This Just In: Upgrades and Downgrades

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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.

Introducing the other mortgage crisis
It's starting to look like a good news, bad news kind of a week for shareholders of Annaly Capital Management (NYSE: NLY  ) . On the one hand, Barron's published a report Tuesday, reminding investors that "a rise in mortgage refinancings and bond prepayments, due to falling rates enabled by Fed policy and large Fed mortgage bond purchases, has left many agency [mortgage REITs] such as Annaly Capital Management and American Capital Agency Corp. (Nasdaq: AGNC  ) trading sharply lower than a month ago."

On the other hand, Sterne Agee pointed out Monday that Annaly shares were starting to look buyable, seeing as they now sell for less than book value. In no time flat, Annaly took Sterne's advice and announced it would buy back $1.5 billion worth of its own shares. Then, jumping on the bandwagon, analysts at Compass Point announced that they too think the stock is a "buy."

Good things come in threes
Compass says Annaly's worth at least "1.05x estimated 3Q12 book value per share," and the stock's "11.8% current dividend yield" only adds to Annaly's attractiveness. Factoring in an expected rise in book value going forward, Compass estimates investors can secure a 21% profit by buying Annaly shares today.

Why? The analyst acknowledges that "prepayment rates will increase in October and remain high throughout year end" (forcing Annaly to buy new securities, at lower interest rates, as the old ones get prepaid). However, Compass also argues that "QE3 will remain a strong ... bid for Agency MBS," providing Annaly a ready buyer for its primary asset.

Consistency is a virtue
Is Compass right? Investors in more than just Annaly should hope so, because as it turns out, Annaly isn't the only mortgage REIT the analyst supports with these arguments. Just this morning, in fact, Compass also endorsed shares of rival mREIT Capstead Mortgage (NYSE: CMO  ) -- and its reasoning should sound familiar: "Our price target represents a multiple of 1.05x estimated 3Q12 book value per share of $13.35 ... and represents a current yield of 10.3%."

Compass seems particularly excited about the potential for further share buybacks at Capstead: "Share repurchases are particularly attractive for mortgage REITs that trade at a significant discount to book value, face reinvestment ROEs below legacy portfolio ROEs and have not been frequent capital raisers. CMO meets all of these parameters..."

That said, not all mREITs are created -- or valued -- equally. What's true for Annaly and Capstead may not hold true elsewhere in the industry. For example, while Barron's is right about the decline in stock price at American Capital Agency, just because the stock is cheaper than it used to be, doesn't mean it's a bargain. To the contrary, according to the "1.05x book value" litmus test Compass seems to be following, American Capital is already fully valued at 1.11 times book (although its 15.6% dividend might still be enough to sway the skeptics). Rival Redwood Trust (NYSE: RWT  ) looks downright pricey at 1.23 times book, and pays one of the skimpier dividends in this group (7%).

Foolish final thought
Your very best bet, though, if you're looking to get ahead of the curve on the next analyst upgrade-induced stock price jump, may lie with ARMOUR Residential REIT (NYSE: ARR  ) . Arguably undervalued at 1.02 times book value, ARMOUR also pays a dividend nearly as rich as American Capital's -- 15.1%.

Annaly Capital Management has a history of paying huge dividends to shareholders. But there are some crucial issues investors have to understand about Annaly's business model before buying the stock -- before buying any mortgage REIT, for that matter. In this brand-new premium research report on the company, our analyst runs through these absolute must know topics, as well as the future opportunities and pitfalls of their strategy. Click here now to claim your copy.

Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 300 out of more than 180,000 members. The Motley Fool has a disclosure policy.

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.

Read/Post Comments (1) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 18, 2012, at 3:57 PM, billr861 wrote:

    Mr. Smith, by virtue of your own profile at MF you invest in, and I quote, " Companies with easy-to-understand business models, copious free cash flow, moderate to strong growth prospects, and minimal debt."

    MReits are extremely complex and, by definition of your own profile, ostensibly filled out by you, are way above your qualifications to discuss with ANY merit. Please find a way not to talk about stocks you know little or nothing about. Thank you.

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