Passive income is one of my passions. My top financial goal is to grow my passive income to the point where it can cover my recurring expenses. I still have a way to go, which is why I’m usually adding to my passive income sources, not subtracting from them.
However, I recently closed my position in Annaly Capital Management (NLY), which I’ve owned for many years. The main draw was its lucrative dividend, which yields nearly 13%, almost 10 times higher than the S&P 500. Here’s why I finally threw in the towel and sold the high-yielding dividend stock.
The dividend will probably continue heading down
Annaly Capital Management was one of the first real estate investment trusts (REITs) I ever bought. I’ve held those initial shares the entire time. While I have added to my position a few times over the years, I haven’t bought more shares in over a decade. Instead, I’ve just sat back and collected the dividend income.
Unfortunately, that income stream has steadily fallen over the years as the mortgage REIT reduced its payout:
I’ve refrained from selling because the income stream was still decent enough. Furthermore, given the decline in the stock price over the years, it would be hard to find an alternative that could generate the same level of income as I currently earn.
However, I’ve decided to throw in the towel after all these years. One of the biggest factors driving that decision is the likelihood that Annaly’s dividend will continue falling.
Annaly’s current dividend payment is $0.65 per share each quarter, or $2.60 annually. That compares with the company’s $0.64-per-share earnings available for distribution in the first quarter. The REIT’s earnings have been in a steady decline. They were $0.81 per share in last year’s first quarter and averaged over $1.00 per share in 2022. The decline from that level led Annaly to cut its dividend from $0.88 per share at the end of 2022 to its current level in early 2023. While the REIT believed it could earn enough to cover its dividend this year, it seems increasingly likely that another cut is in the cards. My income from this position is likely to keep falling.
High yield, low return
My investment strategy has evolved over the years. While I’ve always liked collecting dividend income, I’ve come to the often painful realization that a high dividend yield isn’t as attractive as it seems. Many of the high-yield dividend stocks I bought over the years have cut or reduced their dividends. These reductions have acted as a headwind to my goal of eventually generating enough passive income to cover my expenses.
In addition to falling dividend payments, these stocks have also tended to have falling share prices. My Annaly Capital investment has lost about two-thirds of its value over the years. While the oversized dividend payments have helped offset some of this decline, the overall total returns were lackluster. For example, my initial Annaly Capital purchase delivered only a 7.1% annualized return. That compares with a 10.6% return for the S&P 500 during that period.
That performance aligns with the overall data on dividend stocks. According to data from Ned Davis Research and Hartford Funds, companies that deliver flat or falling dividends have underperformed the market over the years. Companies with no change in their dividend policy have delivered a 6.7% annualized total return over the last 50 years, while the return of cutters and eliminators is negative-0.6%. That compares with a 7.7% annualized return for an equal-weight S&P 500 index. On the other hand, companies that grow their dividends have significantly outperformed, with a 10.2% annualized total return.
That data, along with my observations, has driven me to shift my focus away from a stock’s dividend yield to the company’s ability to grow its payout. I’ve started selling positions where dividend growth is unlikely, like Annaly, to redeploy the proceeds into companies that should be able to increase their payouts in the future. While this will cause a near-term hit to my passive income, I expect it to grow faster in the future as I benefit from rising dividends and my continued purchase of additional shares of dividend growth stocks. Those dual growth drivers should help me reach my passive income goal faster.
An overdue sale
I had held on to Annaly Capital for far too long. While the mortgage REIT still supplied me with a meaningful amount of dividend income, the payments have fallen over the years. That downward trend seemed likely to continue. That’s why I’m throwing in the towel and selling. I plan to redeploy the proceeds into companies that can pay a growing dividend, which should enhance my income and returns over the long term.
— Matt DiLallo
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Source: The Motley Fool