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Forget This 8.8%-Yielding Dividend Stock. Consider These Even Higher-Yielding Payouts Instead.

In Business
January 05, 2024

Redwood Trust (NYSE: RWT) pays a pretty enticing dividend. The mortgage-focused real estate investment trust (REIT) currently yields 8.8%. That’s several times above the S&P 500‘s 1.5% dividend yield.

However, as alluring as the mortgage REIT‘s yield might seem, investors should forget about that big-time payout. That’s because they can earn even higher yields from Energy Transfer (NYSE: ET) and MPLX (NYSE: MPLX). The energy master limited partnerships (MLPs) currently yield over 9%. Further, those MLPs are more likely to increase their already high-yielding distributions in the future, which isn’t something investors can count on Redwood doing.

A spotty dividend track record

Redwood Trust is a mortgage REIT focused on investing in loans for single-family and rental properties. It specializes in jumbo loans used to finance properties that are too expensive for a conventional conforming loan ($766,500 in most counties for 2024). It also engages in business-purpose lending by providing investors with rental property loans. While these are smaller niches than conventional mortgage loans, they’re still very large market opportunities. Further, these markets can be very profitable (Redwood can earn a double-digit return on its assets using leverage).

The issue with Redwood Trust is that its income can be volatile due to changes in interest rates and loan defaults. That variability has forced the REIT to cut its dividend several times over the years:

RWT Dividend Chart

RWT Dividend Chart

RWT Dividend data by YCharts

The company most recently cut its payout in June by around 30%. In commenting on the reduction, CEO Christopher Abate stated, “We believe the Board’s decision to align the common dividend with our anticipated near-to-medium term earnings profile enhances our ability to capitalize on growth opportunities across our businesses and is supported by our robust liquidity position.” The company hopes those growth-related investments will drive higher returns so it can increase its dividend in the future. However, as the above chart shows, it has a spotty dividend growth record. Because of that, it’s not the best option for those seeking a sustainable and growing dividend.

The fuel to continue growing their dividends

Energy Transfer and MPLX have done a much better job distributing cash to their investors. MPLX has increased its payout every single year since it came public in 2012, including by 10% last year. While Energy Transfer hasn’t been quite that consistent, it has steadily increased its payout over the years, outside of a slight blip during the pandemic when it temporarily reduced its distribution to retain additional cash. It quickly returned its payout to its pre-pandemic level and has since resumed its growth.

Their stable and growing cash flows are a big driver of their steadily rising payouts. The pipeline companies generate lots of recurring income backed by long-term contracts and government-regulated rate structures. They typically distribute more than half of that cash to investors. They retain the rest to fund expansion projects and maintain solid balance sheets so they can make acquisitions.

Energy Transfer made two notable acquisitions last year. It also has a few billion dollars of expansion projects under construction (and several more projects under development). Those and future growth-related investments will increase the MLP’s cash flow. That rising cash flow fuels the company’s expectation that it can increase its 9.1%-yielding distribution by around 3% to 5% per year.

Meanwhile, MPLX has several expansion projects currently under construction that should come online over the next two years. It also has a very strong cash-rich balance sheet, giving it the flexibility to make acquisitions as opportunities arise. Those investments should grow its cash flow, giving it more fuel to increase its 9.3%-yielding distribution.

Go for the growing payouts

Redwood Trust has had trouble paying a sustainable dividend over the years. It has cut its payout a couple of times, including by 30% last year. While the company hopes that its latest reduction will enable it to retain more cash to fund growth-related investments so it can increase its payout in the future, that might not happen.

Because of that, income-focused investors should forget about Redwood Trust and consider Energy Transfer or MPLX instead. The MLPs offer higher-yielding payouts that they should be able to continue growing in the future. That should allow their investors to earn more income over the long term.

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Matthew DiLallo has positions in Energy Transfer. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Forget This 8.8%-Yielding Dividend Stock. Consider These Even Higher-Yielding Payouts Instead. was originally published by The Motley Fool

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