Published: September 15, 2010

A 10% yield is high in any market. In today's market, it's stratospheric. The S&P 500 is only yielding 2% and a three-year CD currently pays about 1.77% on average.

Is a 10% yield too good to be true?

Often it is. A yield that high usually just means that the stock price has plummeted because of deteriorating earnings and fundamentals. But, could there be 10% yields out there with strong earnings and fundamentals behind them? If so, they are a tremendous find in today's flat markets. After all, a 10% yield not only provides an income but also gives investors a +10% return per year, even if the stock price does nothing. That beats the S&P 500's return during the past 10 years by about 11% per year.

There are special risks and opportunities associated with these high dividend payers. But, here are three high yielders worth a second look.

PennantPark Investment Corp (Nasdaq: PNNT) is an interesting high yield play from the world of business development companies (BDCs). This company makes money by finding promising medium-sized private companies in need of capital and loaning them money at high rates of interest.

BDCs are strong dividend payers because they do not pay income taxes at the corporate level. PennantPark has paid steadily rising quarterly dividends since its IPO in 2007 and the last payment increased in April to $0.26 per share. At the current rate, the stock yields a not-too-shabby 10%.
Can the company keep it up?

Lately, PennantPark has been raising money to grow earnings in the capital markets. A recent offering of 4.6 million shares diluted existing shareholding by about 14.6%. That means the BDC has to pay out 14.6% more in dividends just to maintain the current one.

But the company might be able to pull it off. Prior to this latest offering, PennantPark has issued stock in the past year that had diluted shareholdings to the tune of 50%. But the BDC has managed to use the money raised to generate returns sufficient to pay the extra dividend. In the third fiscal quarter (June), net investment income (from which dividends are paid) increased +56% from the year ago quarter to $8.9 million.
 

Pennant Park should be able to earn sufficient income to maintain the dividend if demand for new loans remains fairly strong in a decent recovery. However, if the economy falters, the dividend may well be cut. The stock and its mouthwatering dividend is primarily a play on recovery at this point.

IncrediMail Ltd. (Nasdaq: MAIL) is an Israel-based company that develops software for customized email and other personal desktop applications used to generate Internet search-related revenue. The company pays two dividends a year. The last dividend, paid in April, was $0.43 a share, and the next dividend, to be paid in October, has been declared at $0.45. The two dividends of $0.98 give the stock a huge trailing yield of nearly 15.0% at current prices.

IncrediMail sells personal desktop software in more than 100 countries and has contracts with Google (Nasdaq: GOOG) and InfoSpace (Nasdaq: INSP) to share in Internet search revenue. The company has been having solid success. Revenue increased +8.3% ($14.2 million) in the first half of 2010 compared to last year's half, and net profit was higher by +15% over the same period.

While IncrediMail has a policy of paying out at least half of net income in dividends, it's been paying out nearly all of it. In the first half of the year, the company paid $0.45 based on net income of $0.46 a share. However, the company has a cash cushion of about $11.3 million (the second half's dividends totaled $4.4 million) and has no debt.

Annaly Capital Management (NYSE: NLY) is a New York City based real estate investment trust (REIT) that invests in a portfolio of mortgage securities backed by government sponsored entities (GSE) like Fannie Mae and Freddie Mac. The company borrows funds at lower short term rates and invests those funds in higher paying mortgage backed securities, thus making profit on the spread.

In the second quarter, Annaly's earnings took a hit. Core earnings were $0.59 a share, compared to $0.66 a share in the year ago quarter. The primary reason for lower earnings was higher prepayment caused by the government's program to buy back loans more than 90 days delinquent. Annualized prepayment rates at Annaly rose to 32% from 19% a year ago. Annaly was unable to invest the money at comparable interest rates and, as a result, average yield on assets dropped as did the REIT's spread and profits.

Including the declared October dividend of $0.68, the last four quarterly dividends have totaled $2.76 a share, which translates to a remarkable 15% yield at current prices. The company did pay slightly more in dividends than it earned in the second quarter, but the government program ended in June, and results are likely to improve.

The main danger to this dividend is rising interest rates. The company makes profits on the spread, which is directly affected by its cost of borrowing. However, higher interest rates don't appear on the horizon at this point.

Action To Take --> Any stock yielding as high as 10% will carry a fair degree of risk. For the more aggressive part of an income portfolio, investors can consider Annaly in the short term and IncrediMail and PennantPark for longer term.

-- Tom Hutchinson
Staff Writer
StreetAuthority