Editor's Choice

Why This Election's Results Present a Buying Opportunity For These Stocks

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In case you haven’t heard, Barack Obama was re-elected President of the United States on Tuesday. Despite the talk that this election was neck-and-neck or “razor tight” since October, I noticed Obama had a distinct advantage in the states that mattered most. Nate Silver, a statistician and blogger for The New York Times, gave Obama a 90.9% chance of winning the election going into Tuesday. This estimate was based on polling data from around the country. Sure enough, Silver correctly predicted all 50 states, and Obama won the election. Apparently, Mr. Market thought the election was more of a toss-up and had some interesting reactions on Wednesday morning.

Mortgage REITs (mREITs) declined sharply across the board Wednesday morning, as fears that QE3 will continue into perpetuity with the Obama re-election. With share prices significantly depressed, this presents a buying opportunity for long-term investors looking for high dividend yields.

Annaly Capital Management’s (NYSE: NLY) new CEO, Wellington Denehan-Norris, said earlier this week that an Obama re-election would be bad for the company. She fears Obama’s Federal Reserve board will cause more “meddling” than Romney’s would have. In particular, she’s referring to the continuation of quantitative easing, the policy in which the Fed purchases MBS to drive down yields.

Certainly, in the short-term QE will have a negative effect on all mREITs. However, as housing prices continue to rise and the number of defaults falls, the book value of their holdings will surely increase. Additionally, QE3 is not going to last forever despite the nickname “QE-infinity.” When the program ends, long-term rates will rise and Annaly and friends will regain the spread they once enjoyed.

Overall, Annaly’s latest earnings report showed a lot of positive signs. Net income growth from the same period a year ago has far exceeded that of the industry as well as the S&P 500. The company maintained its high margins, and earnings showed quite a bit of improvement even with a decline in revenues.

Despite those numbers, the market pushed shares down on lower than expected EPS and a shrinking net interest spread. The significant drop in share price over the last few trading days now presents, what I believe to be, an excellent buying opportunity for NLY.

On the other hand, American Capital Agency (NASDAQ: AGNC) reported excellent earnings. Among other things, the earnings report indicated the company is prepared to buy back shares when the price is below book value. Interestingly, with the drop in price this morning, share prices are trading significantly below the company’s book value of $32.49.

The company also reported a great prepayment rate of just 9% and an interest rate spread that fell 13 basis points to 1.5%. These are industry leading numbers, and a great sign that the company has aggressively managed its portfolio of MBS. However, the company is deleveraging due to worsening rates, thus return on equity is falling.

Of course, the main reason investors buy mREITs is for dividends, not capital gains. Disappearing spreads and higher prepayment rates threaten to cut those dividends. mREITs make their money off of interest. If people are refinancing mortgages at lower interest rates, revenues and cash flows go down.

A dividend cut may be on the horizon for both Annaly and American Capital. Despite that, I still believe in the strong management from both companies to survive through tough times and flourish when interest rates pick up again. QE3 won’t last forever. Dividends may come down short-term, but will come back up along with interest rates. Yet, by that point, the buying opportunity may be gone. With both companies currently trading below book value it looks like a good time to buy.

Dig Deeper

Annaly Capital Management has a history of paying huge dividends to shareholders, made possible by borrowing at cheap short term rates and investing in longer term mortgage securities. But there are some things investors absolutely must know about Annaly’s business before buying the stock. In this brand new premium research report on the company, a Fool analyst runs through the dynamics of Annaly’s business, as well as the future opportunities and pitfalls of their strategy. Click here now to claim your copy.

adamlevy owns shares of Annaly Capital Management. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

blog comments powered by Disqus