STWD Stock: Collect a Growing Dividend Yield of 8.9%
Top High-Yield Stock You Likely Haven’t Considered
In an era where most companies pay less than four percent, an investor would be considered lucky if they can lock in a yield north of eight percent. And that’s why Starwood Property Trust, Inc. (NYSE:STWD) deserves our attention. The company not only pays generous dividends, with a yield of 8.9%, but will likely grow its payout in the years to come.
Starwood Property Trust is a real estate investment trust (REIT) headquartered in Greenwich, Connecticut. It was created by global private investment firm Starwood Capital Group in 2009. At that time, traditional commercial lenders were withdrawing from the real estate marketplace and there was an urgent need for alternative commercial mortgage financing solutions.
That’s why Starwood Property Trust was created. The company originates, acquires, finances, and manages commercial mortgage loans and other commercial real estate debt and equity investments. It operates through three main segments: real estate lending, real estate investing and servicing, and property. Since its inception, Starwood Property Trust has grown significantly and currently has a portfolio of over $10.0 billion. Commanding over $5.6 billion of market cap, Starwood Property Trust is the largest commercial mortgage REIT in the U.S.
As one of the biggest players in the real estate business, the company has multiple ways of making money. In the large loan lending business, Starwood Property Trust collects repayments on its mortgage portfolio and currently has a targeted levered internal rate of return of 11% to 13%. (Source: “Investor Presentation,” Starwood Property Trust Inc, last accessed November 21, 2017.)
At the same time, the company invests in commercial mortgage-backed securities (MBS), with target unlevered returns in the mid-teens. It also sells commercial mortgages into commercial MBS transactions with multiple dealers. The commercial MBS origination business allows the company to earn a gain-on-sale margin of between two percent and four percent.
Furthermore, Starwood Property Trust invests in physical properties. Its $2.0-billion portfolio is capable of producing cash-on-cash returns ranging from nine percent to 12% and may also provide upside potential through capital appreciation.
In other words, Starwood Property Trust has built an extremely lucrative business. And because it is structured as a REIT, the company is required by law to distribute at least 90% of its profits every year in the form of dividends.
Right now, the REIT pays $0.48 per share on a quarterly basis, giving STWD stock an annual dividend yield of 8.9%.
Quite often, a yield as high this can turn out to be a sign of trouble. But for Starwood Property Trust, that’s not really the case. Once you take a look at its financials, you would see that its payout is more than safe.
The company reported earnings earlier this month. In the third quarter of 2017, Starwood Property Trust generated core earnings of $170.9 million, or $0.65 per diluted share. Considering that it paid $0.48 of quarterly dividends per share, the company had a payout ratio of 73.8%, leaving a margin of safety. (Source: “Starwood Property Trust Reports Results for the Quarter Ended September 30, 2017,” Starwood Property Trust Inc, November 8, 2017.)
In the first nine months of 2017, Starwood Property Trust generated core earnings of $1.68 per share, which also provided more than enough coverage for the $1.44 of dividends per share it paid during this period.
As a matter of fact, the company’s solid business allowed it to pay not only a steady dividend, but an increasing one. The chart below shows STWD’s regular dividend history since its initial public offering in August 2014.
Starwood Property Trust Regular Dividend History
Source: “Dividends,” Starwood Property Trust Inc, last accessed November 21, 2017.
Other than paying regular quarterly dividends, the company also rewarded investors with a one-time special dividend of $5.768 per share in 2014.
Most recently, STWD stock’s dividends have been steady rather than increasing. But that doesn’t mean the company won’t raise them in the future. In fact, there is a major catalyst that could significantly boost Starwood’s payout down the road.
That catalyst is rising interest rates. As of June 30, 2017, Starwood Property Trust has $6.2 billion in variable rate assets and only $2.9 billion in variable rate liabilities. Therefore, when interest rates increase, the company will generate substantially higher interest income while paying moderately higher interest expenses. Management estimates that a one-percent increase in the London Interbank Offered Rate (LIBOR), a benchmark short-term interest rate at which banks borrow from each other, would increase the company’s annual cash flow by $0.09 per share. And if LIBOR rises by two percentage points, Starwood would earn $0.21 per share of extra cash flow.
For REITs, higher cash flows would likely translates to higher dividends. With interest rates on the rise, the best could be yet to come for investors of STWD stock.