Why NCT Should be in Your Portfolio

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REITs are, by law, mandated to distribute at least 90% of their income every year, which is a big reason why REITs are preferred by income investors. However, besides handsome dividends, there are other reasons for selecting one to invest in, such as valuation and profitability metrics.

For example, Newcastle Investment (NYSE: NCT) has a dividend yield of 11.20%, which is in a medium range as far as REITs are concerned, and is still one of the most recommended REITs that you must have in your portfolio. Here's why.

Description of NCT

NCT is a real estate investment and finance company. The company is actively involved in the business of underwriting, acquiring, and managing real estate securities, including commercial MBS' (mortgage-backed securities), loans, excess mortgage servicing rights (MSRs), senior unsecured debt issued by REITs and securities, including sub-prime securities, backed by real estate. The company also provides and acquires loans to real estate owners, including B-notes and mezzanine loans, and acquires residential mortgage loans and manufactured housing loans.

NCT Dividend History and its Importance

The fact that REITs must necessarily pay 90% of their income as dividend to shareholders makes for a high dividend yield – it also brings uncertainty and a fair amount of volatility. Huge dividends are possible only when the REIT makes large profits, but there may be times when only small dividends are paid. In the event of a loss, the REIT obviously may not pay at all.

<img src="/media/images/user_14377/1_4_large.png" />

As we see, the dividend paid by NCT has been falling since 2007, and there was no dividend after October 2008 until June 2011. However, a long history of dividends means a lot if you look at it like this: if you had invested in NCT in October 2002 you would have probably paid something in the region of $13.05 per share. From October 2002 to date, NCT has paid a total dividend of $13.87.

Another way of looking at it: if you had invested $10,000 in NCT in January 2012, your annualized gain would have been 89.70% without reinvesting dividends, as shown in the chart here.

<img src="/media/images/user_14377/1_1_large.png" />

However, if you had reinvested your dividends, you would have gained 92.82% on your investment – see below.

<img src="/media/images/user_14377/2_large.png" />

NCT Financials

NCT has a market cap of $1.36 billion and an EPS of $2.71. At its CMP of $7.86, the price to earnings ratio is 2.90.

The company reported strong financial results in the third quarter 2012. Income available for holders of common stock rose to $272 million from $29 million in the same quarter in the previous year. This translates into a jump from $0.63 per diluted share to $1.63 per diluted share. Cash available for distribution in the third quarter was $36 million, compared to $21 million in the second quarter 2012.

Out of the $272 million, $43 million comprised of core earnings, $5 million was from sale of securities, and the remaining $224 million represented the profit from sale of the company’s CDO (collateralized debt obligation) interests.

Asset Portfolio

Besides a dividend history and improving financials, another reason why NCT offers a great opportunity to investors is the structure of its investment portfolio, despite a lower dividend yield compared to some of the other REITs.

<table> <tbody> <tr> <td> <p>Name of REIT</p> </td> <td> <p>Symbol</p> </td> <td> <p>Dividend Yield</p> </td> </tr> <tr> <td> <p><strong>Western Asset Mortgage Capital Corp</strong> </p> </td> <td> <p>WMC</p> </td> <td> <p>17.56%</p> </td> </tr> <tr> <td> <p><strong>American Capital Agency Corp.</strong> </p> </td> <td> <p>AGNC</p> </td> <td> <p>16.13%</p> </td> </tr> <tr> <td> <p><strong>ARMOUR Residential REIT, Inc</strong>.</p> </td> <td> <p>ARR</p> </td> <td> <p>16.00%</p> </td> </tr> <tr> <td> <p><strong>American Capital Mortgage Investment Corp</strong> </p> </td> <td> <p>MTGE</p> </td> <td> <p>14.86%</p> </td> </tr> <tr> <td> <p><strong>CYS Investments Inc</strong> </p> </td> <td> <p>CYS</p> </td> <td> <p>14.57%</p> </td> </tr> <tr> <td> <p><strong>Annaly Capital Management, Inc.</strong> <span class="ticker" data-id="204722">(NYSE: <a href="http://caps.fool.com/Ticker/NLY.aspx">NLY</a>)</span></p> </td> <td> <p>NLY</p> </td> <td> <p>13.51%</p> </td> </tr> <tr> <td> <p>Newcastle Investment Corp</p> </td> <td> <p>NCT</p> </td> <td> <p>11.20%</p> </td> </tr> </tbody> </table>

Source: www.goggle.com/finance

For example, as we discussed in a prior article on NLY, although it offers a better dividend yield than NCT, it is invested in mortgages, while NCT has a diverse portfolio. So, in this economy, NCT makes a sensible investment option. NCT invests in assets that provide long term cash flows, a strategy designed for reducing risk.

NCT’s real estate securities, including commercial mortgage backed securities and real estate asset backed securities including sub-prime securities, and Federal National Mortgage Association (FNMA)/ Federal Home Loan Mortgage Corp. (FHLMC) securities stood at 47.4% of its assets. 22.3% of its assets comprised of real estate loans, while residential mortgage loans were 9.1% of its assets. Operating real estate (acquiring and managing) assets represented 0.9% of its total assets, and excess mortgage servicing rights (MSRs) were 1.2%. (All asset allocations data as of December 31, 2011)

Asset portfolios of REITs have assumed greater importance in light of announcements by the Federal Reserve that it is speeding up its purchase program for agency mortgage-backed and intends to buy $40 billion a month. NCT’s diversified portfolio is not heavily inclined towards agency MBS' the way NLY’s and AGNC’s are. Increase in demand of agency MBS' will increase their price, translating into lower yield for the MBS holder. The least affected will be REITs like NCT that have a diversified portfolio of investments in real estate-related securities.

NCT Stock

NCT's shares saw some bad days after the financial crisis of 2007-2008 and fell $30 (February 2007) to below $1 (January 2009). But the worst is over and the stock is well on its way to recovery. YTD return to investors was 69.03%.

<img src="/media/images/user_14377/2_3_large.png" />

Source: www.google.com/finance

Stock movement of NCT also compares favorably with the REIT industry as a whole, as is evident in the following chart.

<img src="/media/images/user_14377/3_large.png" />

Source: www.tickertech.com

NCT is externally managed by its affiliate company Fortress Investment Group (NYSE: FIG) In the last six months there have been nine insider trades in NCT, two of them direct buys, mostly by directors, which indicates the belief of the management in the company and future prospects.

<img src="/media/images/user_14377/4_large.png" />


Strong third quarter numbers, a diversified asset portfolio, and faith of management in the company shown by high level of ownership of stock by directors and officers are indications that the stock can only go up from here. Long term investors are likely to get more than market average returns by investing in NCT at these levels.

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