like a terrible long-term investment. The mortgage real estate investment trust (mREIT) went public at $20 per share on May 15, 2008, but now trades at less than $9 per share.

But since AGNC's market debut, it's paid out $51.16 per share in dividends. If you had reinvested those dividends, you'd be sitting on a total return of roughly 520%. Let's see why there's such a gap between its stock price performance and dividend-driven gains -- and if it's still a good long-term play for income-oriented investors.

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AGNC's stock isn't designed to appreciate

As an mREIT, AGNC invests in mortgages and mortgage-backed securities to collect interest. To insulate it from another credit crunch, it mainly invests in agency-backed MBS. It must distribute at least 90% of its taxable income as dividends to maintain a lower tax rate.

AGNC borrows at short-term rates (through "repo" transactions that enable it to sell its MBS to counterparties and buy them back at a set price plus interest at a future date) to fund its purchases of longer-term MBS. For AGNC to keep growing, short-term rates need to be lower than long-term rates. The mortgage market also needs to remain healthy.

Since AGNC distributes most of its profits to its investors, it must continually issue new shares to fund its MBS purchases. That's why its total number of shares skyrocketed from 15 million at the time of its IPO to approximately 1.26 billion shares today. That constant dilution practically guarantees it will underperform the S&P 500 (SNPINDEX: ^GSPC) over the long term.

But is AGNC the best dividend play?

AGNC pays a massive forward dividend yield of 16.4%. That might seem like a bright red flag, but it's sustainable as long as its net interest spread (the gap between the average yield it earns on its MBS and the costs of funding those purchases) stays positive.

That figure has hovered around 2% over the past year, and its projected 2026 EPS of $1.56 will easily cover its forward dividend rate of $1.44 per share. At $9, it trades at less than six times this year's earnings -- so it certainly looks like an undervalued income stock.

However, AGNC isn't necessarily the best dividend play for long-term investors. If you had simply invested in an S&P 500 index fund when AGNC went public and reinvested your dividends, you'd be sitting on a bigger total return of 669%. So while AGNC's dividend payments offset its declining stock price, it still couldn't outperform the market over the long term.

Leo Sun 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.