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No. of Recommendations: 22
....with apologies to the buy and hold forever crew....

Although I left Annaly's party a little too early, I was fortunate not to have been left to clean up the mess. I have been watching closely for a suitable re-entry point. NLY is a conservative, easy to understand business. Just the kind I like (liking something is an emotion not to be confused with a reason to buy the stock). I troll discussion boards, visit the company website, watch the refi index, analyze the yield curve, and try decipher “Greenspeak”. All in an individual investor's noble attempt to outwit Mr. Market.

I've heard some hollow reasons for buying this stock now.

“The price is way below where it was several months ago.” OK, that's great but I dollar-cost-averaged Metro Media Fiber from $32 to $0 during 2000 to 2003. And no, I am not comparing the two companies, just trying to illustrate a point. You don't buy solely because the price went down.

“The management team is great.” I own some restaurants. One of my locations is blessed with management superior to the others. Great attitude, dedication to the customer, attention to the bottom line, yada…yada….yada. Two years ago a major competitor opened up down the street. Although we still kick their butts on quality and service, we've had to increase our advertising budget in the face of a slight sales decline. Expenses up, revenues down. less income for the shareholders (me, myself and I). Unfortunately, my company is not public and I couldn't sell my shares to people who “loved the management team.” A good management team does not make the bad times good, maybe a little less badder…… You get the drift.

If you are going to buy or own a business you should evaluate and investigate, not love or hate. Love and hate are emotions, not investment tools. Annaly has always been praised for its “transparency”. Use this gift to guide your investment decision, not as a reason to buy the stock.

Speaking of good and bad, there are several factors that may give some guidance in the direction of the upcoming 3rd quarter earnings:

Interest rate concerns. If you follow Annaly, you are well-aware that its income is derived primarily from the spread between the 2 and the 10 year treasury note. Though this is an extremely simplistic view, watching this spread can guide you in the future direction of NLY's income and dividends. The ten year note has finally been creeping up the last two weeks (13 basis points). Unfortunately, short term rates are still rising a wee bit faster (16 basis points). Today's Fed hike will put further pressure on short term rates. This could indicate that next quarter's interest income will be slightly lower that 2nd quarter. There has been some fear that the yield curve will invert. I think this is extremely unlikely. Alan et al know far better than I that every yield curve inversion has been followed by a recession. The Fed knows that the measured pace will have to slow soon.
2005 3rd quarter .02 to .08 cent per share reduction vs.Q2

Mortgage prepayments and refinanancing activity. In a low interest environment Annaly typically pays a premium for its assets (Mortage backed securities). This premium is an expense that gets amortized over the life of the MBS. As refis and prepayments occur the “lifespan” of the MBS shortens. The premium expense must be compressed into a shorter time frame. This activity as measured by the Mortgage Bankers Association refi index has been drifting down. As long term rates slowly rise this drift should continue giving a little more lift to earnings.
2005 3rd quarter .02 to .03 cent per share increase vs. Q2

FIDAC. The advisory business continues to flourish. Per Share Earnings from FIDAC:
2004 Q2 .02
2004 Q3 .04
2004 Q4 .06
2005 Q1 .06
2005 Q2 .08
2005 3rd quarter .01 cent per share increase vs Q2

2nd quarter one time gain on sale. In the second quarter report there was a .10 per share Gain on the sale of mortage backed securities. In all the nastiness of the earnings miss this seems to have been overlooked. On average, Annaly earns .01 to .02 per share per quarter on these sales so I would guess that this .10 gain is a one-time event. If you take this item out earnings this quarter would have been only .26 per share. This does not bode well for 3rd quarter, all things remaining equal.
2005 3rd quarter .09 cent per share reduction vs. Q2

In addition there are a couple of factors outside of earnings and dividends that may influence the stock price:

Technical analysis. I am not a technician but those who are advise that the Mortgage REIT sector and indeed the entire REIT sector are done. The recent move down is the beginning of a nasty correction. Its an interesting aside, but for me I only use candlesticks when the electricity goes out. An inverted cup and handle is just a mess I have to clean up.

Insider buying. Good news: Some Senior VP bought shares on 8/2
Less good news: Is 1250 shares a ringing endorsement or just a nephew's birthday present?

In summary, Annaly seems to well on the way to completing its journey to the town of Rock Bottom. Hopefully, one more quarter with a 5-15 cent reduction in earnings and dividends(all other things remaining the same, which they never do). After that, I will re-evaluate all the information available at that time. And then, if the analysis permits, I can start to invest in the company that I've always loved but not always owned.

Tom C

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