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My High Dividend Stocks
This is my high dividend stocks site where I help site members find high dividend stocks with earning power and strong balance sheets.
My High Dividend Stocks
This is my high dividend stocks site where I help site members find high dividend stocks with earning power and strong balance sheets.
August 24th, 2010
You can listen to this article on your smart phone or computer. This is perfect for drive time.
We have been analyzing American Agency Capital Corp. (AGNC) for the past few articles at www.myhighdividendstocks.com . AGNC purchases mortgage-backed securities and collateral debt obligations from Fannie Mae and Freddie Mac. So we must understand what Fannie and Freddie are and how the make/lose money. For those of you who don’t know – Fannie and Freddie are government sponsored enterprises. That means they have special privileges that other corporations don’t. They buy mortgages in the secondary market, repackage them into securitized products, and guarantee the principal and interest payments on those securitized products. They are colossal failures and have to be subsidized by the federal government almost yearly to keep operating. Ron Paul spoke before the House Financial Services Committee years before the housing crisis and the financial crisis. He understands that government intervention in markets distorts the allocation of capital in those markets. The mortgage market is no exception. This is a concise explanation of how the markets are distorted by congress’ subsidies to Fannie and Freddie. AGNC’s dependence on Fannie, Freddie, and Congress is a huge risk that you must understand before investing in this stock yielding 20%.
This article appeared on www.LewRockwell.com way back in September 2003
Fannie and Freddie
by Rep. Ron Paul, MD
by Rep. Ron Paul, MD
Ron Paul in the House Financial Services Committee, September 10, 2003
Mr. Chairman, thank you for holding this hearing on the Treasury Department's views regarding government sponsored enterprises (GSEs). I would also like to thank Secretaries Snow and Martinez for taking time out of their busy schedules to appear before the committee.
I hope this committee spends some time examining the special privileges provided to GSEs by the federal government. According to the Congressional Budget Office, the housing-related GSEs received $13.6 billion worth of indirect federal subsidies in fiscal year 2000 alone. Today, I will introduce the Free Housing Market Enhancement Act, which removes government subsidies from the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the National Home Loan Bank Board.
One of the major government privileges granted to GSEs is a line of credit with the United States Treasury. According to some estimates, the line of credit may be worth over $2 billion. This explicit promise by the Treasury to bail out GSEs in times of economic difficulty helps the GSEs attract investors who are willing to settle for lower yields than they would demand in the absence of the subsidy. Thus, the line of credit distorts the allocation of capital. More importantly, the line of credit is a promise on behalf of the government to engage in a huge unconstitutional and immoral income transfer from working Americans to holders of GSE debt.
The Free Housing Market Enhancement Act also repeals the explicit grant of legal authority given to the Federal Reserve to purchase GSE debt. GSEs are the only institutions besides the United States Treasury granted explicit statutory authority to monetize their debt through the Federal Reserve. This provision gives the GSEs a source of liquidity unavailable to their competitors.
The connection between the GSEs and the government helps isolate the GSE management from market discipline. This isolation from market discipline is the root cause of the recent reports of mismanagement occurring at Fannie and Freddie. After all, if Fannie and Freddie were not underwritten by the federal government, investors would demand Fannie and Freddie provide assurance that they follow accepted management and accounting practices.
Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges granted to Fannie and Freddie have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans.
Despite the long-term damage to the economy inflicted by the government's interference in the housing market, the government's policy of diverting capital to other uses creates a short-term boom in housing. Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.
Perhaps the Federal Reserve can stave off the day of reckoning by purchasing GSE debt and pumping liquidity into the housing market, but this cannot hold off the inevitable drop in the housing market forever. In fact, postponing the necessary, but painful market corrections will only deepen the inevitable fall. The more people invested in the market, the greater the effects across the economy when the bubble bursts.
No less an authority than Federal Reserve Chairman Alan Greenspan has expressed concern that government subsidies provided to GSEs make investors underestimate the risk of investing in Fannie Mae and Freddie Mac.
Mr. Chairman, I would like to once again thank the Financial Services Committee for holding this hearing. I would also like to thank Secretaries Snow and Martinez for their presence here today. I hope today's hearing sheds light on how special privileges granted to GSEs distort the housing market and endanger American taxpayers. Congress should act to remove taxpayer support from the housing GSEs before the bubble bursts and taxpayers are once again forced to bail out investors who were misled by foolish government interference in the market. I therefore hope this committee will soon stand up for American taxpayers and investors by acting on my Free Housing Market Enhancement Act.
Dr. Ron Paul is a Republican member of Congress from Texas.
August 23rd, 2010
AGNC’s income statement must present a fair and undistorted picture of the year’s operating results if we are to use it as a basis for investing our capital. We all still remember the lies of Enron, MCI WorldCOM, and the entire banking industry’s loan write-downs. You can’t just trust the income statement just because they were audited. Enron was audited by the spineless liars such as Arthur Anderson. You may need to critically examine and adjust the numbers with respect to three important elements:
· Nonrecurrent profits and losses
· Operations on subsidiaries or affiliates
· Reserves
Remember that our purpose of analyzing the income statements is to learn:
What are the true earnings of AGNC for the period studied (May 2008 – present)
What indications does the earnings record carry as to the future earning power of AGNC?
What elements in their earnings exhibits must be taken into account, and what standards followed, in endeavoring to arrive at a reasonable valuation of AGNC’s shares?
AGNC’s management has considerable leeway in the method of treating nonrecurrent items. Accounting procedure allows this. Transactions applicable to past years (2008 and 2009 for AGNC) should be excluded from current 2010 income and entered as a charge or credit direct to the surplus account. However, there are many kinds of entries that may technically be considered part of the current year’s results, but are nonetheless of a special and nonrecurrent nature. Accounting rules permit AGNC’s management to decide whether to show these operations as part of the income or to report them as adjustments of surplus. The following are a number of examples of entries of this type:
1. Profit or loss on sale of fixed assets.
2. Profit or loss on sale of marketable securities. (This surely applies to AGNC. We will have to examine this portion of their income statements carefully.)
3. Discount or premium on retirement of capital obligations.
4. Proceeds of life insurance policies (This is probably not applicable to AGNC).
5. Tax refunds and interest thereon (We’ll check to see if they received any tax refunds and interest)
6. Gain or loss as a result of litigation (We’ll find out if there is any).
7. Extraordinary write-downs of inventory (Maybe).
8. Extraordinary write-downs of receivables (I don’t think this has happened yet. But, definately if Fannie and Freddie can’t guarantee MBS principal and interest payments to AGNC)
9. Cost of maintaining nonoperating properties (not applicable – this happens more with manufacturing and mining)
Our object is to segregate all these items from the ordinary operating results of the year. We really want to learn from the annual report and 10-K filings what AGNC’s indicated earning power is under the given set of conditions. All these extraordinary items need to enter properly into our calculation of earning power as actually shown over a period of years in the past. AGNC started operating its business in May 2008, so there isn’t much history for this company. One of its competitors Annaly Capital (NLY) has been around much longer.
AGNC has no controlled or affiliated companies, so we don’t have to adjust reported earnings for this category of analysis.
Lastly, we must give critical attention to the matter of reserves for depreciation and other amortization, and reserves for future losses and other contingencies. If the government changes the laws regarding Fannie Mae and Freddie Mac or the FED buys or sells MBSs, then AGNC can suffer huge future losses on the value of their agency securities. We need to check this out carefully.
If you missed the beginning of the analysis of AGNC, then please visit www.myhighdividendstocks.com to read the last couple of posts. I selected AGNC for high dividend stock analysis because it has a whopping 20% dividend yield. Should you buy it, sell it, or stay away? You’ll find out if you stick around for the next few weeks.
Be seeing you!
In my last post I covered American Agency Capital Corp.’s (AGNC) dividend rate and record. You can read that post and catch up on my analysis of AGNC by clicking here: http://tinyurl.com/3624qch.
Words before we start our analysis of the income account – copied extensively from Security Analysis chapter 31.
I recommend that you value AGNC [and any company for that matter] as you would if you were going to purchase the entire company in a private transaction.
Given sufficient information you shouldn’t go astray in your valuation of AGNC. Their 2009 annual report, most recent 10-K filing with the SEC, and earnings conference call audio recordings should contain the information necessary for analysis of AGNC’s business.
You should arrive at intrinsic values similar to that which bankers evaluating the credit worthiness of the enterprise would arrive at. Basically, I’m saying that you should analyze both corporate earnings and the corporation’s assets (balance sheet). We should not rely on a single earnings test to determine if an investment in AGNC it prudent. A single earnings test would be less dependable than the two fold earnings and balance sheet tests. Earnings statements are subject to more rapid and radical changes than the changes which occur on a balance sheet.
Lastly, earnings statements can be more misleading in their presentation by company management and can contain more mistaken inferences than the typical balance sheet when scrutinized by an experienced investor.
Keep in mind as we begin the analysis of the earnings statement that the meaning of AGNC’s income statement cannot be properly understood without reference to the balance sheet at the beginning and end of the earnings period.
Here is a simplified statement of Wall Street’s method of appraising common stocks:
1. Find out what the stock is earning. (This usually means the earnings per share as shown in the last report.) AGNC earned $1.23 per share in the most recent quarter.
2. Multiply these per-share-earnings by some suitable “coefficient of quality” which will reflect:
a. The dividend rate and record.
b. The standing of the company – its size, reputation, financial position, and prospects.
c. The type of business (e.g., a technology company will sell at a higher multiple of earnings than a slow growth consumer staples manufacturer).
d. The temper of the general market. (Bull market multipliers are larger than those used in bear markets.)
The foregoing may be summarized in the following formula:
Price = current earnings per share X quality coefficient.
Current price ($26.98) = current EPS last four quarters ($6.97) X quality coefficient (3.87)
Graham’s “quality coefficient” is commonly known as “price/earnings ratio” today.
The result of this procedure is that in most cases the “earnings per share” have attained a weight in determining value that is equivalent to the weight of all the other factors taken together. The truth of this is evident if it be remembered that the “quality coefficient” is itself largely determined by the earnings trend, which in turn is taken from the stated earnings over a period.
AGNC’s earnings not only fluctuate, but they are subject to arbitrary determination by the company’s management. It will be illuminating if I summarize at this point the various devices, legitimate or otherwise, by which per-share earnings may at the choice of those in control be made to appear either larger or smaller.
1. By allocating items to surplus (retained earnings) instead of to income, or vice versa.
2. By over-or understating amortization and other reverse charges.
3. By varying the capital structure, as between senior securities and common stock.
4. By the use made of large capital funds not employed in the conduct of the business.
I don’t know if AGNC’s management has manipulated any of their earnings statements yet. We will discover that as I perform analysis on AGNC’s income statements in upcoming posts.
Significance of the foregoing to the analyst and to you
These intricacies of corporate accounting and financial policies undoubtedly provide a broad field for the activities of the securities analyst (that’s me). There are unbounded opportunities for shrewd detective work, for critical comparisons, for discovering and pointing out a state of affairs quite different from that indicated by the publicized “per-share earnings”.
That this work may be of exceeding value cannot be denied. In a number of cases it will lead to a convincing conclusion that the market price for AGNC is far out of line with intrinsic or comparative worth and hence to profitable action based upon this sound foundation. But it is necessary to caution the analyst against over confidence in the practical utility of my findings [Graham is warning me]. It is always good to know the truth, but it may not always be wise to act upon it, particularly on Wall Street. And it must be remembered that the truth that I uncover if first of all not the whole truth and, secondly, not the immutable truth. The result of my study is only a more nearly correct version of the past. My information may have lost its relevance by the time I acquire it, or in any event by the time the market place is finally ready to respond to it.
With full allowance for these pitfalls, it goes without saying, nonetheless, that security analysis must devote thoroughgoing study to AGNC’s corporate income accounts. It will aid in our exposition if we classify this study under three headings:
1. The accounting aspect. Leading question: What are the true earnings of AGNC for the period studied?
2. The business aspect. Leading question: What indications does AGNC’s earnings record carry as to the future earning power of the company?
3. The aspect of investment finance. Leading question: What elements in AGNC’s earnings exhibit must be taken into account, and what standards followed, in endeavoring to arrive at a reasonable valuation of the shares?
Read all about my valuation of AGNC and other topics affecting your investment portfolio at www.myhighdividendstocks.com
Be seeing you!