Investing

A 14% Dividend Yield That Can Keep Growing With Over 25% Implied Upside

Jon C. Ogg

Published: August 19, 2019 10:35 am

Last Updated: March 13, 2020 4:10 pm

It’s no secret that investors love their dividends. Some statistics in the media have pointed to dividends accounting for half of total returns over time. While high dividend yields can be quite attractive to investors, there are some instances when dividends just look and feel too high. After all, if investors currently have to invest for almost 30 years to earn even 2% in a Treasury bond yield, then what does it say if a stock dividend yield is up at 8%, 10% or even higher?

It turns out that many dividends are unsustainably high. One group that has been able to keep paying consistently high dividends is the mortgage real estate investment trusts (REITs). These vehicles come with very high dividend yields, as they are generally leveraged owners of mortgage-backed securities and almost all of their income is redistributed to the shareholders.

New Residential Investment Corp. (NYSE: NRZ) is a residential credit mortgage REIT that invests in residential mortgages, but it operates through three segments: servicing and originations; residential mortgage-related securities and loans; and consumer-related loans. The stock has seen its share price knocked down handily since the start of May, but another leg lower during August has brought its 14% dividend yield into focus.

Wedbush Securities has an Outperform rating and an $18 per share target price in New Residential Investment. What matters here is that the current $2.00 annualized per share dividend payment now generates a yield of 14% because the share price has come down handily. The total return has been a drop of almost 1% so far in 2019, but the shares are down 21% from a year ago and down about 15% in the past 90 days or so.

While a 14% dividend yield sounds almost too good to be true, on top of an implied appreciation of over 26% to this price target, note that Wedbush is not even close to being the most aggressive firm when it comes to its price target. Another issue is that New Residential’s market cap of $5.9 billion is not insignificant.

According to Wedbush’s Henry Coffey, New Residential Investment comes with an attractive dividend that also is likely to still be a growing dividend ahead. His view is that the company is an ongoing evolution “in the early stages of building out a fully enabled operating platform with origination and servicing capabilities, as well as a demonstrated capacity to find creative ways to monetize the process.”

As for that $2.00 dividend, investors generally assume that REITs pay out 90% or more of their taxable net income as dividends as a pass-through entity. Coffey sees its core earnings in 2019, 2020 and 2021 at $2.10 $2.20 and $2.35 per share, respectively. Moreover, with an annualized dividend of $2.00 per share currently, he expects that the company will begin to move its dividend above the current $0.50 per quarter in 2020.

New Residential has paid its same quarterly $0.50 per share dividend since its payment in June of 2017, but it had been a rising dividend prior to that. Coffey’s price target of $18 is based on a projected yield payout to future investors of 11%, keeping true with the formula that as a price of a bond or security rises its effective yield for new investors comes down.

Wedbush’s notations in the earnings outlook did note that its forward quarterly estimates factor in the impact of two recent preferred offerings totaling $385 million in gross proceeds with coupons of 7.500% and 7.125%.

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The base case of the mortgage and interest rate environment is for mortgage rates and interest rates to remain stable and where credit conditions lead to continued performance from portfolio assets and stable dividends. A more bullish scenario is one in which rising interest rates and improving credit conditions would drive book value and higher dividends. In Coffey’s downside scenario, there is a dramatic rise in mortgage prepayments or rapidly deteriorating mortgage credit conditions lead to losses in mortgage portfolios.

With shares trading near $14.20, New Residential Investment has a 52-week range of $13.86 to $18.75. The consensus analyst target price from Refinitiv is $18.78. The highest analyst price target listed is $21.00, from a 2018 Barclays call, but Raymond James most recently had a $20 target price, and Nomura/Instinet’s last seen target price was $18.50.