Has Chimera Become the Perfect Stock?
Feb 2nd 2012 10:03AM
Updated Feb 2nd 2012 10:12AM
Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Chimera Investment (NYS: CIM) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
- Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.
With those factors in mind, let's take a closer look at Chimera.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||NM||NM|
|1-Year Revenue Growth > 12%||25.7%||Pass|
|Margins||Gross Margin > 35%||100.0%||Pass|
|Net Margin > 15%||90.4%||Pass|
|Balance Sheet||Debt to Equity < 50%||184.9%||Fail|
|Current Ratio > 1.3||0.07||Fail|
|Opportunities||Return on Equity > 15%||17.8%||Pass|
|Valuation||Normalized P/E < 20||8.89||Pass|
|Dividends||Current Yield > 2%||14.4%||Pass|
|5-Year Dividend Growth > 10%||NM||NM|
|Total Score||6 out of 8|
Source: S&P Capital IQ. NM = not meaningful; Chimera has been in business less than five years. Total score = number of passes.
Since we looked at Chimera last year, the mortgage REIT has kept its six-point score. But the company's dividend has shrunk somewhat over the past year, and despite positive news from the Federal Reserve, the stock has taken a big hit.
Over the past few years, many investors have gotten acquainted with mortgage REITs. These entities borrow money at low short-term rates and invest it in mortgage-backed securities, hoping to profit from spreads between what they pay in loan interest and what they receive in mortgage portfolio income.
But Chimera's business model differs from most other REITs. Annaly Capital (NYS: NLY) and American Capital Agency (NAS: AGNC) hold only agency-backed mortgage securities, which have done better recently. Annaly saw $132 million in gains from asset sales in the past 12 months, and American Capital Agency posted a $177 million gain, but Chimera has lost $70 million in the same timeframe. Those losses contributed to the company cutting its dividend three times in the past year. Chimera isn't the only REIT that owns non-agency paper, but Invesco Mortgage Capital (NYS: IVR) has a much smaller proportion -- and it too managed to post a small net gain on asset sales.
The Federal Reserve's recent statement said that it planned to keep rates low through 2014, which gave mortgage REITs a big bump up in share price. Essentially, the assurance of low rates lets Chimera take somewhat more risk. Yet one of Chimera's benefits is that it actually doesn't have as much leverage as many of its agency-backed peers.
Still, given that Chimera will always have considerable debt on its balance sheet, the stock is about as perfect as it's going to get. Even if the stock treads water after its 2011 declines, it's on pace to deliver double-digit returns for investors based on its dividend alone. That's a good position for shareholders to be in.
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.
Chimera pays a great dividend, but if you can't afford more payout cuts, we've got some good alternatives for you. Our recently released free report, "Secure Your Future with 11 Rock-Solid Dividend Stocks," includes both stable well-known dividend payers as well as lesser-known high-yielding stocks. To access the report while it's still available, click here now.
Click here to add Chimera to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.
At the time this article was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Chimera Investment and Annaly Capital. Motley Fool newsletter services have recommended buying shares of Annaly Capital. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.
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