This Stock is up 45% and STILL Pays a 7.6% Yield

Inflation fears and rising interest rates are riling the fixed-income market.

I’ve got a solution. But before I go into too much detail about this idea, it’s important to see exactly what’s going on.

Treasury yields, which can serve as a benchmark for other bonds, have risen in recent weeks. The 10-year Treasury now yields 3.7%, up from 2.4% in early October. The problem is that as yields rise, prices move down, reducing returns. As well, when rates rise, the prices drop on lower-yielding bonds because they can’t compete with new bonds that offer higher yields.

Meanwhile, rising energy and food prices are beginning to ignite inflation fears. Inflation is the enemy of fixed-income investments like bonds and preferred stocks. The income they pay is worth less as prices rise.

Many investors are running scared. Bond mutual funds saw the biggest withdrawals in more than two years — withdrawals of $8.6 billion in the seven days ended Dec. 15. That was a rise from $1.66 billion the week before, according to the Investment Company Institute.

Here’s the good news. The panic selling isn’t hitting every investment…

Annaly Capital Management Preferred A (NYSE: NLY-PA) is one such security. It’s the preferred stock of Annaly Capital Management (NYSE: NLY), a real estate investment trust (REIT) that owns mortgage securities backed by government-sponsored enterprises such as Fannie Mae and Freddie Mac.

I know what you’re thinking. Mortgages? Fannie Mae? It sounds risky. But that’s not the case.

Annaly’s portfolio has virtually no credit risk. The company basically borrows at low short-term rates, investing the money into mortgage-backed securities. Because it invests only in securities issued by government-sponsored agencies (backed by the federal government), the securities carry an actual or implied “AAA” rating, the same as U.S. Treasuries.

NLY-PA doles out quarterly payments of $0.492 a share, or $1.97 a share annually. That translates to a 7.6% yield, and the high yield is one reason the preferred shares have held up so well. Dividends are taxed as ordinary income, so the shares are best held in a tax-deferred account.

Perhaps the best news is that with net income $3.7 billion during the past nine months, Annaly has been able to easily cover preferred share dividends of $55.4 million during the same period.

Action to Take — > If you’re a subscriber to High-Yield Investing and bought the shares NLY-PA when I first recommended them back in early 2009, you’re now sitting on a nice gain of about 45%. If you didn’t, I’d keep an eye on the preferreds, but wouldn’t buy just yet.

The shares are callable any time and are now trading at a premium to their $25 par value. If they were called tomorrow, you would lose out. For new money, I think it’s best to look for high-quality bonds/preferreds trading below par or wait for a pullback to $25 or below.

P.S. — Have you heard about PCMs — Perpetual Cash Machines? This small group of securities carry average yields of 10.1%… yet hardly anyone knows about them. Learn more about these rare gems here.