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Thursday, May 30, 2013 - 08:30

5 Offbeat Ways To Generate Market-Beating Yields

Thursday, May 30, 2013 8:30 AM

The S&P 500 has been charging higher in 2013, producing an impressive 16% gain in just the first five months of the year. But certain sectors have performed better than others.

At the bottom of the table are basic materials, down 3.4% on the year due to big losses in gold and mining stocks. At the top is health care, up 28% on the year. But a close second is financials, posting an impressive 20% gain. That strong performance has been driven by two key factors.

Housing
Housing is the single most important factor affecting the growth of the economy. And nowhere is its impact bigger than in financial services. Financial services companies carry huge exposure to the housing industry and its wide range of financial products.

And in 2013, key housing data continue to look bullish. According to the Case-Shiller S&P 500 House Price Index, home prices are continuing to rise, with prices up 10% from last year in its latest reading from February. In addition to values rebounding, sales volumes are up and delinquency rates are down, providing additional tailwinds to financial sector earnings.

Financials
This is just a simple matter of economic growth.

Although unemployment remains high and inflation low, the economy continues to expand, posting a gain of 2.2% in 2012. The New York Federal Reserve is calling for that bullish trend to continue, projecting growth of 2.5% in 2013.

Financial services companies provide investors with leveraged exposure to economic growth, a factor that can produce big gains in an expansionary environment (as well as big losses in a contraction).

With strength in housing and ongoing economic expansion fueling the financial sector, the Vanguard Financials ETF (NYSE: VFH) is up 20% this year, a 25% premium to the S&P 500's 16% gain.

Despite those impressive gains, the financial services sector still boasts some of the market's biggest dividend yields. That's because financial companies are frequently structured as real estate investment trusts (REITs) and limited liability companies (LLCs), requiring them to pay 90% of their income as a distribution to shareholders.

And with financial companies raking in big profits from the rebound in housing and general economic growth, investors are cashing in on eye-popping yields. In an environment of record-low interest rates, a high yield becomes even more attractive. With the 10-year Treasury note yielding a paltry 1.9%, many income investors have rotated into riskier assets in pursuit of yield.

A popular destination has been financial services stocks that pay dividends, giving birth to the recent wave of private-equity IPOs such as Blackstone Group (NYSE: BX) and Carlyle Group (Nasdaq: CG).

Picking up dividends is also a great tax strategy. Dividends are classified as capital gains and taxed at a lower rate.

High-yield equities will be more volatile than the 10-year Treasury, but investors will also be compensated for that risk with huge dividends.

Here is a list of seven high-yield stocks from the financial sector that carry outsize dividend yields.

From the list, I have chosen to highlight Invesco Mortgage Capital (NYSE: IVR) because of its attractive valuation and Newcastle Investment (NYSE: NCT) because of its outsize dividend yield and upward momentum.

Invesco Mortgage Capital
Invesco Mortgage Capital is a REIT that invests in, finances and manages residential- and commercial-backed securities and loans.

As a mortgage specialist, Invesco has been well positioned to capitalize on the rebound in home values, rising mortgage volumes and lower delinquency rates. That has analysts looking for full-year earnings of $2 a share this year.

With a price-to-earnings (P/E) ratio of 8 times, below its peer average of 10, Invesco has value in addition to a serious yield of 13%.

Newcastle Investment
Newcastle Investment operates as a real estate investment and finance company that invests in and manages a portfolio of real estate securities, loans and mortgage services.

The company has been hot in 2013, with shares up a market-beating 29%. But in spite of that bullish movement, Newcastle's forward P/E ratio of 4 times is less than half its peer average of 9. And with a 15% yield, Newcastle is a powerful source of income.

Risks to Consider: Dividend yields can fall due to fluctuations in earnings and distributions. The flip side of the financial services sector's exposure to economic growth is its potential for big losses in a contraction.

Action to Take --> Financials have been one of the top performing sectors of the year, producing an outsize 20% gain. But in spite of that bullish movement, financials carry some of the biggest yields in the market. Consider Invesco Mortgage Capital for its attractive valuation and Newcastle Investment for its dividend yield and upward momentum.

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Michael Vodicka does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.