Stocks Fools Love: Redwood Trust

Redwood Trust (NYSE: RWT)
Trading at $56.89 as of 2/9/05

This article is part of our annual Stocks Fools Love Valentine's Day special.

" 'Tis better to have loved and lost than never to have loved at all" -- Alfred, Lord Tennyson

I have always had a soft spot in my heart for real estate investment trust Redwood Trust. Not because it has done such great things for my portfolio, but rather because I missed the opportunity to put it in my portfolio.

Redwood Trust invests capital in the jumbo home mortgage industry (loans greater than $359,650) in two ways. First, it buys loans from originators and collects the monthly coupon payments. Second, it credit enhances or supports pools of mortgages that are to be sold as mortgage backed securities, much the same way Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) do for the conventional mortgage loan market. As of Sept. 30, 2004, it owned $21 billion of jumbo mortgage loans and provided credit enhancement to $122 billion of loans. Redwood estimates that through those two services, it touches 8.4% of the estimated $1.7 trillion jumbo mortgage market.

So why do I love this company? Because it is very good at what it does. Plain and simple. Oh, and it doesn't hurt that its business model is completely scalable. Stated another way, the longer Redwood stays disciplined, the more loans it can own or enhance, the more money it can make.

And to show you that I am not just falling for a pretty face, here are some numbers to back up the claims. All data is per share unless noted.

	2001	2002	2003	2004	2005*
Standard Dividend	$2.22	$2.51	$2.60	$2.68	$2.80
Special Dividend	$0.33	$0.38	$4.75	$8.68	$3.05
Market Share	2.6%	4.6%	4.8%	8.4%

* estimate

Since 2001, its standard dividend has grown 6.5% per year. Its penetration rate has nearly tripled over the same time period, and it has had to pay special dividends to make sure all of the appropriate income goes to the shareholders. I like to think of this as underpromising and outperforming, but take heed not to rely on the special dividend.

So how did the company break my heart? Well, it didn't really. It was my own fault not to invest way back in 1998 at $10 per share. But I use this company and Best Buy (NYSE: BBY) to remind myself that one has to take advantage of great opportunities when they come in order to generate great returns.

But what about investing in Redwood today? Well, analysts are forecasting $2.80 for the standard dividend and $3.00 for the special dividend. At $57, that's a yield of 4.9% to 9.8% depending on the amount of the special dividend. The industry has grown between 6% and 10% per year historically, and given Redwood's reputation, it should be able to capture additional market share. So, we've got a growth company with an incredible yield. Who wouldn't love getting twice the bang for their buck?

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Fool contributor David Meier wishes you a Happy Valentine's Day and does not own shares in any of the companies mentioned. The Motley Fool has a disclosure policy.