The REIT Market Is Making A Comeback. Five Oaks Is Proof.

| About: Five Oaks (OAKS)

Summary

Five Oaks is increasing earnings by shifting investments back into earnings from the protective hedge funds.

Five Oaks' stock price is higher than the start of the year with a strong recovery building.

Earnings are expected to increase this Summer; with better earnings, profits and higher dividends will follow.

Our target price for the stock by the end of 2016 is $9 per share.

Five Oaks Investment Corp. (OAKS) is a solid, monthly dividend paying real estate investment trust (REIT) that's worth a serious look at where they have been and where we believe they are going. The last two years have been less than stellar, but now a change in market attitudes is showing promise for the company's stock and investors.

Five Oaks is focused on investing in, financing, and managing a portfolio of residential mortgage-backed securities ("RMBS"), residential mortgage loans and other mortgage related investments. The company seeks to provide attractive short-term returns (dividends) and long-term gains through capital appreciation. Investing primarily in both Agency and Non-Agency RMBS allows the company to take advantage of investment opportunities across the residential mortgage market.

In May 2014, the Federal Reserve first started discussing a rate hike, which many feared would hurt the REITs with rising interest rates. So over the last two years many REITs and other companies in the financial sector increased their hedge positions at the cost of taking capital from their investments to protect their companies and investors' funds. This reduced the percentage of funds invested to make money into hedge positions in case interest rates went up. The result was lower earnings and losses from the hedge funds as interest rates stayed low. Lost earnings directly translate into lower profits and dividends for the investors, which pushed the stock prices down in a vicious spiral.

Although I was not a fan of raising the interest rate in December of 2015, this proved to be the singular event that freed many of the REITs from this spiral and freed cash for more investments. This will in time translate into more profits and transition to bigger dividends for investors. In the stock market, everything is cyclical. Even change. What we are seeing now is the changing of the cycle with different factors pushing and pulling on the markets, stocks and investors. The cycle has turned to the recovery phase and the prices based on these new factors, including higher interest rates, will increase earnings, profits and feed the investors pockets to bid up the stock prices of the REITs.

Five Oaks was in the middle of the cycle, lowering dividends as lower earnings pull down on the company. During the fourth quarter of 2015, which was reported on March 23, 2016, the company stated in its financial report that it reduced its Non-Agency RMBS exposure from $303.4 million at December 31, 2014 to $121.5 million at December 31, 2015. It also increased its overall Agency RMBS assets from $314.8 million at December 31, 2014 to $375.3 million at December 31, 2015, 96% of which is represented by Agency hybrid ARMs. ARMs are important to understand as they are short-term (3-5 years) instruments that allow for all the capital to be recycled with higher interest rates in the future. This will allow for increased earnings, profits and dividends.

The stock market was taken hostage by oil prices during January and February of 2016, and every stock dropped as the markets sank about 10%. Some stocks fell much more than others, but the oil industry has not recovered and will not for some time. The rest of the market is doing much better, as 22 of the 30 stocks on the DOW Jones Industrial Average have crossed into positive territory for the year. The DOW crossed above 18,000 on April 18, 2016, and closed above that for 3 days in a row.

The REIT industry has shown a great recovery during the last 2 months, not only from the drop in January/February, but also since the first drop in May of 2014, when the Federal Reserve Board first discussed the rate hike and REITs dropped about 30% within weeks. Now we are seeing a recovery against that drop, and Five Oaks has begun to climb toward its 52-week high of $10.91.

Five Oaks is currently paying a monthly dividend of $0.06, which based on its stock price of $6.14, yields an annual return of 11.7%. The yield has been higher when the stock price was lower, and we believe the dividend will increase this summer, as the company in March just announced the dividend for April, May and June at $0.06. We look for an increase this summer, which should spur the yield and stock price higher.

In my analysis I will not include the dividend return as it can skew the numbers and my analysis. I do want to acknowledge that each month the company pays the dividend, and it allows the investor to take some cash or grow their stock position. Five Oaks' monthly dividend has ranged from $0.125 a month in February 2014 through June of 2015, where it dropped to $0.10, then dropped again in January 2016 to $0.06. During this time the company increased its hedge position, which took more capital from the investments and held it in hedge accounts that were actually costing the company losses. The company reduced its dividend, which caused investors to bid down the stock price. This is a vicious cycle that is difficult for companies to reverse once the pattern has begun

The catalyst to break free was the interest rate hike by the Federal Reserve Board that demonstrated the hedge positions were too large, and many companies have started reducing them. This will start the reverse cycle where the companies will increase their earnings and profits and begin paying out a higher dividend, with investors then bidding up the stock prices based on the higher returns.

From February through August 2014, Five Oaks' stock price was in the $11s. The stock price entered the $10s in September as the Federal Reserve Board kept talking about the interest rate hike. Back then, the Fed did not discuss how much, but just that they were considering returning rates to historical norms. That scared investors and analysts alike, which prompted a protective posture, bidding down the REIT stock prices.

The stock price stayed in the $10s until May 2015, when it dropped into the $9s, then the $8s in June 2015. At this time the dividend was still $0.125, and in July, the dividend dropped to $0.10. The stock price followed down into the $7s and $6s in August 2015. In December 2015, when the Federal Reserve Board announced the rate hike, markets overreacted, with the stock price dropping into the $4s on December 14th. However, the stock recovered and stayed in the $5s the rest of the month.

January brought the oil crisis and the price dropped again, not due to its own issues but the market pulled everything down, and on February 11, 2016, the stock price hit bottom at $3.83 and closed at $3.96.

In the last two months we have see the recovery reach $6.17, with a close on April 19 at $6.15. The stock is about $0.50 above where it started 2016, and this is part of the larger recovery gaining ground from the last 2 years.

As I stated above, one of the drivers is that the company has reduced the size of the hedge fund it was holding against the increase in the interest rates. The second factor I believe is the higher interest rate (even though it is only ¼ of 1%). Interest rates have nudged up a bit, allowing companies to charge higher rates, and earnings are increasing. Although the initial effect is that REITs are sometimes negatively affected by interest rate hikes, the long-term valuation is much more positive for REITs and investors. During the first quarter of 2015, Five Oaks and many other companies are adjusting the rates and have not yet received the resulting benefits. An increase of ¼ of 1% on every new loan written and accumulated in the portfolio will grow over time. This will increase the earnings, profits and return to investors as it cycles through the process.

Another rate hike by the Federal Reserve Board is expected in June. Whenever it does occur, the effect will be the same; it will allow for an increase in earnings that will push the cycle higher for investors' profits and stock prices.

There are quite a few good REIT companies to invest in. Five Oaks Investment Corp. is one of the many companies paying a monthly dividend that is well worth the investment. We anticipate that companies in the financial markets, as well as the REITs, will become more profitable as 2016 moves forward. We believe Five Oaks will increase earnings, profits and dividend payouts to investors as 2016 moves forward. We have a target price of $9 by the end of the year, with increases in profits as investors will bid the value of the stock up. The climb to $9 seems high, but comparing it to historical numbers from 2 years ago, this is still within reason. The $9 price is about a 50% increase in the stock price, and the book value is still listed at $9.58. All of these factors and events are in line with our assessment and general accounting procedures.

Disclosure: I am/we are long OAKS.

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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