Buy And Hold This Rock Solid High-Yield Stock Paying 14% A Year

Yielding a retirement-saving 14% with a rock solid business model and crystal clear cash flows, you may not find a better dividend paying stock in this market. And, as an added bonus this company’s profits will actually increase when the Fed hikes rates. This is a no-brainer investment in a market that’s starved for yield.

Although I don’t like to see falling share prices, last week’s stock market reaction to the strong Jobs Report numbers that increased the probability of a Fed interest rate hike in December, can only make me laugh. Companies with interest rate exposure have been expecting a rate increase for several years, and if management teams are smart they already implemented business plans that will let them thrive in a higher rate environment.

Share prices on many higher yield stocks have been declining for the last six months as market participants have worried about an interest rate increase. Then when economic data comes out that makes an actual rate increase pretty likely, the shares sell off another 3%, 4% or 5%. The illogical nature of the stock market becomes visible when you think about the effects of fear of a future event causing share prices to fall, and then when that future actually arrives, share prices are driven down further.

The market gives no thought to the fact that an interest rate increase is probably the most anticipated and discussed event in the current history of the markets and any effects of higher rates should have been priced into share values months ago ( if you believe in a rational market). Maybe we will actually get an up day for high yield stocks when the Fed finally announces a real interest rate increase.

As dividend focused investors, we need to understand how the individual companies function, and happily buy shares of the better companies at lower prices and higher yields. While the market has punished almost all higher yielding stocks because of interest rate fears eventually the dust will settle and the truth of which companies can perform and which cannot in the new higher rate environment will be evident. Today, I am going to focus on a small and little-known stock that will actually improve their profit margins as rates increase.

This stock is New Residential Investment Corp (NYSE: NRZ), and unsurprisingly the share price is down 25% over the last six months in spite of two dividend increases this year. NRZ yields an astounding 14%, yet this company will do even better as interest rates increase.

New Residential’s primary assets are excess mortgage servicing (MSRs) rights on $399 billion of home mortgages. On every mortgage, the company that services the loan is entitled to keep a portion of the interest to cover servicing costs. The servicing rights are typically 0.25% per year, and the cost to actually service a loan is usually less than 0.10%. To lock in future revenues, servicing companies will sell the excess MSRs above their costs. New Residential is by far and away the largest buyer and owner of excess MSRs.

Since mortgages pay off over time, and home sales and refinancing will accelerate those payoffs, the MSRs are a depleting asset with a variable outcome on the depletion rate. In layman’s terms, when rates go up people are less inclined to refinance their mortgages, therefore NRZ will benefit as the depletion rate for their cash flow generating MSRs decreases.

The New Residential management team is very experienced in the analysis of different pools of mortgages to forecast MSR cash flows. The company targets a 12% to 20% annual return on investment when it buys excess MSRs. Historically, results have come in pretty close to the middle of that range. When interest rates start to increase, the pace of home mortgage refinancing will slow down, increasing the lives of the mortgage pools from which NRZ earns excess MSRs. Increasing the duration of a mortgage pool increases the rate of return on excess MSR investments. This means that the biggest asset owned by New Residential will generate higher than forecasted cash flow for a longer period of time as interest rates increase.

Currently, NRZ trades for less than $13 per share with the previously mentioned 14% yield. In a rational world, a stock and company of this quality should carry a sub 10% yield. That would put the share price over $18. While we wait for the rest of the market to figure out the true quality and stability of the NRZ business, we will happily continue to collect those big dividend checks.

Finding companies that regularly increase their dividends is the strategy that I use myself to produce superior results, no matter if the market moves up or down in the shorter term. The combination of a high yield and consistent dividend growth in stocks is what has given me the most consistent gains out of any strategy that I have tried.