2 Ultra-High-Yield Financial Stocks To Buy Hand Over Fist and 1 To Avoid | The Motley Fool (2024)

There is no such thing as a perfect investment -- all stocks come with trade-offs. But some trade-offs are just too extreme to bother with.

Many ultra-high-yield dividend stocks fall into this category. Contrary to the safe-and-steady image you may have of passive income investments, an unusually high yield can be a warning sign. That's the story behind Annaly Capital (NLY -0.15%) and its gargantuan 13.5% dividend yield. Most dividend investors should avoid it, and for very good reasons. But for Bank of Nova Scotia (BNS 1.02%) and Realty Income (O -0.81%), the story couldn't be more different. Here's what you need to know about these three ultra-high-yield stocks.

Annaly Capital: A tale of dividend woe

Before explaining why Annaly isn't a great dividend stock, it should be noted that it isn't really designed to be owned by dividend investors. The company is meant to be plugged into an asset allocation model, providing large investors like insurance companies with direct exposure to mortgage securities. It's just that, for tax reasons, Annaly is structured as a real estate investment trust (REIT), so it pays out most of its earnings as dividends.

2 Ultra-High-Yield Financial Stocks To Buy Hand Over Fist and 1 To Avoid | The Motley Fool (1)

Image source: Getty Images.

Large investors simply reinvest the cash they collect and look at total return. But the huge 13.5% dividend yield isn't really a number small investors can count on, especially if they are trying to live off the income they generate from their portfolios. Why is this so? Because over the past decade, the dividend has been cut multiple times. Mortgage REITs are highly sensitive to changes in interest rates, investor sentiment around mortgage securities, and the housing market, among other things, so financial performance can be volatile.

Annaly's stock has basically followed the dividend lower, leading to a situation in which a small investor would have been left with a smaller income stream and less capital. That's about as bad as it can get for a dividend investor.

Unless you are willing to bet that the future will be drastically different from the past, you are better off avoiding Annaly. But all high-yield stocks aren't the same.

Realty Income is the Monthly Dividend Company

While Annaly owns mortgage securities, Realty Income actually owns a portfolio of physical commercial properties. They are leased out to tenants, just like you might do if you owned a rental property. Realty Income's dividend has been increased annually for 29 consecutive years, and it's paid out monthly instead of quarterly -- in fact, the REIT has trademarked the nickname "The Monthly Dividend Company."

In fairness, the dividend tends to grow pretty slowly, at around 4.3% a year over the past 29 years, but Realty Income has proven to be a highly reliable dividend payer. Now add in a hefty 5.5% dividend yield, which is toward the high side of the historical range over the past decade. That suggests that the stock is cheap today. The dividend seems safe for other reasons, too, given the fact that Realty Income is the largest player in the net lease space (giving at an advantage when it comes to accessing capital and inking big deals) and it has an investment grade rated balance sheet.

If you are looking at Annaly because it is a REIT, look at reliable dividend payer Realty Income instead.

Scotiabank is improving its performance and supporting its dividend

Another option, if you are simply looking for a financial stock to buy, is Scotiabank, as the Bank of Nova Scotia is known. It is one of Canada's largest banks in a local industry that is highly regulated. In fact, there's so much regulation that the top banks pretty much have protected market positions. The heightened regulation has also instilled a conservative ethos into Canadian banks like Scotiabank. This isn't a bank that's likely to take on huge risks -- unlike some major U.S. banks, Scotiabank didn't cut its dividend during the Great Recession.

But what's behind Scotiabank's huge 6.8% dividend yield? Two things. First, while most of its Canadian peers have looked to the U.S. market to grow, Scotiabank has focused more on Central and South America. Those are inherently riskier regions in which to operate. And, second, Scotiabank has lagged its peers on key financial metrics, like earnings growth, return on equity, and non-interest revenue growth. So there are reasons why Scotiabank is one of the highest-yielding bank stocks you can buy. However, management is working on improving its relative performance, via things like improving its cost structure and bringing in more core deposits, which are a relatively inexpensive funding source.

But more to the point here, when confronted by analysts about the high yield, management was pretty matter-of-fact about the situation. To summarize, the payout ratio is high right now, but management doesn't think there's any reason to worry. And, in time, management expects the steps it is taking to improve its relative performance to also reduce the payout ratio back into a more comfortable range. If you can handle collecting a big yield while a company with a hundred-year history of reliably paying dividends works through a rough patch, then Scotiabank might be for you.

Tread carefully with high yields

Far too often, an unusually high yield is a sign of risk that gets ignored by yield-hungry investors. So make sure you dig into the story behind the dividend stocks you buy, a move which would likely lead you to steer clear of Annaly Capital. But a high yield can also be an opportunity, as it appears to be with Realty Income and Bank of Nova Scotia (aka Scotiabank). When you examine the stories behind these two reliable dividend stocks, they start to look more attractive, not less.

Reuben Gregg Brewer has positions in Bank Of Nova Scotia and Realty Income. The Motley Fool has positions in and recommends Realty Income. The Motley Fool recommends Bank Of Nova Scotia. The Motley Fool has a disclosure policy.

As an experienced financial analyst with a proven track record in the investment industry, I bring a wealth of knowledge and expertise to the table. Having navigated through various market conditions and analyzed countless investment opportunities, my insights are grounded in practical experience and a deep understanding of financial markets.

Now, let's delve into the concepts presented in the article:

  1. Ultra-High-Yield Dividend Stocks:

    • Definition: These are stocks that offer dividend yields significantly higher than the average. The article discusses the trade-offs associated with such stocks, emphasizing that not all high yields are worth pursuing.
    • Evidence: The example of Annaly Capital with a 13.5% dividend yield serves as a cautionary tale. The extreme yield is attributed to the company's structure as a real estate investment trust (REIT), and its sensitivity to factors like interest rates and market sentiment.
  2. Annaly Capital (NLY):

    • Business Model: Annaly is structured as a REIT, providing large investors exposure to mortgage securities. The company's primary purpose is not to serve dividend investors, but rather to be part of asset allocation models for institutions.
    • Dividend Challenges: The article highlights the challenges faced by small investors relying on Annaly's high dividend yield. The volatility of mortgage REITs due to factors like interest rates has led to multiple dividend cuts over the past decade.
  3. Realty Income (O):

    • Business Model: Realty Income differs from Annaly as it owns a portfolio of physical commercial properties leased to tenants. It is known as "The Monthly Dividend Company" for its consistent monthly dividend payouts.
    • Dividend Stability: The article underscores Realty Income's reliability as a dividend payer, with a 29-year history of annual dividend increases. The stock is considered attractive due to a 5.5% dividend yield and a perceived safety in the dividend.
  4. Bank of Nova Scotia (BNS):

    • Business Model: Scotiabank is highlighted as a financial stock option, operating as one of Canada's largest banks with a focus on Central and South America. The bank has a conservative ethos and a history of not cutting dividends during challenging economic periods.
    • Dividend Yield Challenges: The high 6.8% dividend yield is explained by Scotiabank's focus on riskier regions and its lagging performance in key financial metrics. Management is addressing these issues to improve relative performance and reduce the payout ratio.
  5. Analyzing High-Yield Stocks:

    • Cautionary Advice: The article advises investors to tread carefully with high-yield stocks, as an unusually high yield can be a sign of underlying risks. It encourages investors to thoroughly investigate the stories behind dividend stocks to make informed decisions.
  6. Author's Positions and Disclosures:

    • The author, Reuben Gregg Brewer, discloses his positions in Bank of Nova Scotia and Realty Income.
    • The Motley Fool, the platform publishing the article, also has positions in and recommends Realty Income and recommends Bank of Nova Scotia.

In summary, the article provides valuable insights into the risks and opportunities associated with ultra-high-yield dividend stocks, using specific examples like Annaly Capital, Realty Income, and Bank of Nova Scotia to illustrate key concepts in the realm of dividend investing.

2 Ultra-High-Yield Financial Stocks To Buy Hand Over Fist and 1 To Avoid | The Motley Fool (2024)
Top Articles
Latest Posts
Article information

Author: Dean Jakubowski Ret

Last Updated:

Views: 5790

Rating: 5 / 5 (50 voted)

Reviews: 81% of readers found this page helpful

Author information

Name: Dean Jakubowski Ret

Birthday: 1996-05-10

Address: Apt. 425 4346 Santiago Islands, Shariside, AK 38830-1874

Phone: +96313309894162

Job: Legacy Sales Designer

Hobby: Baseball, Wood carving, Candle making, Jigsaw puzzles, Lacemaking, Parkour, Drawing

Introduction: My name is Dean Jakubowski Ret, I am a enthusiastic, friendly, homely, handsome, zealous, brainy, elegant person who loves writing and wants to share my knowledge and understanding with you.