Should Investors Consider This High-Yield Stock?
Due to the massive bull run in the U.S. stock market, dividend yields have been subdued. However, that doesn’t mean investors can’t find high-yield stocks. If you use any of the stock screeners available on the Internet, you can easily find dozens of companies offering double-digit yields.
So why aren’t investors rushing toward these high-yield stocks? Two words: dividend safety.
The No. 1 reason that investors have second thoughts about putting their money into these double-digit yielders is their concern that the payout won’t be sustainable. So today, I’m going to examine the dividend safety of one of these high-yield stocks.
Chimera Investment Corporation (NYSE:CIM) is a real estate investment trust (REIT) headquartered in New York City. The company invests primarily in mortgage loans and mortgage-related securities.
Chimera completed its initial public offering (IPO) in November 2007, which was not exactly the best time for the U.S. stock market. The company has paid a dividend every quarter since then. (Source: “Common Stock Dividends,” Chimera Investment Corporation, last accessed October 20, 2017.)
Right now, Chimera’s quarterly dividend rate stands at $0.50 per share. At the current share price, that translates to an annual yield of 10.41%.
As a mortgage REIT, Chimera earns interest income from its investments in mortgage loans and mortgage-related securities. But, because the company finances those investments with borrowings, it has to pay interest on that too. Therefore, Chimera’s profits come from the difference between interest earned on its assets and the cost of its borrowings.
So far, the strategy has been working quite well. According to Chimera’s most recent earnings report, the company earned a net income of $105.6 million, or $0.56 per diluted share. Considering that Chimera declared $0.50 of dividends per share during this period, the company had a payout ratio of 89.3%. (Source: “Chimera Investment Corporation Releases 2nd Quarter 2017 Earnings,” Chimera Investment Corporation, August 2, 2017.)
Usually, I like companies that pay out less than 75% of their profits, so Chimera’s payout ratio in the second quarter seems quite high. However, note that, when evaluating a company’s dividend safety, quarterly numbers may not give you the best picture. So, let’s take a look at Chimera’s year-to-date results.
Third-quarter results are yet to be announced, so we’ll have to use the numbers for the first half of this year. Diluted earnings for the first six months of 2017 came in at $1.40 per share, while dividends were $1.00 per share. That translates to a payout ratio of 71.4%, which is below my 75% threshold.
Past performance does not guarantee future results. In Chimera’s business, a key factor to consider going forward is the rising interest rate environment. Because the company has quite a bit of debt, rising interest rates could lead to a higher cost of borrowing, which would result in lower profits.
The good news is that Chimera has a risk management team in place. In the past, the team has used various interest rates hedging strategies, such as interest rate swaps, options, futures contracts, and structured term repo. These strategies might not eliminate the risk completely, but they can significantly reduce the company’s interest rate exposure for a certain period of time.
The Bottom Line on CIM Stock
Chimera’s current operations are capable of covering its dividends. There are some inherent risks associated with the business, but, if the company can navigate through the rising interest rate environment, it could still dish out oversized dividends.