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At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
How's this for bad timing?
The announcement on Marketwire sounded propitious. On Tuesday, Paragon Financial Limited released a report touting: "Diversified REITs have taken advantage of low borrowing rates, which are not expected to rise until 2014, to boost profits and provide high dividends. With interest rates and bond yields near record lows investors have flocked to REITs [such as] Chimera Investment Corporation (NYSE: CIM ) and ARMOUR Residential REIT, Inc. (NYSE: ARR ) ."
Ready for the punch line? Less than eight hours later, Chimera announced it was cutting its dividend for the second time in as many quarters (and the fifth time in two years). Over the past six months, dividend payouts have plunged more than 30%, from $0.13 to $0.09.
Wall Street's reaction was as swift as it was predictable -- no sooner had Chimera announced the cut than Credit Suisse downgraded Chimera shares to "neutral." Bank of America, meanwhile, lost no time in downgrading the stock all the way to "underperform" (aka "sell"). According to B of A, profits at Chimera are likely to "trend lower as CIM recognizes losses more aggressively in its subordinated-nonagency investment portfolio."
More importantly to investors, Chimera's probably going to have to cut its dividend even further, as income continues to decline. And the company's book value is also likely to slip below the company's currently claimed $3.03 per share, as even Chimera admits the true "economic book value" of the company is probably closer to $2.76.
What's it mean to you?
Many investors will tell you that Chimera is a bargain because it's selling for "just 0.84 times book value." Problem is, if this book value should happen to get written down, anyone trusting in it could have their legs cut out from under them. Meanwhile, investors who buy the stock based on its apparently high dividend yield risks similar disappointment as the dividend gets cut ... then cut again ... and again. Suffice it to say, these prospects don't exactly inspire confidence -- and not just for Chimera.
After all, while differences exist from REIT to REIT, Chimera's hardly unique. Plenty of other companies invest in mortgage backed securities -- ARMOUR, Capstead Mortgage (NYSE: CMO ) , Invesco (NYSE: IVR ) , and, of course, industry bellwether Annaly Capital (NYSE: NLY ) . But are any of Chimera's many-headed rivals at risk of similar downgrades?
Let's consider a few numbers and see if we can find a pattern:
|P/E Ratio||Price-to-Book Value||Dividend Yield||Dividend Payout Ratio|
As you can see, numbers vary widely within the REIT field. P/E ratios range from single-digit lows at Chimera, Invesco, and Capstead, up to the 30x P/E at Annaly. Dividends, too, while generous across the board, are far more so at Chimera and ARMOUR than at Capstead. Likewise, payout ratios -- the value of a firm's annual dividend as a percentage of annual earnings -- range from an even 100% at Invesco and Capstead, to ARMOUR and Annaly -- where payouts far surpass the earnings that support them.
It seems that the sole constant in this industry is price-to-book. With the sole exception of Chimera -- which is in the process of trying to fix a value on its assets, and publicly admits to an economic book value ($2.76) interestingly close to its share price ($2.62) -- all these companies trade for share prices within spitting distance of their reported book values.
Seems to me that what Wall Street's doing here is pretty clear. They're pricing REITs at book value -- no more, no less. Companies with suspect book values, like Chimera, get punished with low P/Bs. But even well-respected firms, like Annaly, get no premium to P/B assigned to their stock.
The logical conclusion is that any time in this environment that you see a REIT stock run too far ahead of its book value, chances are a downgrade is in the offing. Conversely, any time a company has suspect assets, its book value will be punished -- and the stock price can be expected to follow suit.
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