AGNC Investments (AGNC 0.74%) pays an eye-popping dividend. At over 14%, it's nearly 10x higher than the S&P 500's dividend yield (currently 1.5%).
However, as enticing as that payout might seem, income-focused investors are better off forgetting about the mortgage REIT. They'll likely make far more money in other high-yielding stocks, including MPLX (MPLX 1.50%). Here's why the 9.3%-yielding master limited partnership (MLP) is a better option for those seeking a strong total return (dividend income plus stock price growth).
Not a very bankable dividend
Mortgage REITs like AGNC Investments have more in common with banks than traditional REITs. Instead of owning income-producing real estate, AGNC invests in mortgage-backed securities (MBS) guaranteed by government agencies. While those guarantees eliminate default risk, the REIT faces many other risks that can impact its income stream.
The two biggest ones are interest-rate risk and reinvestment risk. Like a bank, AGNC Investments uses short-term borrowings to fund long-term investments, taking advantage of the spread between short- and long-term rates.
The problem with this is that interest rates can be volatile. An unexpected rate change can drive up its funding costs, squeezing its profit margin. Meanwhile, falling rates allow borrowers to refinance. When they do, AGNC receives its principal back and must reinvest it at a lower rate.
While this business model can be highly profitable (hence AGNC's high-yielding payout), those earnings can be volatile. That variability has forced AGNC Investments to cut its dividend several times over the years:
AGNC Dividend data by YCharts.
With rates expected to fall next year, AGNC might need to cut its dividend again.
The mortgage REIT's falling dividend has weighed on its ability to create value for shareholders over the years. Its stock has lost nearly 50% of its value over the past decade.
While the company's high-yielding dividend has helped make up some of that lost ground, it has only produced a 68% total return (5.3% annualized). That has significantly underperformed the S&P 500's 213% total return (12.1% annualized).
The fuel to continue rising
MPLX has a much more stable business model. The MLP operates midstream assets (pipelines, processing plants, and storage terminals) that generate very steady cash flow backed by government-regulated rate structures and long-term contracts with high-quality customers, including its parent, refining-giant Marathon Petroleum.
The company had generated over $3.9 billion in cash through the first nine months of this year (a 6% increase from the year-ago period). That easily covered its big-time distribution ($2.4 billion in total cash payments). That enabled the MLP to retain enough cash to fund its capital expenses ($727 million) with room to spare ($752 million in adjusted free cash flow).
That excess cash strengthened its already fortress-like balance sheet. MPLX ended the third quarter with $960 million of cash and a 3.4x leverage ratio (well below the 4x range its stable cash flow can support).
Meanwhile, the company's growth-focused investments will help increase its steady cash flow. MPLX currently has several expansion projects under construction that should come online over the next two years. That gives it visible cash-flow growth on the horizon. It also has the financial strength to enhance its organic growth by making acquisitions to boost its cash flow.
The MLP's growth drivers should give it the fuel to continue increasing its distribution. It recently raised its payout by another 10% and has given investors a raise every year since Marathon created the company in 2012, growing the payout by more than 200% overall.
The company's steadily rising payout has helped power much higher total returns than AGNC Investments. It has produced a more than 200% total return since its formation (10.4% annualized). With more earnings and dividend growth ahead, it should be able to continue making its investors more money than AGNC Investments.
The fuel to produce higher returns
AGNC Investments has steadily cut its dividend over the years as interest-rate fluctuations weighed on its cash flow. With more interest-rate volatility ahead, the mortgage REIT could cut its payout again.
On the other hand, MPLX has steadily increased its distribution over the years as it has grown its portfolio of cash-producing midstream assets. With several expansion projects currently underway, it should have the fuel to continue increasing its distribution.
The likelihood of continued growth makes it a better option for income seekers. It should deliver a steadily rising payout and produce higher total returns than AGNC Investments over the long run.
Matthew 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.
