There are few stocks in the market that are more controversial or polarizing right now than Fannie Mae (NASDAQOTH:FNMA). With shares trading for much less than their pre-crisis value, many investors are tempted to scoop up some cheap stock with the hopes of a huge payday down the road. However, the road to profits won't be an easy one.
Here are some of the details of the love/hate relationship investors have with Fannie Mae stock.
Why investors love Fannie Mae stock
Basically, investors love Fannie Mae stock because it's cheap and has massive upside potential. At around $2.75 per share as of this writing, Fannie Mae trades for a small fraction of its pre-crisis share price.
And, the potential is enormous here. Currently under the conservatorship of the U.S. government, Fannie Mae could be worth much more than its current value if the company (and some of its profits) is returned to the shareholders.
In fact, hedge fund manager Bill Ackman, who is the single largest holder of Fannie Mae's common stock made a very compelling case that shares could be worth between $23-47 each if the company is allowed to build up its capital and investors were allowed to share in the profits., even after the dilutive effects of the government's 79.9% ownership stake are factored in.
Why investors hate Fannie Mae stock
The most frustrating thing for investors is that Fannie Mae is a profitable company and none of the profits are going to the shareholders.
Fannie Mae was hemorrhaging money during and after the financial crisis, and the agency was left for dead by most investors and market experts. However, over the past few years, Fannie has been earning a pretty nice profit. In fact, the company has paid the government back a total of $136.4 billion, or over $20 billion more than the original $116.1 bailout it received. So, why aren't investors getting paid?
Under the current terms of the conservatorship, 100% of Fannie Mae's profits are diverted straight to the U.S. Treasury as dividends. In other words, even though the agency has given the Treasury more money than it received, the original debt of $116.1 billion is and will remain outstanding.
Will investors ever get paid?
It's tough to say whether investors will ever see any profit from their shares, and it's probably more likely that Fannie Mae's stock price will eventually go to zero, which is why it trades as cheaply as it does.
That's not to say that investors don't deserve to get paid. It's tough to make the argument that they don't deserve to profit -- after all, many of them took a chance and bought shares when the company was losing money and looked to be on its way out. Now that Fannie Mae is making money again, shouldn't they get rewarded?
To try and correct this situation, several shareholders have sued the government to change the current arrangement, calling it an illegal seizure of profits. However, one judge has already sided with the government, saying that the shareholders' lawsuits have no merit. Some of the lawsuits are set to go in front of a different judge, and investors are hoping for a more favorable outcome.
So, it's an uphill battle to say the least, and even if investors win and are allowed to share in the profits, it is likely to take a long time to work its way through the legal system. Plus, don't forget about the ongoing effort by members of Congress to wind down the agencies entirely, which would likely wipe out current shareholders.
Is it a buy?
While the risk/reward might make sense here, bear in mind that Fannie Mae stock is akin to a lottery ticket. If the legal proceedings go your way, you could see your investment increase tenfold or more, but if not you could see the value of your shares evaporate. The takeaway is that investors should make sure that they fully understand the risks involved before considering an investment in Fannie Mae.
Matthew Frankel 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.