Markets fell into bear territory through the first half of the year – but we saw a summer rebound in July that has stabilized this month. Both the S&P 500 and the NASDAQ indexes have climbed back out of their bear markets, and investor sentiment, at least for now, is positive.
However, at least some of the market experts are taking a much more guarded view of current conditions. Looking into the history of market downturns, Bank of America strategists see indicators that we haven’t hit bottom yet. The team writes, “Households bought $5.9 trillion in equities over the past two years through the end of the first quarter 2022, with inflows recorded in every quarter since Covid. Historically, the past three major market lows have occurred 1-2 quarters after substantial household investor selling.”
But, according to the BofA team, household investors have started selling their stock holdings. When they do, however, the impact will be substantial: household investors hold some 52% of the total US equity market, or some $38 trillion in aggregate. Once they begin divesting, the magnitude of the selling, in the BofA view, could push the S&P down to 3,600, about 16% lower from current levels.
If they’re right, then now is the time for investors to move into defensive plays. Dividend stocks are a traditional move to take in adverse markets environments, as they tend to outperform the market lows – and the dividend payments ensure an income stream and return on investment.
With this in mind, we’ve used the TipRanks database to pinpoint two high-yield dividend stocks, equities that pay out 10% or better through their dividend. With a return like that, it’s no wonder that Wall Street’s analysts are also upbeat, giving these stocks ‘Strong Buy’ status. Let’s take a closer look.
PennyMac Mortgage (PMT)
We’ll start with PennyMac, a real estate investment trust (REIT) with a focus on making direct loans to property buys and investing in mortgage-backed securities. PennyMac has targeted its activities on mortgage assets rather than directly buying properties, a strategy that worked well in a hot real estate market. The first half of 2022, however, has seen this company face a difficult market environment as the combination of inflation and higher interest rates worked to slow down the real estate market.
Simply put, while higher rates may portend higher income for a lender like PennyMac, that was more than offset by reduced purchasing activity. Earnings turned negative in 3Q21, but the most recent quarter, 2Q22, showed a much steeper loss of 88 cents per diluted share, based on a total net loss of $81.2 million.
At the same time, despite the losses, PennyMac is maintaining its common share dividend at 47 cents. The most declaration, of the July 28 payment, marked the 7th straight quarter with the dividend at this level. The annualized rate of $1.88 per common share gives a high yield of 12%, approximately 6x higher than the average dividend yield on the broader markets.
Covering this stock for B. Riley Securities, analyst Matt Howlett believes that this company will likely see a return to profitability as the real estate and mortgage markets get used to the higher interest rate regime.
“We peg 2Q22 core EPS at $0.49, which was well ahead of our $0.40 estimate and its current $0.47 quarterly dividend rate… we would be buyers of additional PMT shares on any weakness and especially if the stock trades below NAV as the company has a history of being an aggressive repurchaser of its own stock… More importantly, the company is in a position to thrive in a higher interest rate environment as it takes share… PMT is uniquely designed to create high-quality credit and interest rate products from its internally sourced platform,” Howlett opined.
Keeping up his optimistic view, Howlett rates PMT a Buy, and his $18 price target implies a one-year upside potential of ~15%. Based on the current dividend yield and the expected price appreciation, the stock has ~27% potential total return profile. (To watch Howlett’s track record, click here)
Howlett is hardly the only bull on PennyMac; the stock has 5 recent positive analyst reviews, for a Strong Buy consensus rating. PMT shares are priced at $15.71 and their $17.40 average price target suggests ~11% gain over the next 12 months. (See PennyMac stock forecast on TipRanks)
Redwood Trust (RWT)
Now we’ll turn to Redwood Trust, another REIT – and another high-yield dividend champ. Redwood operates in the residential real estate sector, where it invests in a variety of mortgage and loan packages, with a portfolio that includes mortgage-backed securities, prime rate jumbo residential loans, and multifamily securities. On that last category, Redwood works with the Federally backed Freddie Mac and Fannie Mae programs.
Redwood’s top line revenue has remained positive over the past year, although earnings dropped sharply into negative territory in 2Q22, the most recent quarter reported. 2Q interest income came in at $167 million, up 20% year-over-year, but the company’s earnings showed a net loss of 85 cents per diluted share. The EPS result represented a severe turnaround from the past two years of positive results. Management attributed most of the net loss (74 cents per share) to an unrealized change to net fair value on long-term investments.
Despite the net loss, Redwood has maintained its dividend payment. The current common share payment is 23 cents, the third quarter in a row at that level after 5 dividend increases since June of 2020. The dividend annualizes to 92 cents per common share and yields 11%. This is a dividend yield far higher than average, and more than enough to beat the current rate of inflation.
Kevin Barker, 5-star analyst with Piper Sandler, notes that Redwood has seen increased volatility recently in rates and spreads, volatility which has impacted the business model. However, he remains upbeat on the stock, writing: “[We] expect the volatility to moderate in the third quarter as the market has settled a touch with RWT noting a 2% increase in book value since quarter-end. The company is re-allocating capital into the investment portfolio and maintaining a defensive approach in the near-term. We believe the market has discounted a large portion of these headwinds with the stock now trading at 82% of pro-forma TBV.”
To this end, Barker puts an Overweight (i.e. Buy) rating on RWT shares, and his $10.50 price target indicates his confidence in a 23% gain for the stock in the months ahead. (To watch Barker’s track record, click here)
Overall, Redwood has attracted positive attention from Wall Street, in the form of 7 optimistic analyst reviews that support a Strong Buy consensus rating. Shares in RWT are trading for $8.30 and their $11.36 average price target implies a 33% one-year upside potential. (See RWT stock forecast on TipRanks)
To find good ideas for stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a newly launched tool that unites all of TipRanks’ equity insights.
Disclaimer: The opinions expressed in this article are solely those of the featured analysts. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.
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