Annaly Capital Management (NYSE: NLY) is a very alluring dividend stock. The mortgage real estate investment trust (REIT) currently has an eye-popping 14% yield. That’s about 10 times higher than the S&P 500‘s 1.4% dividend yield.
However, income-focused investors should forget about the mortgage REIT. Instead, they should buy Realty Income (NYSE: O). While the retail-focused REIT has a lower-yielding monthly dividend of 6%, it has steadily increased its payout over the years (whereas Annaly has cut its payment several times). With Annaly’s payout at risk of another reduction, it’s not a good option for those seeking a sustainable income stream and higher total return potential.
A high-risk, high-yielding payout
Annaly hasn’t been the most reliable dividend stock over the years. The REIT focused on investing in the residential mortgage market has cut its payout several times, including by about 26% last year:
The REIT had to reduce its payment level last year because it expected rising interest rates to weigh on its earnings, which is what happened:
As that chart shows, the company’s earnings available for distribution (EAD) nearly dropped to its reset dividend level by the third quarter. On a more positive note, its EAD improved during the fourth quarter even though it reduced its leverage (its leverage ratio fell from 6.4 to 5.7 times). That would seem to suggest the dividend is on a more sustainable level.
Unfortunately, that might not be the case. Annaly recently revised its return expectations, given the tightening it saw in the market during the fourth quarter. While the company believes it can earn enough to cover its dividend in the first quarter of 2024, it might need to adjust its payment again this year if market conditions continue to tighten.
A magnificent dividend stock
While Annaly’s dividend has steadily declined over the years, Realty Income’s payout has headed in the opposite direction. The diversified REIT has increased its monthly payout 123 times since its public market listing in 1994, including for the last 105 straight quarters. The REIT has grown its dividend at a 4.3% compound annual rate since coming public, a more than 240% increase:
Realty Income is in an excellent position to continue growing its dividend. A big driver is the overall sustainability of its income. The REIT’s diversified portfolio of net lease properties provides it with a very durable rental income stream. Meanwhile, unlike Annaly, it has a low dividend payout ratio (75% in the third quarter). Realty Income also has a very strong balance sheet (one of the best in the REIT sector).
The REIT’s strong financial profile gives it the flexibility to acquire additional properties that produce stable rental income. The company recently acquired rival REIT Spirit Realty in a $9.3 billion deal. The acquisition should increase its adjusted funds from operations (FFO) by more than 2.5% this year. That’s halfway to its target range of growing its adjusted FFO by 4% to 5% annually. It also recently bought a portfolio of retail properties in Europe from Decathlon. Realty Income’s growing cash flow from an ever-expanding portfolio should enable it to continue increasing its dividend.
Realty Income’s steadily rising dividend has helped drive higher total returns than Annaly over the years. Since Annaly’s initial public offering in 1997, Realty Income has delivered an 11.9% annualized total return compared to 8.4% for the mortgage REIT. It’s in a stronger position to continue growing shareholder value at a higher rate than Annaly, given the likelihood that its earnings and dividend will keep rising even as Annaly’s appears likely to fall.
A more enriching dividend stock
While Annaly currently offers an eye-popping dividend yield, that payout doesn’t seem sustainable. That’s why income-focused investors should forget about its higher-yielding payout and buy shares of Realty Income instead. It has a magnificent track record of growing its dividend, which should continue. That should enable it to continue producing higher total returns than the mortgage REIT.
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Matt DiLallo has positions in Annaly Capital Management and Realty Income. The Motley Fool has positions in and recommends Realty Income. The Motley Fool has a disclosure policy.
Forget Annaly Capital Management, Buy This Magnificent Dividend Stock Instead was originally published by The Motley Fool
Source: finance.yahoo.com