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Subprimal Fears Signal a Time to Buy

Brett Arends

Ackor is an analyst for RBC Capital Markets, and the cause of his bemusement is the share price and dividend yield of a conservatively managed company he follows closely: American Home Mortgage (AHM Quote).

Thanks to the panic over subprime mortgages in the past few weeks, any stock even associated with the mortgage business has seen its price bludgeoned.

In the case of American Home, the panic's knocked it a third in a month to just $25.10 at the market close on Friday.

At these levels, the shares have a forecast dividend yield of 18.5%. That's right: 18.5%. The company is organized as a real estate investment trust, or REIT, which basically means it pays out all its earnings as dividends.

How vulnerable are those dividends?

Ackor notes that subprime mortgages made up less than 2% of American Home's business last year. And American Home chose to increase its latest dividend a week ago, even as the subprime panic was taking hold of the market. "American Home has been unfairly clumped together with the subprime originators," he argues, and "the company's decision to declare its 1Q '07 dividend of $1.12 suggests to us that business trends remain largely on track." His worst-case scenarios only see modest cuts in the dividend.

Best news of all? The insiders haven't been selling the shares. In fact, Michael Strauss, founder and chief executive, holds 9% of the stock and hasn't sold any since 2002, according to regulatory data tracked by Interactive Data Corp.

It's just one case that suggests Wall Street may, in places, have overreacted to the subprime lending fiasco and other fears that have reared their heads in the last month. Later in this column I'll discuss an ETF that could profit from the panic.

But for now, the question for subprime is how bad it is.

Dan Fuss, the veteran bond guru at Loomis Sayles, is cautiously optimistic that the aftershocks of the subprime fallout will be contained. "It's probably not serious," he says, though he says he remains watchful.

Margie Patel, junk bond manager at Pioneer Investments, takes a similar view. "At this point, it doesn't look as if the subprime problems have really spread to other areas," she says. She believes the housing market will continue to slide "for about another year" but that the rest of the economy is growing nicely and will pick up the slack.

Well, you can take your own view. Certainly it's hard to see why Citigroup (C Quote) should be worth about 8% less than it was a month ago. At $49.53 on Friday, it was 11 times forecast earnings, yielding more than 4%.

Bank of America is also down 8% in a month to $49.62, 10 times likely earnings, yielding 4.5%. Wells Fargo (WFC Quote), Warren Buffett's favorite bank, is down 6%. Surely the prices either were too high a month ago or are too low today.

Even if you take the gloomiest view on the likely economic fallout, there is value around. Ken Heebner, of CGM Focus mutual fund, is taking a deeply pessimistic view of the subprime collapse and the housing market but is still happy to hold investment bank stocks such as Merrill Lynch (MER Quote), Morgan Stanley (MS Quote) and Goldman Sachs (GS Quote).

All of which makes the iShares Dow Jones US Financial Sector Index (IYF Quote) exchange-traded fund look like an interesting play.

The ETF, which trades through the day like an ordinary share, spreads your money across the sector. Its top 10 holdings are Citigroup, Bank of America, JP Morgan Chase (JPM Quote), insurance giant American International (AIG Quote), Wells Fargo, Wachovia (WB Quote), Merrill Lynch, Goldman Sachs, Morgan Stanley and U.S. Bancorp (USB Quote).

At $112.70, the shares are down to their lowest levels since last September and yield 2.5%, according to Nuveen Investments.

If you're bullish overall, that's probably the place to buy. The great paradox of financial stocks generally is that over the long haul they have been fantastic investments, but you only get to buy them at a bargain when everyone is panicking -- and that's when you don't really want to buy them.