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American Capital Agency Corp. (AGNC) & Stocks to Buy When Others Are Fearful

Investors often love to quote Warren Buffett’s timeless mantra, “Be fearful when others are greedy and greedy when others are fearful.” However, very few investors ever  put those wise words to good use. Instead, they sell at the bottom of bear markets and buy at the top of bull markets, with their investing decisions dictated by irrational fear or exuberance.

Recently, the market was dragged down by several major headlines. First, Ben Bernanke suggested that QE3 might end by early 2014, which caused bond prices to spike and stocks to plunge. Then, China reported that its bank interbank lending rate was rising rapidly and that it could face a liquidity crisis. Finally, the first quarter GDP in the U.S. rose a mere 1.8% and missed the 2.4% growth that the Commerce Department had originally reported. All these factors have caused some fundamentally robust stocks to slide, creating some major buying opportunities across several industries.

Let’s see if there are any safe stocks to buy on the recent dip.

The Collapse of Mortgage REITs

American Capital Agency Corp. (NASDAQ:AGNC)

Mortgage REITs (real estate investment trusts) have been crushed over the past month.American Capital Agency Corp. (NASDAQ:AGNC), one of the largest names in the industry, plunged 20% over the past month after bleak first quarter earnings derailed investor confidence and a spike in 10-year treasury started to flatten the yield curve, which adversely impacts the firm’s ability to profit.

American Capital Agency Corp. (NASDAQ:AGNC)American Capital Agency makes its money playing the interest rate spread game. It buys up mortgage-backed securities (MBS) at a short-term rate (such as the 2-year rate), then lends them out at the 10-year rate. The wider the spread is between these two, the more profitable its core business is. Those three rounds of quantitative easing were very good for American Capital, since increased government purchases of MBS kept the long-term rate artificially low, increasing the firm’s bottom line. Business at American Capital hummed along, and the company issued secondary offerings several times to get more capital to invest in more MBS.

However, American Capital Agency Corp. (NASDAQ:AGNC)’s heyday came to an end with its terrible first quarter earnings, in which it reported a loss of $1.57 per share, or $557 million. Book value, which is considered the benchmark for the share price of REITs, fell from $31.64 to $28.93. American Capital’s highly leveraged business model backfired, and it was forced to report losses on marked-to-market agency securities.

After its steep plunge to the low $20s, however, American Capital Agency Corp. (NASDAQ:AGNC) seems to have stabilized, even as the 10-year treasury sits near a two-year high. Management claims to have restructured its MBS portfolio to persist in current market conditions, and recent unemployment and GDP figures suggest that Uncle Ben won’t taper bond purchases as soon as the market had thought. Best of all, the stock did not plunge further after its ex-dividend date on June 26. This means that the stock could have bottomed out here, offering a hefty dividend yield of 18%. If book value stabilizes this quarter, shares could steadily recover.

Big Tobacco gets snubbed out

Meanwhile, the spike in bond prices led to a mass exodus from dividend stocks. Since bonds are generally regarded as “safer” investments than stocks, many institutional investors increased the weight of bonds in their portfolios to prepare for market turbulence. For individual investors, however, I believe that dumping fundamentally strong stocks for the much lower yield of government bonds is just foolish.

Take for example Philip Morris International Inc. (NYSE:PM) and Altria Group Inc (NYSE:MO), two of the largest names in the tobacco industry. The two companies were once a single entity, Philip Morris Companies, but they were later spun off from each other, with Philip Morris handling its international brands and Altria remaining in charge of the domestic tobacco business. Since the spin off, Philip Morris has enjoyed rapid growth in Asia, which has helped offset losses in Europe. Meanwhile, Altria has diversified into chewing tobacco, alcohol and electronic cigarettes to offset the declining sales of cigarettes.

Fundamentally, these two stocks don’t exhibit exceptional growth, but their dividend yield is rock solid, and a fairly low beta indicates that they aren’t particularly volatile investments.

Forward P/E Price to Sales (ttm) Profit Margin Qty. Revenue Growth (y-o-y) Qty. Earnings Growth (y-o-y) Dividend Yield Beta
Philip Morris International 14.07 4.54 27.81% 1.80% -1.70% 3.9% 0.86
Altria Group 13.72 4.04 25.00% -0.50% 15.90% 5.0% 0.46

Source: Yahoo Finance, 6/27/2013

Therefore, why did Philip Morris International Inc. (NYSE:PM) and Altria Group Inc (NYSE:MO) slide 7% and 5% over the past month, respectively? The only real explanation is a natural market pullback that coincided with a renewed appetite for bonds. In my opinion, if you’re a long-term investor focused on slow and steady growth through dividends, you should pick up some shares of both companies while they’re still trading at a discount.

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