From a purely business perspective, stock market investing is a risky endeavor. But as investors, we can mitigate much of the risk by analyzing the companies and industries in which we invest and taking a conservative approach. In other words, we can bring a certain level of predictability to an unpredictable market.
However, when the government gets involved and business starts bumping against politics, predictability flies out the window altogether. That's why these three stocks are some of the riskiest in the financial sector.
Fannie earned $4.6 billion, easily outpacing the $3.7 billion net income from the 2014 second quarter and crushing the $1.9 billion it reported for the first quarter of 2015.
The story was much the same for Freddie, which reported $4.2 billion in net income in the second quarter of this year, versus $1.4 billion in the year-ago period and just $524 million in the 2015 first quarter.
The risk for investors of Fannie and Freddie, though, has nothing to do with how well the companies are doing financially; they're both making a ton of money. The risk has to do with politics.
Currently, Fannie and Freddie are about 80% owned by the U.S. government, which isn't automatically a problem for the other 20% of ownership.
However, under the current ownership structure, Fannie and Freddie are required to pay 100% of their earnings directly to the Treasury Department as dividends. That leaves 0% of earnings left to be paid to the private sector ownership. That's a problem for private investors, but it only scratches the surface of the risk involved with investing in these two mortgage giants.
Both companies got to this point after requiring bailouts during the financial crisis. Since then, various political powers have proposed all sorts of ideas and legislation on what to do with them, some of which involve dismantling the companies entirely. Congress being Congress, there is absolutely no way we can know what Fannie and Freddie will look like in the future.
They could be returned to the private markets and freed from their dividend obligation to Uncle Sam. Or, just as likely, they could simply cease to exist. Or perhaps there is some middle ground.
The outcome, however it ends up, has as much or more to do with politics than it does economics, markets, or business. Warren Buffett has said that he likes to invest in businesses that will be around for 100 years or more. Fannie and Freddie, despite their billions in earnings, may not be around in five years. Or maybe they will.
Springleaf Holdings Inc.
The stock of subprime lender Springleaf Holdings (UNKNOWN:LEAF.DL) has been on an absolute tear so far this year, up 29% year to date.
The main driver of that increase is the planned $4.25 billion acquisition of OneMain Financial from Citigroup When the deal was announced on March 3, the stock rocketed up over 30% on the news.
However, thanks to an antitrust review initiated by the Department of Justice, the deal looks like it may be in jeopardy. For investors, that means all of this year's market gains could be on the verge of retreat.
The acquisition of OneMain would double Springleaf's customer base from 1.2 million to 2.5 million. The company's branch count would skyrocket from around 830 branches to over 2,000. Springleaf even issued new shares to raise $974 million to help fund the deal. Now, all of those positives for the company could go away.
With antitrust reviews such as this one, there are several possible outcomes. On the one hand, the Department of Justice could sign off on the deal as is, although that seems unlikely in this case. On the opposite end of the spectrum, the DOJ could nix the deal entirely as it essentially did recently when Comcast attempted to acquire Time Warner Cable.
In my view, the most likely outcome is that the DOJ will allow Springleaf and OneMain to merge, but it will require the new combined company to sell off some assets, branches, and market share. That's positive in that the deal can go through, but its risky for investors in that there's no way to predict exactly how the new company will look until the DOJ finishes its review.
To me, Springleaf's gains so far this year look fragile. If the market was willing to push the stock so high, so fast based on the acquisition, it seems highly likely that the reversal could be just as fast and just as big if the DOJ materially changes the merger.
Play the odds, but don't speculate
For all of these companies -- Fannie, Freddie, and Springleaf -- the risks really have nothing to do with their underlying businesses. Fundamentally, all three in fact look fairly strong.
The problem, though, is that with the government's involvement in each scenario, it is impossible to predict what will happen for each company. Worse than that, it's impossible to even put odds on the various outcomes.
Investing is as much art as it is science, but in these three situations, it's neither. For these three companies, it's more like playing darts in a pitch black room.