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)

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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 enthusiast and expert in investment strategies, particularly dividend stocks, I've spent years navigating the complex landscape of the financial markets. My extensive experience in analyzing various investment options has equipped me with a deep understanding of the risks and rewards associated with different stocks. I've closely followed market trends, scrutinized company financials, and assessed the long-term viability of countless dividend-paying entities.

Now, delving into the specifics of the article you've shared, I want to shed light on the key concepts discussed regarding three particular ultra-high-yield dividend stocks: Annaly Capital (NLY), Realty Income (O), and Bank of Nova Scotia (BNS).

1. Annaly Capital (NLY):

  • Annaly is structured as a Real Estate Investment Trust (REIT), primarily catering to large investors like insurance companies with exposure to mortgage securities.
  • Despite its tempting 13.5% dividend yield, Annaly may not be suitable for individual dividend investors due to its historical dividend cuts and volatility tied to interest rates, investor sentiment, and housing market fluctuations.
  • The article emphasizes that Annaly isn't designed for direct ownership by dividend-focused individuals, as its structure and sensitivity to market conditions pose significant risks.

2. Realty Income (O):

  • Realty Income is a REIT that owns a portfolio of physical commercial properties, leased out to tenants.
  • Unlike Annaly, Realty Income has a remarkable track record, having increased its dividend annually for 29 consecutive years.
  • The company is recognized as "The Monthly Dividend Company," paying dividends on a monthly basis.
  • While the dividend growth rate is moderate at around 4.3% per year, the reliability of payments and a 5.5% dividend yield make it an attractive option for income-focused investors.
  • The article suggests that Realty Income's status as a reliable dividend payer, along with its position as the largest player in the net lease space, makes it a more appealing choice compared to riskier alternatives.

3. Bank of Nova Scotia (BNS):

  • Scotiabank is one of Canada's largest banks, operating in a highly regulated industry with protected market positions.
  • The bank's 6.8% dividend yield is attributed to its focus on Central and South America, considered riskier regions compared to its Canadian peers.
  • Scotiabank has lagged behind in key financial metrics, but management is actively working on improving its performance through measures like cost structure enhancements and attracting more core deposits.
  • Despite the high yield, management expresses confidence in the sustainability of dividends, expecting the payout ratio to improve over time as the bank enhances its relative performance.

In conclusion, the article provides a nuanced perspective on ultra-high-yield dividend stocks, cautioning investors about the potential pitfalls associated with seemingly attractive yields. It advocates for a careful evaluation of each stock's story, advising against Annaly Capital while highlighting the potential opportunities offered by Realty Income and Bank of Nova Scotia for those willing to navigate the associated risks.

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

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