|
Published: October 9, 2009
How many companies have seen profits explode
+86% in the past three months? I've found a company that's
making a killing in today's economy. It's also selling dirt
cheap, at just seven times earnings.
Best of all, it's yielding a spectacular 17.7%
How can this be?
This company is invisible to most investors because it operates
in a sector few investors would even consider. This company's
business is at the epicenter of the financial crisis:
Mortgage-backed securities. These, as you will recall, are the
very financial instruments that brought the U.S. economy to its
knees.
In light of their nefarious role in the subprime debacle,
investors have a similar connotation "mortgage-backed
securities" as they have to "Hindenburg" or "black plague." This
negative association has kept most investors away -- and kept
this security at a rock-bottom price.
But there's a critical, and potentially lucrative, distinction
to be made.
It's simply this: Not all mortgages are subprime. And though
foreclosure rates are still high and the economy has been in
better shape, the fact remains that most mortgages are doing
just fine. Most borrowers are current.
The second point is who’s backing these securities. It used to
be Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE). Today,
it's Uncle Sam. That's right, a lot of mortgage securities have
been guaranteed by the U.S. government. Some people hear
"mortgage security" and they think "risk." But these
government-backed securities are actually no more risky than
Treasuries!
American Capital Agency
(Nasdaq: AGNC) is a real-estate
investment trust that invests in
mortgages. It invests in securities
issued by Fannie Mae, Freddie Mac
and Ginnie Mae. All of the
mortgage-backed securities it buys
are guaranteed by the federal
government. They carry an implied
AAA rating, meaning these securities
have essentially zero default risk.
American Capital borrows at low,
short-term rates and uses the money
to buy higher-yielding longer-term
securities. The difference between
the rate it borrows at and the rate
it invests at -- the "spread" -- is
its profit.
Today's spreads are wide. The
Federal Reserve, in an attempt to
stimulate the economy, has lowered
the discount rate from 2.25% a year
ago to just 0.50% today, making
short-term borrowing costs dirt
cheap. At the same time, a 30-year
mortgage is paying more than 5.0%.
Spreads just keep on rising. Rates
on long term mortgages increased
once again from the previous quarter
while short-term borrowing rates
fell even lower. American Capital
achieved a spread of 3.55% in the
second quarter versus 3.02% in the
first quarter and just 1.19% in the
fourth quarter from the previous
year. The asset yield for the second
quarter was 5.35% while the average
cost of financing was just 1.80%.
These ideal business conditions led
to a remarkable +86% surge in net
income last quarter. The company
earned $30.4 million compared with
$16.3 million in the first quarter,
or $2.02 a share versus $1.09 a
share.
Even though the price has surged
+31% so far this year, American
Capital still sells at a microscopic
seven times projected 2009 earnings.
But here's the best part. As a REIT,
the company is required to pay out a
least 90% of taxable income to
shareholders. Its rising profits go
right from the company's balance
sheet to your pocket.
AGNC pays quarterly dividends in
January, April, July and October.
Dividends vary with income. This
past year's dividends have ranged
between $0.85 a share to $1.50.
October's announced $1.40 per share
dividend gives the stock a trailing
twelve-month yield of 17.7%.
Inflation could spoil the party. In
order to fight rising prices, the
Fed might restrict the country's
money supply by raising short-term
rates. Higher short-term rates would
increase AGNC's cost of capital and
hurt earnings.
But inflation doesn’t appear to be
anywhere on the horizon at this
point. American Capital's prospects
for the near-term look bright as
spreads remain wide. As a matter of
fact, management at one of AGNC's
peers recently said that they
"expect the current favorable
conditions to persist for some
time."
A 17.7% yield won't last forever --
rising prices push down yields. But
right now AGNC is a great place to
park some cash to generate a rich
income stream and position your
portfolio for price appreciation as
well. -- Tom Hutchinson
Staff Writer
StreetAuthority |
