With interest rates at all-time lows, investors are hard pressed to find investments that can provide regular income. The high 5%-yield savings accounts of the 1990s are long gone. Today, investors have to think outside the box. Real estate investment trusts (REITs) typically have the sort of high dividends investors are looking for. In order to qualify as a REIT, a company has to meet certain parameters. It has to invest at least 75% of its total assets in real estate, earn at least 75% of its income from rents or interest on property, and distribute at least 90% of its taxable income to its shareholders as dividends.
Armour Residential REIT (ARR) is Maryland-based real estate investment trust that invests primarily in mortgage-backed securities issued by or guaranteed by government entities such as Fannie Mae, Freddie Mac, and Ginnie Mae. According to its website, Armour Residential REIT is managed externally by Armour Residential Management LLC, and it generates returns outside the returns available on its mortgage assets by leveraging its mortgage investment portfolio with borrowings that are usually short term and secured by the company's investment securities.
Earlier this year, Armour Residential announced a secondary share offering of 22 million shares. It also gave underwriters a 30-day option to purchase up to 3.3 million additional shares. According to the press release announcing the sale, the company "intends to use the net proceeds of the offering to acquire additional agency securities as market conditions warrant and for general corporate purposes." Then, in March, the company announced an underwritten public offering of 31 million shares with a 30-day option to purchase up to 4.65 million additional shares, again citing that it "intends to use the net proceeds of the offering to acquire additional agency securities as market conditions warrant and for general corporate purposes," as the reason for the offering.
In addition to the frequent stock offerings, Armour Residential offers something incredibly unique: It pays a monthly dividend. Granted, its dividend recently decreased from 12 cents a month to 11 cents, but a monthly dividend is pretty sweet. Given Armour Residential's recent trade price of just under $7, investors buying in now would only have to hold on to their investments for 62 months to get back their entire investment in dividends -- assuming that the dividends remain constant and not excluding any tax liabilities or fees. Alternatively, reinvesting them would mean that you would be able to double your total shares in less than five years.
The company's income is strong, but it is lacking in a lot of other areas. It has a very high debt-to-equity ratio, at 8.52, and its return on equity was negative at the end of the fourth quarter 2011, at -1.51%. Armour Residential has had a strong net income increase, going from $7.39 million at the end of the fourth quarter 2010 to $23.71 million at the end of the fourth quarter 2011, but the company still reported reduced earnings of 2 cents a share in 2011 vs. 56 cents a share in 2010. Earnings expectations for this year are high, at $1.19 a share, but its numbers do not reflect that. So far this year, Armour Residential has remained flat after returning 8.56% in 2011.
The company has an extremely positive relative valuation. Right now Armour Residential is priced at 5.50 times its forward earnings, vs. 52.91 for its peers, and 1.04 times its book value, vs. its peers' average of 2.92. But I think the reason the company is priced so low is because its earnings expectations are low, rather than that it is priced artificially low. Analysts are estimating that the company's earnings will increase by just 2% a year on average over the next five years, vs. 12.91% for its peers. Annaly reported earnings of just 49 cents a share for 2011, down from $1.90 the previous year, but by all accounts the company's earnings are expected to be $1.94 a share for 2012.
Overall, I think Armour Residential is an OK pick. However, competitor American Capital Agency (AGNC) also looks good. American Capital recently traded for $30 a share with a $5 dividend (16.70% yield). It is priced at roughly 6 times its earnings and 1.08 times its book value. Analysts estimate that American Capital's earnings will increase by an average of 2% per annum over the next five years. The company has attractive valuation levels, strong revenue growth, and expanding profit margins. On the down side, its earnings per share fell from $7.55 in 2010 to $5.22 in 2011, and it has a high debt-to-equity ratio of 7.68, which is marginally lower than Armour Residential's.
I also like real estate investment trust Annaly Capital Management (NLY) better than Armour Residential. It is trading at a little under $16 a share and pays a $2.20 dividend (14%). Unlike Armour Residential, Annaly Capital's disbursements are quarterly. Annaly Capital is priced almost as low as Armour Residential at 7.60 times its forward earnings, and it is actually low-priced with regard to its book value, at just 0.98. Furthermore, while Annaly's earnings growth estimate is just 3% a year on average over the next five years, it is 50% higher than Armour Residential's earnings growth estimate.
Armour Residential, American Capital, and Annaly Capital each have attractive valuations, trading at roughly 7 times future earnings and about 1 times book value. Also, the dividends are there, which is of course a draw -- but I think higher earnings growth is the key here. If a real estate investment trust's main claim to fame is its high dividend payout, and that payout is based on its income, you want a company with income that is growing -- the more the better. Annaly fits that bill and it gets my vote as a result.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
