A Government-Guaranteed 16% Dividend... This Won't Last Long
By Dr. Steve Sjuggerud
September 22, 2008
Two weeks ago, I told you something foolish...
I told you about the best investment to make if the Feds took over Fannie Mae and Freddie Mac. But that was silly... nobody really thought the government was about to take them over.
Then it happened... that weekend.
The stock I recommended – Annaly Capital Management (NLY) – moved from $15 up as high as $17.
It came back down a bit on Friday, but I think Annaly shareholders are exactly where they want to be. Annaly's business is incredibly simple... It borrows money at a low interest rate and invests it at a higher interest rate in government-guaranteed bonds. It earns the difference – the spread. And when it's in its sweet spot, it makes a fortune.
Right now, the business is in a sweet spot.
It can borrow money incredibly cheaply... The Fed has cut short-term interest rates down to 2%. So Annaly can borrow money at about 3.5%.
It invests the money in government-guaranteed bonds. When the Treasury bailed out Fannie Mae and Freddie Mac, it wiped out shareholders, just like I predicted. But it explicitly guaranteed the bonds. So the bonds Annaly buys are just as good as risk-free Treasury bonds. Since the bailout, both bonds have the same guarantees, the same government backing.
In the latest-reported quarter, Annaly earned 5.5% interest on its bonds. So it earned a 2% spread. If the company uses eight times leverage, that's roughly a 16% return on its money. (The actual return in the second quarter was 18%.)
Analysts figure Annaly will earn an even wider spread next year... for earnings of $2.78 per share. Annaly is required by law to pay out almost all its earnings in dividends. If it pays out $2.78 next year, that's a 16% dividend yield (based on a $17 share price).
If you buy Annaly today, you'll probably earn more than 30% in dividends over the next two years. This is ridiculous... An opportunity like this only appears during market turmoil like we're experiencing now.
And with the company paying such a huge dividend, investors are going to pile in, boosting the stock price... Shares could go as high as 50% above their net worth.
So in addition to 30% in dividends, you could also make a nice capital gain.
The best part is, it's safe. Before the takeover, we only had an "implied" guarantee the government would back the bonds Annaly owns. We weren't absolutely certain the government would follow through on that guarantee. But now that the government has taken over Fannie Mae and Freddie Mac, that guarantee is explicit. Those bonds are as safe as Treasuries.
At $17, Annaly trades at a big premium to book value. At that price, your upside is limited. But the company is in its sweet spot.
You'll collect a 16% dividend yield next year on a safe business. It's definitely worth looking into now...
Good investing,
Steve
Editor's note: Steve Sjuggerud is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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