Why Redwood Trust Shares Barked Loudly

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Redwood Trust (NYSE: RWT  ) , a diversified real estate investment trust that primarily invests in residential and commercial mortgage loans, vaulted higher by as much as 13% after handily topping Wall Street's estimates in the second quarter.

So what: For the quarter, Redwood Trust delivered a diluted profit of $0.71 per share, which was nearly triple the $0.24 per share it delivered at this time last year, and a clean $0.43 ahead of the Street's projections. Adding the biggest boost to its bottom line was net mortgage banking activity income, which totaled $59 million this quarter as compared to a loss of $4 million at this time last year. Redwood's book value also increased modestly to $14.69 from $14.54 in the previous quarter, but notably from the $12.00 in the second quarter of 2012.

Now what: As long as the Federal Reserve's monetary easing policy is still on the table and mortgage rates remain near historic lows, a REIT like Redwood that's primarily tied to residential and commercial mortgages should prosper. However, once the Fed begins paring back its monthly bond-buying program, which has kept rates artificially low, Redwood may see these gains slowly evaporate as rates rise and net margins tighten. At roughly 1.2 times book value and sporting a yield nearing 7%, I feel the company may be cheap enough to give investors some decent downside protection should lending rates turn against Redwood, and I would at least recommend REIT-savvy investors add it to their Watchlist.

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