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Company Profile

American Capital Agency (NASDAQ:AGNC) is a mortgage REIT. This label is simply a taxation designation for a corporation or company that is involved in real estate investment. In other words, this designation allows the reduction or elimination of corporate tax charged to the company. However, being an REIT, AGNC has a responsibility to distribute at least 90% of all the taxable income that the company earns in a given period to its investors, which is usually at the close of a quarter, calendar year, or fiscal year. Like any REIT, AGNC owns and operates several real estate units that produce revenue or income for the company and its investors. Among the mortgage-backed securities that the company is investing in are agency-resident, pass-through certificates, as well as collateralized mortgage obligations. Both of these securities, as their names suggest, are collateralized by various pools of different FRM or fixed-rate mortgage loans, as well as adjustable-rate mortgage or ARM loans, and even a combination of the two.

Stock Performance and Competitors

In terms of market capitalization, AGNC is not the leader in the industry. It is, in fact, just behind Equity Residential (NYSE:EQR), which ranks first, and Avalon Bay Communities (NYSE:AVB). This is because AGNC is short by 36% and 16% of the market capitalization of EQR and AVB, respectively.

Indicator

AGNC

EQR

AVB

Industry Average

Current Price

$30.8

$54.7

$130

-

Market Capitalization

$10.5 bil

$16.5 bil

$12.6 bil

$3,430M

FFO per share

$12.97

$2.42

$4.60

$2.32 (apartments)

P/B Ratio

1.0

2.8

2.7

1.8

Dividend Yield

15.2%

2.9%

2.9%

6.3%

Return on Equity

8.4

9.8

14.1

6.5

On the one hand, currency price levels of the three stocks show a significant disparity. AVB seems to be overpriced, giving it a superior market capitalization to that of AGNC. Nevertheless, the current valuation of AGNC stock is still more than double that of EQR, and four times lower than that of AVB. On the other hand, their market capitalization shows that all three companies are above the industry average of $3.45 billion.

Further, looking at the Funds from Operations (FFO) of the companies is essential when assessing REITs. This is because FFO evaluates the capability and potential of the companies to generating cash from their existing properties. FFO excludes cash from acquisitions or selling assets. As shown in the table above, AGNC's FFO per share in 2011 is far superior to that of both EQR and AVB. AGNC's $12.97 FFO per share is also higher than the sector average (apartments) for both EQR and AVB, which stands at $2.32. However, investors should be cautious when comparing these companies side-by-side in terms of FFO indicators, because although these three companies withal operate in the same REIT industry, they are in separate sectors within in. AGNC is in the home financing category, while both EQR and AVB are in the apartment sector.

Its P/B Ratio of 1, on the other hand, suggests that its assets are fairly valued. The ratios for EQR and AVB tell us that the stocks are currently overvalued. Now, these are extremely valuable indicators when assessing the future potential of these stocks. As a general rule, in purely a competitive market, an overvalued stock tends to face a downward correction in the immediate future, which will probably result in its stock price to going down. Nevertheless, combining this ratio with the ROE of these stocks would guarantee stability for investors, because the ROE of these three stocks are still higher than the industry average of 6.5.

Furthermore, the dividend yield of AGNC and its competitors would summarize the other indicators above. A 15.2% dividend yield for the AGNC stock, which is significantly higher than the 2.9% of EQR and AVB, respectively, suggests that AGNC is worthy of an investor's bet.

What Does The Future Hold?

There should always be a wider outlook when it comes to assessing stock. It is in this light that we will compare the movement of AGNC against the real estate industry as a whole. In the short run, there might only be a few shaky movements on this stock and the industry in general. However, there are some reports predicting that the mortgage industry will behave as follows in 2016 and beyond:

  1. The United States will face shortages in housing and elevated demand;
  2. There will be major changes in participation in the industry due to consolidations and production efficiency factors;
  3. Government-sponsored enterprises or GSEs will prevail;
  4. Vanilla mortgage, or FRM loans, will be less prevalent; and
  5. Transactions will be forced into streamlining, modernization and greater efficiency.

With the above predictions on the future trends of the mortgage and real estate market, investors should be better prepared for whatever position they adopt for their investment. While these are mere predictions, it does no harm for a trader to prepare, just in case these forecasts come true.

However, there are also some reports suggesting that AGNC is not stable in the short or long run. This is because of its restricted characteristic, which limits its investment to government mortgage-backed securities (gMBS) only. This is in contrast to the flexibility of most other REITs, which earn income from various sources.

Make or Break for Investors

Deciding whether or not to invest in AGNC would depend on various factors. Investors who value a high return on their investment would surely choose AGNC over EQR or AVB. It is among the top five companies for dividend yield, and one of the few stocks with a double-digit yield.

A discounted-earnings-plus-equity model, developed by Efsinvestment and applied to AGNC, suggests that the company is presently trading at a discount. EFS's fair stock price valuation indicates that currently undervalued AGNC stock has at least 11% upside potential to reach its fair value.

AGNC is also a good buy because its sources of income, though limited, are somewhat secure and guaranteed. So, it would also be a good option for investors who value security of earnings more than anything else. After all, being an REIT guarantees that at least 90% of its income will be remitted to its investors.

For the medium and long term, however, both EQR and AVB would be good alternative investments. After all, they are more flexible and aggressive in generating income, since they are not limited to gMBS.

Source: What Lies Ahead For American Capital Agency And The mREIT Industry?