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Annaly Capital Management, Inc. (NLY), American Capital Agency Corp. (AGNC), Invesco Mortgage Capital Inc (IVR): How to Make the Fed Pay You

The valuation

For any REIT, the preferred plot is price as a function of FFO (Funds from Operations). FFO is close kin to operating cash flow, from which the book value is derived. Earnings per share mean little to mREITs. Cash is king. Consensus Wall Street analysts forecast Annaly Capital Management, Inc. (NYSE:NLY)’s future cash flows to increase in the low single digits. If so, the price-to-FFO line should not retreat. Therefore, unless the historical trends are now somehow broken, the price will eventually follow. Even at a P / FFO multiple of 6, this year’s projected FFO indicates a 2013 price of nearly $19 a share. Applying the same calculation to American and Invesco Mortgage Capital Inc (NYSE:IVR) result in share prices of $33 and $25, respectively. That’s roughly a 30% upside from today’s current prices.

Another way to value mREITs is to calculate their book value per share. For example, Annaly Capital Management, Inc. (NYSE:NLY)’s book value per share is currently $15.20. With shares trading hands at $13.36, we are looking at a discount of 13% to book value. Keep in mind that whenever shares traded at a 10% discount-to-book in the past, they have always tended to regress back to the mean, that is – to their book value within a year. That means that if history is any guide, by buying now you are potentially securing a 13% return (plus dividends) on your invested capital. That’s impressive. Even American Capital Agency Corp. (NASDAQ:AGNC) and Invesco Mortgage Capital Inc (NYSE:IVR) are trading at large discounts of 11% and 12% to book value. Opportunity is abound.

The Foolish conclusion

I strongly believe that after the strong sell-off that the mREIT sector has experienced, it’s finally on the verge of a fierce rebound. A higher spread will eventually lead to bigger profits for all mREITs. Make sure your’e on board.

Shmulik Karpf has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

The article How to Make the Fed Pay You originally appeared on Fool.com.

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