If you are looking to live off the income your portfolio generates, AGNC is not for you.
AGNC Investment (AGNC -0.58%) looks like an income stock, but it doesn’t actually behave like one. At least, it’s not a stock that many dividend-focused investors would want to own.
And while lower interest rates are likely to be a net benefit for companies, improving conditions alone won’t be enough to turn this ultra-high yielding stock, which yields around 14%, into a stock that dividend investors will want to buy. Here’s what you need to know before you get fooled by high yields and end up making investment mistakes.
What does AGNC Investment do?
AGNC Investment is a mortgage real estate investment trust (REIT). Its structure is designed to give small investors access to institutional-level real estate investing, with the idea being that they can profit from the cash flow the assets generate.
In fact, one of the keys to being classified as a REIT is that a company must pay out at least 90% of its taxable income as dividends. Although this allows the REIT to avoid corporate-level taxation, it is important to note that its dividends are taxed at the investor’s ordinary income tax rate. (Uncle Sam still wants his share.)
Image source: Getty Images.
From this big-picture perspective, AGNC looks like an income stock, especially considering its huge dividend yield. But when you look at a stock price graph and overlay dividend history on top of that graph, you run into a problem. Notice the purple line, where the stock price initially rises rapidly and then steadily declines. This is the same trend as the orange line, or quarterly dividend payments.
AGNC data by YCharts.
Let’s think about that for a moment. If you’re a dividend investor and you’re trying to live off the income your portfolio generates, do you want to own stocks that have high yields but keep falling in price and pay dividends as well? After all, income and capital, which is the worst possible outcome based on your investment goals.
Lower interest rates are favorable for AGNC investment
An important question arises here. AGNC is a total return investment that assumes dividends are reinvested. This will completely change the story of the performance.
In the graph below, the orange line is the total return, which is very positive compared to the purple line, which is steadily declining. The purple line is still the stock price. REITs pay very high dividends, so if you buy more AGNC stock, the dividends you receive will more than offset the decline in the stock price.
AGNC data by YCharts.
This is not how income-oriented investors operate. This is how institutional investors such as pension funds do this, usually using an asset allocation model. If that’s what you do, buy AGNC Investment and reinvest the dividends.
If you’re a dividend investor, AGNC isn’t made for you. And now may be the time to make up your mind on this.
As a mortgage REIT, AGNC Investment buys mortgages pooled into securities such as bonds. These assets trade throughout the day and are influenced by many unique factors.
But one of the most important is the interest rate. Rising interest rates tend to push down bond prices, and falling interest rates tend to support bond prices. If interest rates fall, AGNC Investment’s performance may improve and its stock price may rise.
Perhaps if competition in the mortgage space increases as more banks re-enter the mortgage business (after avoiding it after the Great Recession) and the prices of these securities rise, AGNC Investment’s mortgage bond portfolio has the potential for even greater returns. .
The outlook for mortgage REITs like AGNC Investment has improved significantly. But this improvement is not permanent and is subject to the whims of the Federal Reserve and the broader mortgage market.
From a total return perspective, AGNC could be poised for a period of strong performance. They may even increase their dividends. However, none of this changes the fundamental nature of REITs, which continue to focus on total return.
If you want to live off your dividends, be careful what you buy.
A high dividend yield alone isn’t enough to make a stock an attractive addition to a dividend-focused portfolio. If you need dividends to pay your living expenses, perhaps as a supplement to your Social Security check, you need to own a company that is a reliable payer.
The history is very clear. Mortgage REITs like AGNC Investment are not reliable dividend payers. That fact remains true even though interest rates have pushed yields significantly higher and the outlook for companies has improved.
