Buy Fannie Mae??? My initial reaction to Ken's question of the week was very similar to toroandbruin's. But, a quick look at the numbers is in order to see if there might be a good deal here.

From Yahoo's profile page, "Fannie Mae provides funds to mortgage lenders through the purchase of mortgage assets, and issues and guarantees mortgage-related securities that facilitate the flow of funds into the mortgage market in the United States." Not the best of businesses to be in lately. Some fundamentals - fwd PE of 10.22, return on assets 0.48%, return on equity 10.02% and a dividend yield of 4.2%.

FNM issued a news release on 9 Nov summarizing results for the first three quarters of 2007. Year over year comparisons are pretty ugly, $1.5 billion in net income for the nine months compared to $3.5 billion a year.

FNM has over $76 billion of securities backed by subprime and Alt-A on the books. As we're all well aware, these securities have not been good to financial firms lately and present a big risk of markdowns going forward.

Since the market is well aware of the risks associated with anything related to the mortgage business, the valuation question a buyer needs to address whether the market has overly discounted the risks and 'thrown out the baby with the bath water.'

Some will point to the implied government guarantee as a risk reducer. That may prevent FNM ever going belly up and may protect bondholders, but it certainly doesn't protect shareholders from loss. I believe there's an additional risk that goes with Fannie's government sponsorship. There could well be significant political pressure to help bail the industry out by buying less than stellar paper.

For valuation, lets compare FNM to a bank I have in both SLO and real life - Wells Fargo (WFC). WFC trades at a forward PE of 11.39, return on assets is 1.7% and return on equity is 19.4% with a yield of 3.8%. The market values it at a slight premium to FNM, but I would argue that premium is well deserved due to the better returns and, more importantly, a much more diversified business model. For another data point, JP Morgan trades at a forward PE of 9.4 with return on assets of 1.2% and return on equity of 14% with a yield of 3.6%. For a financial more levered to the mortgage business, Washington Mutual (WM) trades at a forward PE of 9.1, return on assets is 0.73%, return on equity is 9.8% and has a dividend yield of 10.8% (which is either a fantastic bargain or will be cut soon).

If you want a concentrated bet that the mortgage business has bottomed, WaMu looks like a better buy than Fannie. Since today's market isn't charging a premium to invest in a big diversified bank like WFC or JPM, they look like better investments than Fannie.

Given the problems in valuing mortgage securities, I just don't see any reason to buy FNM when it isn't trading at a substantial discount to financials with better returns and more diversified revenue bases.

In this case, I stick by my initial reaction.

FWIW, my track record with financials isn't so great. I boldly proclaimed Mastercard fully valued 40 bucks ago. Hope nobody listened to me on that one.

Comments: View Comments |  Wednesday November 14, 2007

I didn't have much success trading the earnings releases of Sun Hydraulics (SNHY) and Kubota (KUB) last week. I've sold them both out of my slo-port at a slight loss. Over the past two weeks of trading heavy industry earnings, as described in my earlier blog entries here and here, I've made a little profit with two winners (BUCY and NC) and three losers (RBC, SNHY and KUB). The most successful of the five trades was Bucyrus and while reviewing it, I noticed a competitor in the mining equipment business, Joy Global (JOYG) will be reporting on Dec 18.

From the Yahoo profile, "Joy Global, Inc. engages in the manufacture, servicing, and distribution of mining equipment for the extraction of coal, and other minerals and ores worldwide." Heavy industrial companies with a worldwide market have been holding up pretty well in this market and JOYG definitely fits that profile. Mining has been a strong sector and JOYG's competitor Bucyrus recently reported strong earnings and a solid order book. Joy trades at a slight discount to Bucyrus on fwd PE and a substantial discount based on PEG.

As of 10 Nov 07, the company is trading at a trailing PE of 20.15, fwd PE of 15.75, PEG of 0.62. Profit margin is 11.81% with an operating margin of 18.78%. JOYG pays a dividend of 60 cents/year for a yield at today's price of 1.1%.

I believe JOYG is a buy here in the mid-50's and could easily trade up to the mid-60's / low-70's if it were to get a similar multiple to Bucyrus. I've added some to my slo-port and have room to add a little more on any further pullbacks.

Other notes:
This was not a good week to have a big position in Cisco. The earnings report was pretty good, but forward guidance was a little lower than expected. From the sell-off, it looks like the market was expecting a 'beat and raise.' I haven't had a chance to read the conference call transcript yet, but plan to over the weekend. This sell-off looks very similar to what happened after the May earnings call - if so, it's a good buying opportunity. I'm holding on to my SLO Cisco overweight, but will sell it down to an 8-10% position if we get a bounce next week.

RPM has been hammered lately on no news. Bank of America downgraded it to neutral on Friday. The stock now sports a dividend yield of 4%. The CEO made a 10,000 share open market purchase on Friday. Not sure what's going on, but if this is just getting caught in the market downdraft, it's worth a look for income investors. This is one of those companies that have been raising the dividend every year for 34 years. It's probably not a great SLO buy since there aren't likely to be any events to drive the stock price between now and the end of the year.

With last week's market slide, the S&P 500 is now down for the contest duration.

Thanks for reading and have a great week.

Disclosure: I own shares of CISCO and RPM, but don't have a position in any of the other companies mentioned.

Comments: View Comments |  Saturday November 10, 2007

Last week, I wrote about a plan to trade the earnings releases of heavy industrial companies with worldwide markets based on the recent track record of similar companies.

I had identified five companies with earnings releases this past week that fit the profile of manufacturing heavy industrial equipment and selling around the world. Those candidates were Nacco Industries (NC), Manitowoc (MTW), Bucyrus (BUCY), Regal Beloit (RBC), and ASV, Inc. (ASVI). I ended up working with NC, BUCY and RBC. MTW started to run up in the after hours Fri, Oct 26 and didn't pull back before earnings. ASVI was trading near its 52-week low and I wasn't sure why, so I opted not to use it.

First up - Nacco. They make lift trucks and housewares and they mine and market coal. Interesting business mix. On Monday, they reported earnings of $2.55 a share vs. $2.27 last year and provided good guidance for 2008. There are no analyst estimates listed on Yahoo. I entered a limit order Mon morning, but only got 20 shares at $102 before it climbed above my limit. Sold on Tues at $107. Gain of about $100 on $2000 overnight. Good percentage, but couldn't get a big enough position to make much impact.

Next out of the gate - Regal Beloit. RBC makes electric motors, generators and gears. On Thursday morning they reported a good quarter, but lowered estimates for the next quarter. I bought this one in increments Mon - Wed in the low to mid 48's. Sold on Friday at 47.47 for a loss of $560. On a percentage basis, that was less of a loss than the S&P 500 for the week.

Finally, Bucyrus. BUCY makes mining machinery. They reported during the day Thursday. It was a good report, but kind of confusing because there were results from an acquisition mixed in along with some non-recurring expenses related to the acquisition. After the non-recurring expenses were backed out, they handily beat estimates and reported a solid backlog. I bought 1080 shares on Mon and Tues at 80.28 and 80.91 and sold 500 of them on Fri at 83.73. I opted to hang on to part of the position and see if the there's any follow through to the good earnings. That resulted in a combined realized and unrealized gain of $1300 or 1.5% over a week where the S&P lost around 2%.

The biggest problem I had was having enough cash to invest without cannibalizing the rest of my portfolio. That's particularly difficult when two of the trading candidates are releasing earnings close together. In the case of Nacco, I would have needed to start accumulating a few days earlier or taken more risk by buying with a higher limit price to build a decent position. With BUCY and RBC reporting close together, I had to build positions in parallel and decided to put more focus on BUCY since I thought it was the stronger candidate. As it turns out, a smaller position in RBC was a good thing.

In summary, nothing earth shattering. But the net result was a small profit over a week that saw the overall market take a hit. A little less than 1% for the week across the three trades doesn't sound very impressive, but it would be 46% annualized.

Based on this small experiment, the keys to success are identifying the characteristics of companies that are beating earnings and responding well to earnings releases, finding companies reporting in the near future that fit those characteristics, and having a buy-sell plan. The price moves both this week and from my research the week before were typically fairly small, so it's important to have disciplined buying approach and not chase a stock price that starts to run up. Low or free commissions would be critical to making this work in the real world.

This type trade is outside my risk tolerance with real money, but I've decided to give it a go again next week with Sun Hydraulics and Kubota. Sun reports early Monday morning and Kubota reports overnight on Monday. I bought some Sun and a little bit of Kubota today. I would have liked to get a bigger position in KUB, but it's pretty thinly traded and I would have had to chase it a bit. I'll put in a limit day order for Monday to see if I can build a little bigger stake before the earnings release.

Comments: View Comments |  Friday November 2, 2007