Stock traders that get their investing advice on Reddit are still looking for the next Gamestop moon shot. One company that has been in some of the discussion lately is Invesco Mortgage Capital (IVR +0.60%). The company's stock price jumped 15% earlier this month on hopes of a short squeeze.
Veteran stock investors have learned that betting on short squeezes is generally a long shot. Most investors are far better served by buying stock in strong companies with great fundamentals.
Mortgage REITs have a different business model
Invesco Mortgage Capital is a mortgage real estate investment trust (REIT). Unlike most REITs, which invest in properties and then rent them out, mortgage REITs invest in real estate debt; in other words, mortgage-backed securities and similar assets. These companies resemble banks more than they resemble a mall REIT or office REIT. They borrow money (similar to the way banks take deposits) and then buy mortgage-backed securities (similar to the way banks make loans).
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Invesco Mortgage Capital focuses primarily on mortgage-backed securities which are guaranteed by the U.S. Government. The company also has a portion of its investment portfolio (about 8%) in non-guaranteed mortgage-backed securities. The weighted average yield on the portfolio is 1.95%. Invesco Mortgage borrows money at about 0.15%, so its net interest margin is 1.8%.
Invesco Mortgage Capital had a near-death experience
Mortgage REITs generally make money gradually, although they can lose money quickly as we saw last year around this time. In 2020, when the country went into a pandemic-induced economic lockdown, the mortgage-backed securities market froze up. Mortgage REITs were hit with margin calls, and many were forced to liquidate large portions of their portfolios at fire-sale prices.
Invesco Mortgage Capital was one mortgage REIT that was affected particularly hard and ended up entering into a forbearance agreement with its creditor banks. While it was able to emerge from forbearance, the cost was a major curtailment in its business activities.
Invesco Mortgage Capital is a completely different company now
Invesco Mortgage Capital entered 2020 with $22.3 billion in assets and $2.9 billion in equity. It exited 2020 with $8.6 billion in assets and $1.4 billion in equity. Invesco Mortgage sold off its entire $8.6 billion commercial mortgage-backed securities (CMBS) portfolio. These are mortgages made to institutions to buy buildings, not to individuals to buy a house. During the credit crunch in the early days of the pandemic, these CMBS were highly illiquid. Invesco Mortgage decided to focus its portfolio on government-guaranteed mortgage-backed securities, which recovered the fastest during the early days of the pandemic.
Invesco Mortgage Capital is a vastly different, and smaller, company than it was when it entered 2020. In February of 2020, the stock was four times higher than it is now. Since mortgage REITs generally trade based on book value per share and dividend yield, it will take years to build back up to those levels organically. Invesco Mortgage is trading above its book value per share of $3.65 per share as of March 31, 2021.
Investors hoping for a short squeeze in the stock will probably be disappointed. The company has been issuing stock, and the fundamentals of the business don't lend themselves to a fast-growth story. If anything, Invesco Mortgage Capital is a much more conservative company than it was a year ago, and as a general rule conservative business models emphasize increased safety over faster growth. Invesco Mortgage Capital should be bought based on its 8.8% dividend yield, not on hopes that it will quickly become a $16-a-share stock again.
