Is Annaly Capital the Best Ultra-High-Yield Stock for You?

What should investors make of a real estate investment trust (REIT) with a yield over 13%? That's the first hard question you'll face when it comes to Annaly Capital (NYSE: NLY) , and it will likely be followed by an even harder one: Should you buy it?

Your answer will depend heavily on what you are trying to achieve with your portfolio. And somewhat counter-intuitively, if your goal is income, you'll probably conclude that this ultra-high-yield stock is not for you. But that doesn't mean it isn't a good fit for some investors.

The complicated business model of the mortgage REIT

Most real estate investment trusts buy physical properties and then lease them to tenants, collecting the rents and using that cash flow to distribute dividends to investors. In fact, REITs were specifically created to allow retail investors to participate in institutional-level property markets. Their business model is, basically, the same one you would use if you owned a rental property. It's just scaled up to large portfolios of apartment buildings, offices, and warehouses, among other property types.

Annaly Capital doesn't do that. It buys mortgages that have been pooled into bond-like securities, often called collateralized mortgage obligations or something similar. These securities trade all day and their prices can be impacted by interest rates, housing market dynamics, default rates, and repayment trends, among other things. So while you as an investor might be able to do some research and get a read on how the apartment sector is going, for example, it would be a lot more difficult to figure out how a mortgage bond issued in 2023 (meaning that the mortgages it contains are from roughly that year) is performing relative to one issued in 2019. Yet that sort of minutiae is exactly what Annaly has to be on top of as it builds its portfolio.

Notably, the value of a mortgage REIT (its book value ) is, effectively, the value of its portfolio. And mortgage REITs often try to enhance returns by using their portfolios to back loans that they can use to buy more mortgage bonds. Leverage can enhance returns, but it can also exacerbate losses. In a worst-case scenario, the leverage that a mortgage REIT like Annaly Capital takes on can lead to a margin call , forcing management to sell assets at what would probably be an inopportune time.

NLY data by YCharts.

But the issue that will cause many dividend investors to cross Annaly Capital off their watch lists is shown clearly in the chart above. Not only is Annaly Capital a fairly complex investment to understand, but if you used the dividends it paid over time, you would have been left with both less income and less capital thanks to the long downtrend in the payout that has been accompanied by a parallel downtrend in the share price. It's probably best to forget about that huge 13% dividend yield if your long-term goal is to build a reliable stream of dividends you can live off of in retirement.

Another Annaly Capital chart tells a more compelling story

But what if your goal isn't collecting regular dividends ? That actually changes the investment thesis materially. As the chart below shows, Annaly Capital's total returns compare favorably to the S&P 500 index's over the long term.

"But wait," you may be asking yourself. "How can a stock with a falling price and declining payouts end up being such a strong long-term performer?"

NLY Total Return Level data by YCharts.

The answer is that if you're using the cash from those ultra-high-yield payouts to buy more shares, the compound growth effect can more than offset the stock price decline. Annaly is a total return investment that essentially requires dividend reinvestment to "work." It is most appropriate for investors as part of a broader asset allocation model that devotes a portion of one's assets toward mortgage REITs. If that's what you do, Annaly Capital could be a great way for you to get exposure to the mortgage sector.

Annaly is not an easy stock to love

Annaly Capital is going to be something of an acquired taste for most investors. Either it will fit perfectly with what you are looking to do (in terms of asset allocation) or it could end up being a disastrous choice (if you plan to take your dividends rather than reinvesting them). There's not much middle ground here, and the ultra-high yield isn't the most important part of the story. Make sure you understand what you're getting and why you want to own it if you decide to buy Annaly Capital.

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy .