Buy, Sell, or Hold: American Capital Agency

When considering any stock for your portfolio, don't be swayed by just the positives. Examine its pros and cons, and decide whether it's possible upside outweighs its risks. Let's take a look at American Capital Agency (Nasdaq: AGNC  ) today, and see why you might want to buy, sell, or hold it.

Founded only a few years ago, in 2008, and based in Maryland, American Capital Agency sports a market capitalization of about $11 billion and is what many refer to as an mREIT, a real estate investment trust specializing in mortgage-related investments.

The stock has gained some 34% over the past year, leading some to wonder whether it's now overvalued, or if it might still be a smart buy.

Buy
One reason to consider investing in this company is its business model, which is rather light, though not without risks. The company employs leverage (i.e., borrows money) as it invests in (mostly government-backed) mortgage-related securities, profiting from a "net interest margin" -- the spread between the interest rates at which they borrow (which have been extremely low in recent years) and the rates at which they can lend. It's a beautiful system -- as long the right conditions are in place.

When assessing mREITs, know that they differ in how much leverage they use and what kinds of securities they invest in. Chimera Investment (NYSE: CIM  ) and Invesco Mortgage Capital (NYSE: IVR  ) , for example, are known for using less leverage, but investing in non-government-backed securities, while American Capital Agency, Annaly Capital Management (NYSE: NLY  ) , and Capstead Mortgage (NYSE: CMO  ) use more leverage and invest in less risky fare. It doesn't all necessarily even out, though -- those taking on more risk have performed the worst.

The most compelling aspect of American Capital Agency may well be its dividend, which is simply enormous, recently yielding 15.8%. Part of the reason for the hefty payout is the company's REIT status, which grants it tax exemption as long as it pays out at least 90% of its earnings in dividends. While companies don't like to reduce dividends, they sometimes have to, and even this hefty payout is actually lower than it used to be. American Capital's quarterly payout is $1.25 now, but was $1.50 back in 2009.

Other mREITs have cut back, too: Capstead Mortgage's (NYSE: CMO  ) quarterly payout has fluctuated, but it's down to $0.36 recently, from $0.59 in 2008. Annaly Capital Management's dividend went from $0.75 in late 2009 to $0.50 recently, while Chimera Investment's dividend has been halved between 2010 and 2012. Two Harbors Investment (NYSE: TWO  ) sports one of the lowest reductions, going from $0.40 to $0.36 recently. All of these companies still sport double-digit yields, though American Capital's is the steepest.

Sell
Since mREITs depend on their net interest margin, it deserves a lot of attention. Interest rates have been at or near record lows for some years now, but that won't last forever. If the housing market, which has been recovering lately, reverses course, that could hurt mREITs. Policy changes from the Federal Reserve, which influences interest rates, can also make a big difference. The Fed's "Operation Twist," for example, which is in effect at least through the end of the year, has the Fed buying long-term debt securities and selling short-term ones. This could squeeze net interest margins, as could its plans to not raise target interest rates until at least 2015 and its plan to spend billions on quantitative easing in the form of purchases of mortgage-backed securities.

My colleague Sean Williams isn't too worried about any immediate crisis for these companies, sensing that they still have a year or two in which to adjust their operations to meet upcoming challenges. Annaly, for example, was recently looking into expanding its scope via commercial real estate. However, my Foolish colleague Alex Dumortier notes several reasons mREITs are not the best kind of business. For example, they have very little in the way of barriers to entry, thus additional competition is always possible.

Finally, remember that the company's dividend, which has already been reduced, might be reduced further, making that 15.8% payout possibly too good to be true.

Hold (off)
Given the reasons to buy or sell American Capital Agency, it's not unreasonable to decide to just hold off on it. You might want to wait until its future seems clearer, or perhaps you might evaluate its peers to see if any of them seem more compelling.

The verdict
I'm holding off on American Capital Agency for now. I see plenty of opportunity in it, but also plenty of risk. Everyone's investment calculations are different, though. Do your own digging and see what you think. American Capital Agency may perform spectacularly in the coming years, but remember that there are plenty of compelling stocks out there.

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  • Report this Comment On November 26, 2012, at 12:05 PM, LarryECenter wrote:

    I think this is a kind of simplistic article. AGNC has multiple ways of fairly stabilizing itself in up or down interest rate environments. It's far from a perfect stock, but it's not, I think, going to go either up or down in dramatic ways.

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