The Fed's decision to start tapering at the December meeting was a good outcome for American Capital Agency (NASDAQ:AGNC). While many investors believe that higher interest rates are negative for AGNC, I believe this outlook is short sighted. It is a mutual consensus among almost all of Wall Street the Fed will stop tapering (or drastically reduce buying bonds) at some point in the future. Whether that point is six months or four years from now, it appears no one is sure. At that point, interest rates will almost undoubtedly be higher than they are today. Higher interest rates (once stabilized) will actually benefit AGNC. The higher interest spreads between the long-term interest rates and the short-term interest rates will be able to generate more money. Below is AGNC's goal:
The principal objective of AGNC is to preserve our net asset value (also referred to as 'net book value,' 'NAV' and 'stockholders' equity') while generating attractive risk-adjusted returns for distribution to our stockholders through regular quarterly dividends from the combination of our net interest income and net realized gains and losses on our investments and hedging activities.
Even though the fourth-quarter dividend has been cut again, management is still following their mission statement of trying to preserve the book value while still paying a dividend of more than 10%.
AGNC's stock price is unquestionably tied to its dividend and its book value. Based on the current dividend of $0.65, I believe the stock has room to go lower. The table below shows the lows (and subsequently the highest yields) of the last five quarters. The average yield has been 19.02%, which would be $13.67 per share. I don't see the stock price getting that far below book value, though. Based on this history, I could conservatively see AGNC going down to $16.77, which would be a 15.5% yield.
Even though the current quarter's dividend was only $0.65, the total gain could be closer to $0.98 per share. This is assuming management was able to weather the fourth quarter without a loss to their book value. At the end of September, the book value was $10,180,200,000 ($25.27 per share on 402.85 million shares). During the quarter, management spent $587,690,000 on buybacks ($20.84 per share on 20.8 million shares). This leaves 374.66 million shares left at a total book value of $9,592,510,000, which is $25.60 per share of book value. This is $0.33 more than the end of the third quarter. By buying back shares at a significant discount to book value management was able to increase the remaining book value per share.
Another reason I am confident in American Capital Agency's ability to make money in the future is because management is confident. The following is a quote from the Q3 2013 Shareholder Presentation:
While the short term outlook is difficult to predict, we do believe that asset positioning for the intermediate to longer term (2 -5 years) is more straightforward.
Gary Kain and other insiders have also made the biggest endorsement of the company they could; they risked their own money. Since Oct. 31, 2013, insiders have purchased 33,500 shares.
On the surface an 18.75% cut to the dividend would not seem like a good quarter, and by all accounts it probably wasn't. And while I think the stock will continue to fall (as far as $16.77) in the near term, I believe soon could be a good time to start accumulating more shares. By repurchasing 20.8 million shares in the quarter, AGNC is still following their core mission of trying to preserve book value while paying out a respectable dividend (more than 10%). My estimation is that by buying back stock under book value, the valuation of the remaining stock increased by $0.33. This, added to the dividend of $0.65, would give a total gain of $0.98 for the quarter. A gain of $0.98 per quarter at the current price of $19.12 would be an annualized gain of 20.50%, which is not nearly as bad a quarter as an 18.75% dividend cut sounds.