Fannie Mae update (FNM)

Yesterday, I mentioned that Fannie Mae as a stock to look out for. Today, I did a slightly more in depth analysis of FNM.

First, and most importantly, the book value of FNM is an unbelievable -$60! Even at the current price of $1.20, by book value it is still not a bargain. Besides that, the annual EPS estimate for December 2009 is -$10.53. Data obtained from Yahoo! finance.

To obtain a rough estimate of the future EPS after the recovery of the housing markets, I averaged the earnings per share of FNM for 8 years, from 1999 to 2006. The average P/E for those 8 years stands at about $5 per share. Data obtained from MSN Moneycentral and MarketWatch.

In other words, in the most optimistic senario, it's going to take FNM almost 12 years just to bring it's book value back to $0. I don't know about your investment timeframe, but I think there should be better investments elsewhere.

However, perhaps some positives for FNM are income tax deductions due to it's losses, setting it up for a potential asset play in the future. Besides that, the real estate backing its mortgage securities are still worth something, and perhaps in a few years when housing prices pick up again, FNM book value would also recover some of the losses.

In summary, I'm keen on scouting out other easier and more clear cut bargains. However, FNM has the benefit of never going bankrupt and has the potential of being a future turnaround. Besides, the technicals may give a clear signal if, and when, it breaks out above resistance.

(Disclosure: I do not hold any FNM stock at this point in time)

Fannie Mae (FNM)

Are the US-government mortgage securitization agencies worth a look? As determined yesterday, the financial sector was the worst performing sector over 2 years, and the mortgage-backed securities probably had a huge contribution to the deterioration.

However, intuitively, I have made a few assumptions. One is that these agencies have fallen so much, they have probably already discounted the worst possible news. Secondly, these are US-government backed agencies, and are unlikely to go out of business.

Next, the securitization of mortgages are in my opinion still an essential financial instrument. With mortgage backed securities, there would be a larger supply of capital to fund mortgages, instead of it being limited solely to the neighbourhood commercial banks. The only problem occurs when mortgages are leniently granted (sub-prime) as the risk will be passed on to other parties. So, I believe in the long-term, mortgage securities are here to stay, unless the government explicitly restricts their operation.

That being said, let's look at the Fannie Mae (FNM) 3 year daily chart.

3 year daily chart of FNM
Source: StockCharts.com

FNM has suffered a huge drop in price. However, there seems to be some sign of life now. First, we have been seeing higher lows, one in December 08, another in March 09 and one more in July 09. Next, recently FNM has been testing the high set in December 08. Thus, FNM is currently consolidating, showing that it has stopped dropping, and there is a possibility of breaking out.

Fundamentally, there has been some positive news recently about FNM. Firstly, the housing market is showing some firming, with July home sales surging 7%. Besides that, the Fed has just bought a record $5.6 billion of agency debt yesterday, which can be interpreted as a sign that the government will not let Fannie Mae fail.

All in all, FNM goes on my watchlist. I would see a buy signaled when the management of FNM details a recovery plan and a change in business strategy to prevent housing bubbles, or to minimize the impact of a housing bubble. Technically, I might buy when prices break out strongly from the current consolidation.

(Disclosure: I do not hold any FNM stock at this point in time)

Market and Sector Overview

For me very first blog entry, I will be looking at the big picture. I'll first look at the S&P 500, and then do some basic sector analysis.

Here's a chart of the S&P. Dow Theorists signaled a probably long entry in June 2009 and a definite buy when price broke above the intermediate high set at the start of 2009 in mid-July 2009. More important for our purpose, the S&P has been in a bear market, dropping from a high of 1303 to 666. This means that stocks are relatively cheap at this point in time.

1 year daily chart of the S&P 500
Source : StockCharts.com

The next step would be to verify the "cheapness" of equities.The P/E ratio and dividend yield are probably the 2 best indicators to use here. Taking data from the article S&P P/E Ratio Is Low, But Has Been Lower, we can immediately see that the P/E is at the lower range of the spectrum. According to Yahoo finance, the current P/E of the S&P is around 14.

S&P 500 monthly P/E Ratio
Source: Prof. Robert J. Shiller

Besides that, the dividend yield for the S&P 500 is also decent, according to NYU. Again, according to Yahoo finance, the current dividend yield is approximately 2.7%.

S&P 500 Yearly Dividend Yield

Source: NYU

It is simple to conclude that stocks as a whole are cheap, and there should be plenty of bargains available for the investors who are careful and thorough.

Next, we move on to sector analysis. To make things simple, I used the S&P Sector SPDR PerfChart feature from StockCharts.com. Of the ten sectors, the 3 most underperforming sector over 757 days (~2 years) are financials, industrials and consumer discretionary, with financials the clear underperformer, at -30% return relative to the S&P. Industrials and consumer discretionary matched the S&P with relative returns of just above 0%.

S&P 500 Sector SPDR PerfChart for 757 days

Source: StockCharts.com

To wrap up my first blog entry, prices have dropped over the past two years, and have broken previous highs recently, showing that it’s a good time to buy. Fundamentals are also strong, with the low P/E ratios and decent dividend yield. Treasuries are yielding close to 0%, so bonds are probably an unattractive investment. Therefore, stocks present a prudent investment at this time.