Mortgage REITs are popular with many investors right now for the high dividend yields they currently provide. Sporting a dividend yield of 19%, Armour Residential (NYS: ARR) is certainly no exception.
Mortgage real estate investment trusts issue shares to investors to raise capital, which they use to buy mortgage-backed securities. They also use short-term financing to boost their returns. They repay lenders out of the mortgage payments they collect, and most of the rest is returned to shareholders in dividends.
Here's a simple visualization:
Let's take a quick look at four things investors in Armour need to know. After that, we'll find out how Armour stacks up next to its competitors.
1. Interest rate spread
A REIT's interest rate spread is the difference between a REIT's financing costs and its interest income. It's a decent measure of investing profitability -- and portfolio risk.
2. Debt-to-equity ratio
Since interest rate spreads tend to be pretty narrow, REITs like to leverage those returns to generate bigger returns. Companies with safer portfolios can afford to take on more leverage risk than those with riskier investments.
3. Share growth
Since REITs have to pay out the vast majority of their earnings in dividends, the only way to grow their business is to take on more leverage or issue new shares. If a company issues a lot of shares, we want to make sure it does so at attractive prices so investors aren't diluted.
4. Dividend yield
The main reason to buy mortgage REITs is for their dividend. The forward yield tells us what dividends we'll get paid over the next year if earnings hold constant.
Let's see how Armour stacks up next to its peers in these four crucial areas:
Interest Rate Spread (2010)
3-Year Annual Share Count Growth
Dynex Capital (NYS: DX)
Cypress Sharpridge (NYS: CYS)
Invesco Mortgage (NYS: IVR)
Source: Capital IQ, a division of Standard & Poor's.
Armour doesn't have a meaningful share count growth history because it was only founded in 2008.
Compared with its peers, Armour carries a high debt-to-equity ratio. Armour only invests in ultra-safe "agency securities" -- mortgages whose interest payments are guaranteed by Fannie Mae and Freddie Mac, and sometimes debt issued by those agencies, debt from the U.S. government, and money market instruments. Because these are the safest type of mortgage to own (from the perspective of possible default), Armour produces an interest rate spread that's lower than some of its peers. Though it means taking on greater leverage, Armour's high debt-to-equity ratio compensates for the interest rate spread, allowing the company to carry little default risk while still paying out a juicy 19%-plus dividend yield.
At the time thisarticle was published Ilan Moscovitzdoesn't own shares of any company mentioned. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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