In case you haven’t noticed, most goods and services are a lot pricier now than they were a year ago.
Earlier this month, the U.S. Bureau of Labor Statistics reported that the Consumer Price Index for All Urban Consumers (CPI-U) rose 7% over the trailing-12-month period. That’s the highest level of inflation in four decades, and it’s been spurred on double-digit increases in energy and new/used vehicle costs. Even food (6.3%) and shelter (4.1%) expenses have been rising at a faster pace than in recent years.
Dividend stocks can help investors trounce high inflation
Sitting on cash when inflation is skyrocketing is less than ideal since it’ll reduce your purchasing power. This is why putting your money to work in dividend stocks can be so appealing in a high-inflation environment. Companies that pay a dividend are almost always profitable and time-tested. Plus, according to a report from J.P. Morgan Asset Management, a division of JPMorgan Chase, dividend stocks have a history of handily outperforming their non-dividend-paying peers over the long run.
But investing in dividend stocks does come with its own quirk: the higher the yield, often the lower the real return. Since yield is a function of payout relative to share price, a business with a broken operating model and a plunging share price can offer a juicy payout but be nothing more than a yield trap. In other words, it means high-yield stocks (those with yields north of 4%) require extra vetting by investors.
While some ultra-high-yield stocks (companies I’m arbitrarily defining as having yields of 7% or above) are bad news, a handful can prove quite lucrative to patient income seekers. In fact, a trio of ultra-high-yield dividend stocks with yields above 10% can confidently be bought by investors right now with the purpose of crushing the prevailing inflation rate.
Annaly Capital Management: 11.4% yield
Mortgage real estate investment trust Annaly Capital Management (NYSE:NLY) is arguably the surest income producer in the double-digit yield category. Annaly has paid out more than $20 billion in dividend income since its inception in 1997 and has averaged around a 10% yield over the past two decades. Its current yield of 11.4% would easily outpace the 7% CPI-U from December.
Mortgage REITs are a fairly easy-to-understand operating model, even if the securities they buy can be somewhat complex. A company like Annaly aims to borrow money in the short-term at the lowest rate possible and uses this capital to purchase higher-yielding long-term assets, such as mortgage-backed securities (MBS). The goal is very simply to maximize the difference in yield between the assets in its portfolio and its average borrowing rate. This “difference” is known as net interest margin.
One reason investors should be excited about Annaly Capital Management’s prospects is where we are in the economic growth cycle. If you were to look back multiple decades, you’d see that it’s common for the interest rate yield curve to steepen when the U.S. economy is bouncing back from a recession. This “steepening’ is where the gap in yield between short-and-long-term U.S. Treasury bonds widens. When this happens, Annaly is often able to secure higher yields from its MBS purchases, which lifts its net interest margin. In short, the company can become more profitable and its book value tends to rise.
Something else to consider here is that Annaly Capital Management’s investment portfolio consists of 92% agency securities. An agency asset is backed by a federal agency in the unlikely event of default. On one hand, this added protection does lower the yield Annaly receives from the MBSs it purchases. On the other hand, it allows Annaly to prudently deploy leverage to maximize its profit potential.
With Annaly trading slightly below its book value and maintaining a double-digit yield, it’s a good bet to generate real-money returns for its shareholders after accounting for inflation.
New York Mortgage Trust: 11.02% yield
Have I mentioned how lucrative the mortgage REIT space can be for income-seeking investors? Although I’m personally a fan (and shareholder) of Annaly Capital Management, another mortgage REIT that’s delivering a nearly identical dividend yield is New York Mortgage Trust (NASDAQ:NYMT) (also known as NYMT).
The operating premise described above for Annaly holds true with New York Mortgage Trust. It’s wanting to minimize its borrowing costs, maximize the yield on the assets it buys, and should see a healthy bump up in its net interest margin as the interest rate yield curve steepens over time.