1 Massive Dividend Payer's Bold New Plan

American Capital Agency has been buying millions of dollars' worth of its rivals' shares.

Feb 7, 2014 at 7:00AM

Knowing that American Capital Agency (NASDAQ:AGNC) reported a fourth-quarter loss of $0.28 per share on Monday practically guaranteed an especially interesting earnings call -- and that is exactly what investors and analysts got the following day.

Not only did President and CIO Gary Kain address the earnings issue, he also revealed a surprising new investment tactic: Instead of buying back more of his own company's stock or more mortgage-backed securities, Kain has been buying up the stock of his agency-only mortgage REIT competitors.

An outstanding opportunity?
Kain notedthat the volatility of 2013 took its toll on many mortgage real estate investment trusts, and changes made during the fourth quarter, such as raising leverage and increasing duration gap, are beginning to pay off this quarter. Another good sign is that the current tapering of the Federal Reserve's quantitative easing program finally appears to be baked in. In Kain's opinion, 2014 should represent much smoother sailing for mREITs.

Perhaps this explains American Capital Agency's new stock-purchasing scheme. After all, if a stock is trading at a discount, and it looks like a turnaround is imminent, how can you lose?

The line of reasoning makes sense. As Kain explained on the conference call, the value of the agency REITs themselves dropped more quickly than that of the portfolios they held. Noting American Capital Agency's own price-to-book ratio of 81%, Kain inferredthat stock buybacks are a no-brainer.

Applying Kain's logic to other agency mREIT stocks -- some of which have been trading even lower than American Capital Agency -- it stands to reason that they, too, would be a good investment.

While Kain demurred when asked which agency mREITs were the object of his investments, both Armour Residential (NYSE:ARR) and Anworth Mortgage (NYSE:ANH) were discounted by about 30% last quarter and certainly would have fulfilled Kain's bargain-hunting criteria.

It's all about value
American Capital Agency bought roughly $400 million of other mREITs' stock by the end of January, with $163 million of the spending spree taking place in the first quarter. The company also repurchased $600 million of its own shares in the last quarter of 2013.

When questioned about this strategy, Kain noted the company is dedicated to bringing the best returns possible to its shareholders while investing in the mortgage space. Therefore, it makes more sense to sell mortgage-backed securities at full price, then purchase competitors' stock at a minimum 20% discount -- creating a sort of indirect MBS investment, on the cheap.

That's hard to argue with, but KBW analyst Michael Widner made a couple of valid points regarding investors. He highlighted that by buying other mREITs' stock, Kain to some degree is taking a choice away from his investors -- who, after all, are investing in American Capital Agency, not its rivals.

Secondly, Widner opined that such a strategy changes the risk profile, adding in an unknown for both investors and analysts. How can Kain know how the other mREITs' managers are handling their own portfolios?

Only time will tell if Kain's innovative investment plan pleases investors or puts them off. Following the conference call, American Capital Agency's stock rose despite the somewhat lackluster earnings report. Gary Kain just might be on to something.

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Amanda Alix has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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