Annaly: Buy Now Before It Soars Higher

| About: Annaly Capital (NLY)
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Ever since the famed "Black Helicopter" speech, Ben Bernanke (aka "The Barnank") has wowed investors with his attempts to devalue the U.S. dollar faster than at any previous time in history and for his role in exploding the U.S. deficit at a pace that makes even FDR look conservative.

Bernanke's recent comments that the Federal Reserve is unlikely to continue to buy bonds in an effort to stimulate the economy did little to sway investors. Companies like Annaly Capital Management (NLY), which profit by capturing the spread between long- and short-term rates in the mortgage market, may be impacted, but with rates being as low as they have been, it is hard to imagine where deeper cuts would even come from.

QE3 and the Capital Markets

While it is difficult to imagine how the Fed could ever justify burning huge quantities of additional capital in order to prop up the economy and the market, it is an election year, so anything is possible. A report by Credit Suisse states that recent trading of government-backed mortgage securities indicates that the market is pricing in a 37% chance that further quantitative easing activities will be undertaken by the Fed. The report notes that this is a small decline from the 40% chance present a week ago, but remains a significant uptick from the 25% number earlier in the month. While these statistics are not dispositive, the fact that chances remain this high is instructive.

Managing Income

Annaly has been a long-time favorite of investors seeking yield in an otherwise anemic environment, offering a current dividend yield of over 14%. The stock went ex-dividend on March 28 and will pay $0.55 later this month. In a recent article at The Motley Fool, investors were encouraged to look on these types of dividends with a high degree of skepticism. The articles notes that Annaly's current dividend is more than 25% less than it was in late 2009. These figures are on an absolute basis and fail to mention that the stock was trading at a higher price in late 2009, so, depending on the day one chooses, the dividend yield of the stock has not decreased significantly. Furthermore, as was mentioned above, there is essentially no more room for rates to fall, so the "downward pressure" on rates is somewhat irrelevant. At a time where yield in essentially non-existent, seeking yield in a well-run company like Annaly is a reasonable choice.

The Mortgage Market

One of the key drivers of any business that centers on the mortgage business is the demand for mortgages. According to the Mortgage Bankers Association, mortgage applications rose by 4.8% for the week ending March 30 and are up by more than 2% over the levels observed for the same period a year ago. This strong showing of demand is a positive sign for companies like Annaly because increasing demand for mortgages has the tendency to keep the spreads upon which Annaly relies wide. With the Fed continuing to play an active role as a buyer, increased consumer demand is particularly positive, allowing the Fed to provide good liquidity, while consumer supply offers the best sourcing of spread yields.

Annaly and Peers

Regardless of whether one is considering buying, selling or holding a given stock, placing the company into the proper context relative to its peers is a valuable exercise. Even when there is a particular catalyst or motivation to trade a specific stock, understanding peers places the stock appropriately within the market and can inform the trader as to additional forces that may drive performance. The three most direct competitors are Capstead Mortgage (CMO), Impac Mortgage Holdings (IMH) and Redwood Trust (RWT).

On a valuation basis, Capstone and Impac appear to be the best values in terms of their price-to-earnings ratios, trading at a multiples of 7.4 and 6.3 respectively, relative to 42.1 for Annaly and 36.2 for Redwood. When growth is considered, the field evens considerably. Annaly has a price-to-earnings over growth (PEG) ratio of 2.68, relative to 2.66 for Capstead and 3.38 for Redwood. On this basis, Annaly and Capstead appear to be the two best values relative to their respective growth profiles.

In terms of operating efficiency, the advantage again goes to Capstead, which has an operating margin of 90.7%, relative to 62.9% for Annaly, 7% for Impac and 53.3% for Redwood. When market capitalization is made a factor, Annaly and Capstead pull away from the other two companies. Annaly is the largest with a market cap of $15.1 billion, followed by Capstead at $1.2 billion; both Impac and Redwood are sub-$1 billion. On this basis, the spread between Annaly and Capstead on a market cap basis places the two companies into different strata and, therefore, make them better considered as independent options at different market cap levels than as outright alternatives.

Annaly is Actionable

Given the recent uptick in mortgage applications, Annaly appears to be at an attractive entry point. Increased mortgage demand may couple with the market's belief as to likely Fed action for a solid catalyst to drive the stock higher. In addition to these fundamental arguments, the stock seems to have solid support at $15.50 per share when looking back over a complete two-year period. Each of these factors support an argument for positive price action in the stock. I recommend buying Annaly in the current market environment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.