It's Time To Lower My Rating On Arbor Realty

Summary

• The share price has rallied by double digits in the past six weeks.
• A forward dividend yield of just over 10% remains attractive.
• Further share price appreciation is expected to be somewhat constrained.

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At this point, you have already read the title of this article. So, before anyone starts calling their broker and telling them to sell their Arbor Realty (NYSE:ABR) shares, consider the following - although I am lowering my rating on Arbor, I continue to believe this stock is still an above-average investment. It's just not quite as attractive as it was when I rated it a Strong Buy on December 15th in an article titled Arbor Realty Trust Common Stock: My 'Perfect 10' Dividend Idea. At that time the share price was $13.72 and the $1.60 annual dividend was yielding 11.7%. The Strong Buy was based on the attractive dividend yield and my expectation of the share price appreciating 15%-20% over the subsequent one year period.

To be clear, as far as I know, Seeking Alpha has not given any specific numerical guidance as to what constitutes Strong Buy, Buy, Hold, Sell or Strong Sell ratings. I would have preferred to have specific designations for price movements and total return, something one might have expected from someone that chose Crunching Numbers as a pseudonym. Regardless...

Background

The dividend was the primary reason I had first purchased this stock, and it was the reason I have been writing positive articles about this equity for the past several years. Obviously, ten consecutive quarterly increases of that dividend and a low payout ratio have also been contributing factors. The CEO, Ivan Kaufman, noted the following early in the Q3 earnings conference call:

We have a premium operating platform, with multiple products that generate many diverse income streams, allowing us to consistently produce earnings that are well in excess of a dividend. This has allowed us to once again increase our dividend to $0.40 a share, representing our 10th consecutive quarterly dividend increase with 33% growth over that time period, all while maintaining the lowest payout ratio in the industry. We've also strategically built a platform to succeed in all cycles, and as a result, we believe we are extremely well positioned to thrive in this economic downturn.

So, with all of these positives, why am I lowering my rating? The main reason is the current price, and its rise to $15.12. At that price, the forward yield drops to 10.58%, and 10% should be an important yardstick for investors. Over the past decade, we have seen outsized gains and losses in the market as measured by the S&P 500. Last year, the S&P 500 returned a negative 18%, although the gains for the past three, five, and ten year periods were all quite positive. Most important, however, is that over the past century the long term average annual total return for the S&P 500 (including reinvested dividends) is just a bit below 10%.

The current Arbor dividend alone is more than 10%, and that should be enough to earn the equity a hold. To earn a Buy rating I would like my recommendation to beat the long term average total return for the S&P 500 by five to ten percentage points over the following year. For a Strong Buy, I would want to see a total return of 20%-25%. Clearly, Arbor has essentially met the Strong Buy criteria made in the December of 2022 based on price appreciation of more than ten percent in addition to its 10% dividend.

Then, consider that the dividend represents "the lowest payout ratio in the industry" and that Arbor's income streams "produce earnings that are well in excess of a dividend". These factors should indicate that further increases to the dividend will be on the way to shareholders. And, of course, all things being equal, the share price should show significant gains based on the expectation of rising earnings and dividends.

For me, these factors alone would be enough to justify a buy rating at the current price. To justify a Strong Buy, I would want to see the share price appreciate at least 15% from the recent $15.12 price. Can it get above $17.38 over the next year? It's possible, but in a rising interest rate environment I believe it will be difficult to achieve. For these reasons I am lowering my rating from "Strong Buy" to "Buy".

Additional Disclosures

We are currently overweight Arbor, with the equity representing approximately 8.8% of our investment accounts. This includes one large trading position where I was caught holding a block of shares not too far off its 2021 high. The large dividend makes holding the shares tolerable, but should I get the opportunity to liquidate the position at a gain - or even a reasonable loss, I could sell that position at any time. I would like to think that I am able to write about Arbor without letting my personal holdings and the gains and losses unduly bias my assessment.

Recent News

The company is scheduled to release its Q4 results before the market opens on Friday, February 17, and subsequently hold its Q4 conference call at 10:00 a.m. Eastern Time. I expect more good news from the company, and would not be at all surprised to see an eleventh consecutive quarterly increase in the dividend that morning.

Less clear was Arbor's December news release about co-funding New York based Emerald Empire's acquisition of Pangea Properties' Chicago Portfolio, where details of the transaction were not fully disclosed.

Summary

Arbor is currently a solid investment opportunity, and despite its recent price appreciation, is still worthy of a Buy rating. It's just not quite worthy of a Strong Buy rating from this particularly picky author.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of ABR either through stock ownership, options, or other derivatives. 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.

In addition to long term core holdings, I also hold a significant trading position that could be liquidated should the price reach $20.