With Invesco Mortgage Capital's (NYSE: IVR ) stock price up nearly 18% year-to-date, it's worth considering whether it's roamed into overvalued territory.
Since mREITs are asset-based businesses, looking at the company's price-to-book value can help answer this question. Essentially, this tells investors how much they're paying for the company's assets minus its liabilities.
On its own, however, knowing the company's stock price is trading at .93 times its book value isn't particularly helpful. So, instead -- and this is where valuation becomes more art than science -- think of price-to-book value as a starting point.
Then factor in additional variables: how it stacks up to similar companies, opportunities, risks, and the current investment environment. By doing so, we'll be able to determine whether Invesco Mortgage is over, under, or fairly valued.
Scouting the neighborhood
By comparing Invesco Mortgage's price-to-book value and dividend yield to similar companies, we can get a rough idea on how the company stacks up.
Compared to a few of the more popular mREITs, Invesco Mortgage falls somewhere in the middle on both price-to-book value and dividend yield.
Now that we know where the company stands, it'll take some extra digging to determine where it belongs.
Where's the opportunity?
Compared to similar businesses, few have as diverse a portfolio of investments as Invesco Mortgage. However, as CEO Richard King noted in the company's first quarter conference call, he is most excited about three asset classes in particular.
First is GSE credit risk transfers, which are debt notes backed by residential mortgages and secured by Freddie Mac. However, unlike most of Freddie Mac issued securities these assets do not come with a guarantee against default -- instead investors receive a higher yield.
Secondly, commercial loans, or loans to businesses for property. And third, jumbo prime residential loans, which are large (in principal value) residential mortgage loans with strong credit quality.
Over the last year the company has invested $2.5 billion in these three assets. Going from zero percent of Invesco Mortgage's total assets at the beginning of 2013, to 12% at the end of the first quarter.
As the chart below shows, all three assets generate a higher yield than the typical mREIT bread and butter investment of 30-year agency mortgage-backed securities. GSE credit risk transfers are within "nonagency".
|Company||Nonagency||Residential loans||Commercial loans||30-year agency mortgage-backed security|
Ultimately, I think the company's diversity, and it's pipelines for collecting these assets, give it a ton of opportunity to find attractive investments.
Weighing the risks
Over the last quarter Invesco Mortgage has made some significant moves to help protect their portfolio against risk.
This included diversifying its funding sources, which helps stabilize borrowing. Adding more adjustable rate mortgages, or ARMs -- because the interest rate on ARMs adjust based on prevailing rates it leaves the company less vulnerable to interest rates affecting the market value of their securities.
I also believe the addition of more jumbo residential loans, due to the high credit quality, is a more stable investment class.
With that said, Invesco Mortgage -- unlike agency mREITs like American Capital Agency -- does invest heavily in assets that are not protected against defaults. While mortgage defaults have been on the steady decline since the financial crisis, if that were to change it would have a damaging impact on the company's returns -- and should factor into the valuation.
Over the course of the year, interest rates have trended downward and housing prices have risen – lowering the likelihood of defaults -- and Invesco Mortgage has created a total return of roughly 25% year-to-date.
Considering interest rates will likely stay low for the next year or so, the housing market looks like it will continue to improve, and spreads – difference between short and longer-term interest rates – are still high compared to historical norms, things look good for mREITs.
Though, based on how important the investment climate is for mREITs, and how utterly unpredictable it can be, I think the uncertainty warrants a fair amount of caution.
Over, under, or just right?
Based on the steps taken to reduce risk, the current investment environment, and the company's diverse and unique array of assets, I believe Invesco Mortgage is slightly undervalued compared to its peers.
With that said, based on long-term environmental uncertainties I think the stock becomes less attractive above 1x price-to-book value. So, for investors interested I think now is the time to strike.
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