The Dividend Farm

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

Dividends come in a lot of different forms, but REITs and other kinds of trusts are some of the best ways to supercharge your income from stocks. One of my favorite inventions of all time is the DRIP (dividend reinvestment plan), because it allows your dividends to automatically purchase more shares and literally build your wealth for you.

Now, I would never suggest you fill your entire portfolio with REITs, even though that's what I did a few years ago. They tend to take a lot of risks, and I'd suggest you keep them balanced with far different types of companies. But here are a few companies that I think might have potential as both long-term holdings and solid dividend generators.

A Good Commodity Producer

Terra Nitrogen (NYSE: TNH) is a fairly straightforward company that handles the production of nitrogen, urea, and nitric acid. As the name suggests, they mostly get into nitrogen, but I like how Terra also has some extra opportunities in other industries. I also like Terra's financials, which paint a picture of a 10.7% dividend yield supported by 35% profit margins and 43% earnings growth over the past 5 years. The only real problem I see with Terra is that its primary business model is all about commodities, so there's the possibility of being underbid and seeing a serious loss of business as a result.

Serious Risk for Serious Potential Profit?

MFA Financial (NYSE: MFA)Capstead Mortgage (NYSE: CMO) and Anworth Mortgage (NYSE: ANH) all have a lot in common. They're all American REITs that invest primarily in mortgage-backed securities. They all specialize in MBSes that are focused on hybrid and adjustable-rate mortgages. They all have a decent amount of debt that's necessary to gain leverage and make significant profits. I used to love REITS because they offer serious dividends (MFA's is 10.3%, while Capstead pays 12.4% and Anworth pumps out 14.9%), but lately I've grown concerned about how they actually do this.

There are some serious financial calculations that have to go into analyzing a mortgage REIT, and lately the balance has shifted toward lower risk. It's common practice nowadays for companies to only touch mortgages that are guaranteed by Fannie Mae or Freddie Mac, as the relative risk of a government-supported mortgage defaulting is extremely low. I like that these companies have a solid backup plan.

What I don't like is that this has led to extreme laziness in the underwriting of mortgages. Everybody initiates and then sells the loans, so nobody is really accountable. In 2008, the US government solved the problem by simply buying up massive amounts of horrible "assets" that were anything but, and essentially putting a number of ostensibly trustworthy companies on welfare. I'm not in favor of government handouts because they're self-perpetuating. In essence, these companies have little to no motivation to do anything beyond what they're already doing --investing in loans designed to entice people with a low monthly payment just to jack it up later on. I say the biggest risk of all is in trusting a company that does business in a way that encourages laziness, corner-cutting, and a general lack of ethics.

Maybe 2008 just burned me really badly, but I feel bad thinking about investing in companies with returns on equity in the 12-13% range, even if they have profit margins in the 90% range. If they put more emphasis on making every dollar work harder, I can only imagine what these companies could accomplish.

Are REITs Worth It?

For the time being I'd say that REITs are a valuable component in cultivating your dividend farm. But like rotating corn with soybeans, you need to keep everything balanced. The US government spends more than it makes, so its "guarantees" are a little suspect from the get go. I'll take at least one Terra Nitrogen for every Capstead Mortgage because I like businesses that produce something beyond trading one debt for another. For the time being, I'll keep a little bit of REIT exposure but I'm not going crazy with it. Now that everyone's being greedy, I'm being fearful.

pongun has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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