A High Yielding Income Investment

Anmol is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Why buy Dynex Capital (NYSE: DX)? Dynex is a mortgage REIT that invests in mortgage assets on a leveraged basis. It mostly invests in agency mortgage-backed securities (which are guaranteed by government sponsored entities like Fannie Mae and Freddie Mac). But it does also invest in non-agency assets, including single family (RMBS) and multifamily (CMBS) in both broad categories. Dynex has been around since 1987 and is the second oldest mortgage REIT in the space. Dynex not only survived the financial crisis, but remained profitable throughout it.

So how does the company actually make moneyIt essentially borrows money short-term and invests it in long-term mortgage securities. The difference between what it pays in interest and what it collects is net interest income. According to its 10K, Dynex’s investment strategy is to target high credit quality and short duration mortgage backed securities.

There are several other high yielding REITs, such as Annaly Capital Management (NYSE: NLY), but what makes Dynex better is its focus on short duration securities, which makes it relatively less exposed to interest rate risk than other mortgage REITs. And that’s a good thing considering that the aim of QE3 is to lower mortgage rates, which could flatten the yield curve and squeeze margins at firms that invest in longer duration assets.

Although Dynex is not completely immune to a flatter yield curve, I think this is already priced into the stock, with shares trading at just 1.0 tangible book value. That means if the company were to sell off all of its tangible assets and pay off all of its liabilities, the amount left over would roughly equal its current stock price. That seems very cheap considering that Dynex consistently generates double-digit returns on equity (ROE). And on a dividend discount valuation, assuming a steady 3% annual dividend increase and a 13% required return, shares would be valued at $13.28 per share. That’s a 40%+ premium to Monday's closing price of $9.43.

Even though Annaly Capital Management is a great REIT, Dynex has an edge over Annaly in a host of metrics, such as cash flow per share, net income, sales, quarterly revenue growth, quarterly earnings growth, five year sales growth, three year total return, and five year dividend growth rates. One area in which Annaly beats Dynex is the dividend yield. Dynex yields around 12.78%, while NLY yields around 14.08%.

There are several other REITS getting a lot of attenion lately. One such REIT is One Liberty Properties (NYSE: OLP), which is a self-administered and self-managed real estate investment trust (REIT). The company manages and owns a diversified portfolio of retail (furniture, office supply stores), as well as a host of other properties, and is also geographically diversified. One Liberty Property yields around 7.4% and is also a good investment; however, Dynex still has an edge over OLP and has a better dDividend yield.

As you can see in this chart, Dynex has been steadily increasing its dividend over the last few years:

<img src="http://www.zacks.com/images/upload_dir/1351888919.jpg" />

On top of this, the company delivered solid third results on Nov. 1. It reported EPS of $0.34, which beat the consensus estimate by a penny.

Dynex triples as a income/value and growth investment since it has a better valuation than the other REITS, has much more room to grow, and offers a steady dividend that has been increasing every year.

Please be aware that this stock has a history of being volatile, and any meaningful drop in its net income would likely mean a cut in that juicy dividend. However, you could make this company a small, high-dividend part of your portfolio, so you can weather any potential losses. 

Dig Deeper

Annaly Capital Management has a history of paying huge dividends to shareholders, made possible by borrowing at cheap short term rates and investing in longer term mortgage securities. But there are some things investors absolutely must know about Annaly’s business before buying the stock. In this brand new premium research report on the company, a Fool analyst runs through the dynamics of Annaly’s business, as well as the future opportunities and pitfalls of their strategy. Click here now to claim your copy.

Anmolsc has no positions in the stocks mentioned above. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

blog comments powered by Disqus