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On Thursday, September 13, analysts at Macquarie downgraded shares of Annaly Capital Management (NLY). The firm lowered its rating on the stock from Neutral to an Underperform and set a $15.50/share price target. An analyst downgrade can result in an immediate sell-off for a stock (NLY was down 1.15% at 11:00 a.m. EST), and in the wake of NLY's downgrade, I wanted to highlight several of the negative catalysts behind my decision to avoid a position in the company, and take a position in two alternatives that could certainly enhance any portfolio.

Overview

Annaly Capital Management, which is based in New York, New York, is a real estate investment trust, engages in the ownership, management, and financing of a portfolio of investment securities. The company invests primarily in mortgage pass-through certificates, collateralized mortgage obligations, agency callable debentures, and other mortgage-backed securities representing interests in or obligations backed by pools of mortgage loans. Annaly Capital also invests in Federal Home Loan Bank, Federal Home Loan Mortgage Corporation, and Federal National Mortgage Association debentures. The company has elected to be taxed as a real estate investment trust (REIT). As a REIT, the company would not be subject to federal corporate income tax, provided it distributes at least 90% of its taxable income to its stockholders. It was formerly known as Annaly Mortgage Management, Inc. and changed its name to Annaly Capital Management, Inc. in August 2006.

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 establishing a position in the company. In the last 12 months, NLY has demonstrated a profit margin of just 50.98%, which in my opinion would be a great number, but when it comes to REITs, that number isn't so hot. For example, Chimera Investment Corp. (CIM) has demonstrated a profit margin of 90.42%, and American Capital Agency (AGNC) has demonstrated a profit margin of 87.84%, both of which were over the same 12-month period as NLY.

By examining the numbers closer we'll notice that CIM and AGNC both outpace NLY quite significantly. CIM outpaces NLY nearly 1.77 to 1, and AGNC outpaces NLY nearly 1.72 to 1, which in my opinion, clearly demonstrates a good enough reason to avoid NLY at current levels.

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 establishing a position in the company. In the last 12 months, NLY has demonstrated an operating margin of just 60.25%, which in my opinion, is pretty good, although, and like I've stated previously we're dealing with the REIT sector, so at best that number is only mediocre. For example, CIM has demonstrated an operating margin of 90.53%, and AGNC has demonstrated an operating margin of 88.48%, both of which were over the same 12-month period as NLY.

By examining the numbers closer we'll notice that CIM and AGNC both outpace NLY quite significantly. CIM outpaces NLY nearly 1.50 to 1, and AGNC outpaces NLY nearly 1.46 to 1, which in my opinion, clearly demonstrates a good enough reason to avoid NLY at current levels.

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 the 2.00% to 4.00% found in many Dow Jones Industrial Average stocks. NLY currently carries one of the more attractive yields within the REIT sector; however that too is also outpaced by both CIM and AGNC.

In the last 12 months, NLY has demonstrated a yield of 12.50% ($0.16), and although some income investors may in fact think a yield of that size is attractive, I still think there are a few alternative options to consider. For example, CIM has demonstrated yield of 13.40% ($0.36), and AGNC has demonstrated a yield of 14.00% ($5.00), both of which were demonstrated over the same 12-month period as NLY. By examining the numbers closer we'll notice that the yields of CIM and AGNC clearly outpace NLY and create two very attractive options, especially for conservative income driven investors.

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 NLY should be avoided and positions in CIM and AGNC should be considered as alternatives.

Source: In The Wake Of Annaly's Downgrade, It's Time To Consider Alternative Options