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On Tuesday, September 11th, analysts at ISI Group upgraded shares of Equity Research (EQR). The firm raised its rating on the stock from a Hold to a Buy and set a $65.00/share price target. An analyst upgrade can mean great things for a stock, but in the wake of EQR's upgrade, I wanted to highlight some of the negative catalysts behind my decision to avoid a position in the company, and take a position in three alternatives that could certainly enhance any portfolio.

Overview

Equity Residential, based in Chicago, Illinois, a real estate investment trust (REIT), engages in the acquisition, development, and management of multifamily properties in the United States. As of December 31, 2007, it owned and invested in 579 properties in 24 states and the District of Columbia consisting of 152,821 units. The company qualifies as a REIT for federal income tax purposes. As a REIT, it would not be subject to federal income tax to the extent that it distributes at least 90% of its taxable income to its shareholders.

Profit Margin Comparisons

In my opinion, the larger the profit margin, the more attractive the company, and the smaller the profit margin the more potential investors should be wary of a position in the company. In the last 12 months, EQR has demonstrated a profit margin of just 21.71%, and even though a profit margin that high would normally be an attractive variable, in the REIT sector it's actually quite low when compared to some of the companies in the sector. For example, Annaly Capital Management (NLY) has demonstrated a profit margin of 50.98%, Chimera Investment Corp. (CIM) has demonstrated a profit margin of 90.42%, and American Capital Agency (AGNC) has demonstrated a profit margin of 87.94%, all three of which were over the same 12 month period as EQR.

By examining the numbers closer we'll notice that NLY, CIM and AGNC all outpace EQR quite significantly. NLY outpaces EQR nearly 2.34 to 1, AGNC outpaces EQR nearly 4.05 to 1, and CIM outpaces EQR nearly 4.16 to 1, which in my opinion, clearly demonstrates a good enough reason to avoid EQR.

Operating Margin Comparisons

In my opinion, the larger the operating margin, the more attractive the company, and the smaller the operating margin the more potential investors should be wary of a position in the company. In the last 12 months, EQR has demonstrated an operating margin of just 29.31%, and even though an operating margin that high would normally be an attractive variable, in the REIT sector it's actually quite low when compared to some of the other companies in the sector. For example, NLY has demonstrated an operating margin of 60.25%, CIM has demonstrated an operating margin of 90.53%, and AGNC has demonstrated an operating margin of 88.84%, all three of which were over the same 12 month period as EQR.

By examining the numbers closer we'll notice that NLY, CIM and AGNC clearly outpace EQR quite significantly. NLY outpaces EQR nearly 2.05 to 1, AGNC outpaces EQR nearly 3.02 to 1, and CIM outpaces EQR nearly 3.09 to 1, which in my opinion, clearly demonstrates yet another good reason to avoid EQR.

Yield Comparisons

When it comes to the REIT sector, the most attractive catalyst for many potential investors is clearly the company's yield. These yields are generally not your typical 2.00% to 4.00% yield you'll find in many Dow Jones Industrial Average stocks. These dividend yields are very dependent on the way the Federal Reserve handles interest rates and the behavior of those rates in both the short and long terms. EQR currently carries one of the least attractive yields within the REIT sector and not only did I want to note that, but demonstrate how it compares to some of the more attractive yields in the sector.

In the last 12 months, EQR has demonstrated yield of just 2.20%, and even though a yield at that level would be attractive, in the REIT sector it's actually quite low when compared to some of the other industry components. For example, NLY has demonstrated yield of 12.50%, CIM has demonstrated a yield of 13.60%, and AGNC has demonstrated a yield of 14.10%, all three of which were demonstrated over the same 12 month period as EQR. By examining the numbers closer we'll notice that the yields of NLY, CIM and AGNC clearly outpace EQR and based on those numbers potential investors should be driven more toward the higher yields.

Final Analysis

Potential investors looking to establish a position in the REIT sector should consider a company's profit and operating margins as well as a company's yield before deciding where and how to establish a long-term position. Based on the fundamental comparisons I've demonstrated EQR should be avoided and positions in NLY, CIM and AGNC should all be considered.

Source: 3 Reasons To Avoid Equity Residential And Begin Considering Alternative Options In REITs