Traders who use the investing app and website for the financial services company Robinhood seem to have a propensity for liking volatile stocks that can create opportunities to trade the technicals (i.e., trading on whatever is trending) and benefit from short-term gains. As a general rule, The Motley Fool focuses on stocks from a long-term investing perspective.
That said, even day traders should have some basic understanding of what these stocks do and what they are worth if they hope to succeed long-term. Invesco Mortgage (NYSE: IVR) has been a favorite of the Robinhood crowd of late, so if you are following the trend, here is some background on the stock and what it might be worth.
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Understanding the basics of REITs
Invesco is a real estate investment trust (REIT). Real estate investment trusts are a special type of stock that is exempt from paying corporate taxes, provided the company is involved in real estate and pays out at least 90% of its earnings as dividends to its shareholders. Most REITs are in the business of owning properties and charging tenants rent. They generally will buy property, finance it through longer-term debt, use the rental income to pay the interest and maintenance, and then distribute whatever is left to shareholders.
It is an easy-to-understand business. There are all sorts of different business models, including mall REITs, net-lease REITs, office REITs, apartment REITs, storage REITs, and healthcare REITs. Historically, REITs have been known for high dividends and low volatility, which makes them perfect for income investors more interested in a predictable dividend yield than volatile capital gains.
Why mortgage REITs are different
Companies like Invesco are a different animal. These REITs are mortgage REITs, and they are not in the business of owning property and collecting rent. These REITs hold mortgage debt. They more closely resemble banks or hedge funds than a traditional landlord/tenant model.
Essentially, instead of buying property and charging rent, these REITs buy mortgage debt and collect interest. The difference between their cost of funds (what it costs them to borrow) and what they earn on these assets is called their interest spread, and that spread is how they make money.
The bonfire of the mortgage REITs
Historically, the mortgage REIT sector was an esoteric backwater of the REIT sector. Investors were attracted to the big dividend yields, but the stocks generally weren’t the type to attract headlines. That changed when COVID-19 hit.
The economy essentially hit the wall, which wreaked all sorts of havoc in the financial markets. Mortgage REITs were hit particularly hard. Their assets slumped in value, which caused their banks to pull their financing. Think about what happens when you buy a stock on margin and the stock starts to fall. You get a margin call, which is a requirement from your broker to put up more cash. To meet that margin call, you must either transfer in cash from another account or sell the securities. The same exact thing happened to the mortgage REITs in late March and April.
Since none of them had the cash on hand, they all sold securities at the same time, and there were few (if any) buyers. All of the forced selling sent mortgage-backed securities into a downward spiral, which ended only when the Federal Reserve stepped in and started buying mortgages to support the economy.
What is Invesco worth?
Invesco held some of the hardest-to-sell mortgage-backed securities. The company basically sold what it could, paid off most of its debt, and now is looking to change its investment strategy. Invesco entered 2020 with a book value of $16.29 per share. As of March 31, book value had dropped to $5.02 per share. During the second quarter, the company sold off more assets, and as of late May, the company estimates that its book value is somewhere between $2.65 and $3.15 per share.
With the stock trading at $3.45 a share, the company is trading at a premium to book value. Every other mortgage REIT is trading well below book value, not above. It is critical to understand that the pre-COVID-19 chart for this company has been rendered meaningless. The company has completely changed, and unlike tech stocks, which can trade on hope, REITs generally stick around book value and are supported by their dividend yield.
Invesco really should not be trading where it is. Be careful with this one, even if it is trending at the moment.
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