While reviewing REITs and comparing stats, I noticed one I was reviewing had an incredibly low cash flow per share relative to the others, and decided to take a closer look to see what was going on with ARMOUR Residential REIT (ARR). Investing in hybrid adjustable rate, adjustable rate and fixed rate residential mortgage-backed securities issued by or guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae is the company's focus. But why is it so different from its peers?
ARMOUR is currently showing a cash flow per share of only .18, giving a relatively poor level of strength for the firm. The price to cash flow ratio (dividing the stock's share price by the cash flow per share) then inflates to 38.30, hinting at expectations from the market for its financial health, and its price to earnings ratio is negative (indicated as non-applicable). I'm going to compare ARMOUR Residential to four other REITs to see what the picture looks like for them as well.
Analysts are predicting a couple of bad quarters before ARMOUR Residential will be able to turn itself around; by this time next year it's poised to be ahead in earnings per share by quite a bit, but not nearly as much as the industry. This seems in sync with overall predictions for the economy, as post-election seems to be the time to be looking at.
American Capital Agency (AGNC) is a REIT formed in 2008, and specializes in US government-backed RMBS, with a less extreme cash flow per share of 3.37, price to cash flow ratio of 8.90, and price to earnings ratio of 5.99. CYS Investments (CYS), investing in government-backed residential mortgage pass-through securities, reads a bit lower than American Capital with a 2.61 cash flow per share, 5.10 price to cash flow ratio and earnings ratio of 3.60. With its initial public offering in 2009, analysts are not giving their opinions or estimates for CYS at this point.
Invesco Mortgage Capital (IVR), another mortgage REIT, handles both government-backed (RMBS) and non-government-backed residential and commercial mortgages. Its cash flow per share is slightly lower than CYS Investments at 2.44, and its price to cash flow is higher than CYS at 6.90, and its price to earnings ratio also higher at 5.20. Analysts aren't estimating growth in the black until next year, and only by a few percentage points; the next three quarters are in double-digit negative growth. Also a REIT that invests in government-backed RMBSs, especially pass-through securities, Hatteras Financial (HTS) was formed in 2007. Most closely resembling American Capital, Hatteras Financial's cash flow per share is 3.69, the price to cash flow ratio is currently 7.70 and earnings multiple is slightly higher at 7.10. Also like American Capital, these are not analyst estimates for this coming year, only for the past year.
Comparing price to cash flow ratios for the industry ratio of 63.70, ARMOUR Residential is less than two-thirds of the industry, which could be construed that the industry is overvalued. But its non-applicable (negative) price to earnings ratio is further stunted by the industry's earnings ratio of 72.90. Certainly these comparisons indicate that ARMOUR's current prospects are not as promising as the industry average, and could be risky.
American Capital's cash flow ratio is not as inflated-appearing as ARMOUR's, nor are the price to cash flow ratios of CYS Investments, Invesco Mortgage and Hatteras Financial. This could result in looking at these four as safer REIT investments than ARMOUR Residential. The earnings multiple of between around 4 to almost 8 for the non-ARMOUR REITs again, relative to ARMOUR's negative price to earnings ratio implies better future performance for those four REITs.
However, something else needs to be looked at regarding the industry numbers. Upon closer inspection, it's noted that the REIT - Residential industry numbers are much higher than the financial sector in general. Half the companies in the industry have price to earnings ratios of not-applicable, and are listed as such instead of any negative number they each represent. This would cause the average number to be higher than a true average of all actual numbers.
Also, there are a handful of REITs that each have an enormous, three-digit earnings multiple, the highest being Colonial Properties Trust (CLP) with a ridiculous price to earnings ratio of 535.00! Naturally, a couple of REITs with such a large number will also make the average so much higher, and much less achievable. And, of course, price to earnings ratios are created from numbers that are easier to "re-state" than cash flow numbers.
Another factor for all of these REITs is that they were founded (or in initial public offerings) between 2007 and 2009. They have mostly existed only during a recession, and performance outside of the recession is yet to be determined. Also, the relatively short time they have existed means there is not as much analyst attention on them yet, and if there is an analyst opinion or two, there is not likely enough balance from others to paint a more complete picture. Some were only followed by more important analysts during this past year. If they lose a lot of money they'll get some attention; if they gain their holders some real money they will garner even more.
With all of these variables, it would appear that ARMOUR Residential needs to "get on the board" with a positive price to earnings ratio so it can be more accurately compared to its peers. But with the residential REIT industry so wild itself, it may be that ARMOUR is not the long-shot it appears to be. I don't think anyone is betting on residential sales to be recovering at a fast pace, but it does seem considerably more likely than commercial, and these companies have made it so far only in a bad economy - another reason not to take a single valuation ratio at face value. I am not writing off ARMOUR Residential or the other REITs at this time. I think there is significant value here.