American Capital Agency: The Good, The Bad, And The Ugly

| About: AGNC Investment (AGNC)

I had been watching American Capital Agency (NASDAQ:AGNC) and mainly paying attention to the articles that touted the value and future of the company. The price seemed right (it was selling below book of $25.53) and the return looked very attractive even with the dividend cut that had just been announced. The dividend cut notwithstanding, Barrons, for example, had a very positive article as late as September 24th. This was two days before the ex-dividend date of September 26th. So, with the ex-dividend date fast approaching, I thought that I saw a golden opportunity to take advantage of the "dividend capture" strategy and celebrate my brilliance with my banker.

In the event you are not familiar with the dividend capture process; in theory, it works like this: You buy the stock the day before the ex-dividend date and sell it on the next day or shortly afterwards when the stock price returns to its pre-dividend price level. Here, you have to remember that, on the ex-dividend day, the price of a stock that has paid a dividend is automatically adjusted downward by the amount of the dividend. In American Capital's case, this was $0.80 per share.

Now that you have the dividend captured, as I said, you wait until the stock returns to its pre-dividend level and sell. For the stock, you have a wash; the buying and selling price are the same (ignoring brokerage fees). Your immediate gain is the dividend. So, what could go wrong?

With this in mind, let's look at how it went for me.

The good: At the moment, at its current price in the $24 to range and probably is a very good buy. It pays dividends (at least for the moment) of $0.80 per share, per quarter. In addition, the stock price not only has been beaten up, it has been outright mugged.

The bad: I bought it at over $24.00 on September 25th, the day before the ex-dividend date.

The ugly: No how, no way, no time soon is the stock price likely to go back to anywhere near its 6-month high in the $32.00 range.

Some days you get the bear; some days the bear gets you.

As they say: "Stupid" is doing the same thing over and over and expecting a different result. "Dumb," on the other hand, is a one-time event - hopefully. I'm banking on being in the second category. However, don't ask my wife about that. So, what happened? Maybe my experience can prove to be a learning experience for you, it certainly has been one for me. So here goes.

My first error was that I misjudged the impact of American Capital's announcement that it had reduced its dividend payout by 40%. I looked at the financials that were available and believed that the cut in dividend obligations had the effect of strengthening the balance sheet. It reduced the required cash outlay for dividends by 40%. I also learned that the company had repurchased a large number of its shares (31 million-plus) over the past year. Since 2011, it had repurchased over 81 million shares. This created what I saw as huge multiplier effect, not only did they have to pay less in dividends, there were fewer shares outstanding on which a dividend had to be paid. However, in the detective business, a dividend cut is called a clue. My thought process that followed is called: rationalization. Clues are fact-based and trump rationalizations that fall into a category called: wishful thinking.

So, with the wishful thinking outlined above, I bought the stock. I also recognized that the dividend would cushion any unforeseen negative impact on the price of the stock, and I would have time to get out with a profit -- less of a profit, but a profit nonetheless. For example, if the stock price after the dividend adjustment does not fully go back up to the pre-dividend level, the dividend in-hand offsets some of the difference; and it does, and for me, it did. For example, in American Capital's case, assume that the stock price went up $0.40 on or after the ex-dividend date and you sold the stock. In this scenario, you would have a loss of forty cents per share on the stock transaction and a dividend gain of eighty cents per share for a net gain of forty cents per share. The big rationalization here is that the stock price has to go up some amount. Unfortunately, the stock price doesn't always go up, and in this case, it didn't.

Next came the announcement by a major rating firm that it had initiated coverage of American Capital and rated it as a Neutral - not a buy, not a weak buy, but a Neutral. To be candid, this is not a sterling recommendation. It's ho-hum at best. This too was a clue that I ignored thinking that, at least, it wasn't a sell recommendation, and the market would ignore the announcement. I saw a bumper sticker the other day that said: Don't believe everything you think. I should have heeded that admonition. Another clue ignored; a real Sherlock Holmes, I am.

Well, if American Capital were a boat, it would be a submarine; the klaxons would be going off and the loud speakers would be blaring: "Dive, dive!" On the ex-dividend day, right after the downward price adjustment, the stock price jumped up a few cents (commonly called a dead cat bounce) and then headed for deep water. The automatic price adjustment took $0.80 off the share price, and the market price immediately began to fall.

At this point, I thought I'd better do a reality check. After looking at the numbers and not seeing a rational justification for the price drop it seemed logical that the price dip was temporary and it soon would come back. In fact, I felt so strongly about my findings, I wrote about it. My article generated several helpful comments pointing out facts that my evaluation had not considered, which were appreciated. You believe that, right... (Note to readers: Anytime you write, at some point you have to stop and submit your product for consideration. There will never be a time when you know everything there is to know about your subject. It's called: you don't know what you don't know. Also, there will be people out there to help you fill in the blanks in your knowledge. Learn from it.)

By now, it was September 30, and I was in a full funk. The stock had dropped well over a dollar a share, and my sunny disposition was further "enhanced" by rereading the helpful comments about my article. It had been six days of darkness and then the sun came out. The stock price started to come back; the downward trend had reversed itself. I was vindicated! This comes under the heading of: Hope springs eternal.

Then came the President's refusal to compromise on the budget. Yes, I know everyone said it was the Republicans in the House, but the facts don't bear that out. The Republicans agreed to pass a clean bill giving the President everything he wanted but Obamacare; that would have been dealt with as a separate item. The President refused to compromise and held the Congress hostage - he took a scorched earth position: All or Nothing! There is a difference between compromise and capitulation. (Whatever your view, it finally worked itself out.)

Politics aside, it was another clue ignored. In the nation's capital, furloughs were implemented and Washington went into the Chicken Little mode - The sky is falling!

This act drug on for a couple of days, and on October 7th, the sky did fall, not on Washington but American Capital. The stock price took another nosedive. I may have missed the clue, but the stock price didn't. All of those guys who reviewed my article were right - don't you hate it when that happens. The price steadily fell until the 14th of October when it started to come back.

By now the bears were feasting on my back side, and I had decided to bail on October 9th. I took the loss.

So what general lessons are to be learned from this tale of woe?

First: investing during uncertain times is problematic at best. If you see a budget battle looming, you just might want to sit back and watch for a while before investing.

Second: Unforeseeable events can dramatically impact your investment decisions. In this case, following the well-publicized dividend cut, we had an announcement of a less-than-stellar rating of the stock followed by the budget battle. Tucked in all of this mess was the announcement of the continuation of Quantitative Easing and the resolution of the budget standoff. Both events saw American Capital's stock decline -- who would have thought it?

Third, as I said earlier, sometimes you get the bear and sometimes the bear gets you. You have to be prepared to live with the fact that investing involves risk and at some point you probably will be faced with taking a loss in a stock. Either that, or you'd better kiss it and learn to love it. This latter approach also is a rationalization that involves telling yourself that the loss is short term and you are a brilliant investor who is in the market for the long term, and the price will not only come back but also go up. This approach works but is wholly dependent on how long you are willing to wait and watch as other better investment opportunities pass you by. Had I been patient, this approach would have proved the wiser choice because as of this writing, the stock price has returned to the $24 level.

Commenting on long-term investment strategies, it was John Maynard Keynes, the economist, who said: "In the long run, we all are dead." My take is that the long run is a series of short runs and you have to be prepared to make decision at some point. Timing is, of course, the key. How short is a short term? When do I sell or hold and for how long? These are universal questions and sometimes the decision involves selling at a loss. Selling at a loss does not mean that you are a bad, dumb or stupid person, it only means that there are alternative opportunities available where you can invest your money with a greater chance for a gain. It doesn't make the loss hurt less, but see number four below.

Fourth, when employing the dividend capture strategy, it must be remembered that, the bigger the dividend, the longer the price climb back to the pre-dividend level. What goes down eighty cents must come back eighty cents to make the strategy work.

Fifth, just because a stock price goes down doesn't mean it can't go down further. (This paraphrase is from Peter Lynch's "Beating the Street.)

In my case, as I said, I took the loss and have found more attractive opportunities.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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