The dividend yield on the S&P 500 is very low these days. At 1.2%, it's near its lowest level in more than 20 years. Because of that, you won't generate much passive dividend income by investing in an S&P 500 index fund.
While the S&P 500 doesn't pay much these days, plenty of other dividend stocks pay a lot more. One of the more impressive payouts comes from AGNC Investment (NASDAQ: AGNC), which currently yields almost 15%. Here's a look at how it can afford to pay such a lucrative dividend.
A simple investment strategy
AGNC Investment is a real estate investment trust (REIT) focused on investing in residential mortgages. The company buys residential mortgage-backed securities (MBS), which are pools of mortgages guaranteed against credit losses by government agencies like Fannie Mae, Freddie Mac, or Ginnie Mae. Those credit protections make MBS very low-risk fixed-income investments.
MBS investments also have a relatively low return profile (typically in the low- to mid-single digits). However, mortgage REITs, like AGNC Investment, can enhance their returns by investing in MBS on a leveraged basis (i.e., borrowing money to finance additional MBS investments). The company capitalizes on the difference between shorter-term interest rates (where it borrows) and longer-term rates (where it invests), making money on the spread between the two rates.
AGNC Investment currently holds $73.1 billion in MBS assets with an average yield of 4.73%. It has a leverage ratio of 7.2 times, meaning it has borrowed more than $7 for every $1 of equity it has invested in its portfolio.
That leverage significantly increases its return on equity, which is currently in the mid to high teens. Using leverage enables AGNC to generate more income for every dollar of equity it invests in MBS.
The mortgage REIT is currently generating more-than-enough income to cover its monster dividend. AGNC Investment recorded $0.48 of comprehensive income per share during the third quarter. That compared to dividend payments adding up to $0.36 per share in the quarter ($0.12 per share each month).
A higher risk
AGNC Investment has paid over $13 billion in dividends since its formation during the financial crisis. Its dividend payment has been stable since the pandemic at $0.12 per share each month. However, the REIT has reduced its dividend level several times over the years:
AGNC Dividend data by YCharts.
The REIT has had to cut its payment during periods of significant changes in interest rates and the MBS market. While the company has faced some challenging conditions in more recent years, it has maintained its dividend for the past 55 months by adeptly navigating those market conditions.
Looking ahead, the company believes that the recent interest-rate cuts by the Federal Reserve will have a positive impact on its business. CEO Peter Frederico stated in the third-quarter earnings press release, "The outlook for Agency MBS today is decidedly better than it was in 2022 and 2023 as a result of the positive direction of the broader economy, the accommodative Fed monetary policy stance, and the stability of Agency MBS spreads at these historically favorable levels." That drives the REIT's belief that it can continue generating a high-enough return to maintain its current dividend level.
However, there's always a risk that the future won't play out as expected. A resurgence in inflation could cause the Federal Reserve to backpedal on rate reductions, while an unexpected event could impact the MBS and credit markets. For example, no one expected a pandemic to upend the market in 2020, which was the last time AGNC cut its dividend.
An intriguing way to potentially make a lot of income
AGNC Investment currently offers a dividend yield more than 10 times higher than the S&P 500. That makes it a potentially lucrative income investment opportunity these days. While it's a higher-risk dividend stock due to its use of leverage, it also offers higher return potential.
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Matt DiLallo 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.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
