I recently bought about 2k shares of Fannie Mae common stock. It seems like the ultimate rabbit hole stock. There are so many factors to consider in the valuation of the company, that just doing the research on it can take up a whole day.

It has a beta of 3. Which means it has 3x the normal volatility of the S and P 500. So daily moves of 5 percent either way are standard. It also trades with strong volume. In many ways it's almost as good of a day trading stock as Bank of America(BAC).

The question I am trying to answer is what is it worth right now considering all the risks? My opinion is that if you consider all risk factors that the market is highly undervaluing it. Like if someone were to make this bet 100 times how far would be they be ahead/behind if they paid the current market price?

why don't you start by posting why you think it is seriously undervalued.

Yeah I'm reasonably sure that the number of people on this forum who could even successfully pretend to give you an intelligent answer is <=1. I'm certainly not one of them.

Also stop using beta to measure anything fundamental.

So you are saying volatility has nothing to do with fundamentals?.

Well OK I will give it a shot. It has to reduce its assets to 250 billion dollars by 2017 if nothing changes and housing reform doesn't pass as part of its recently amended conservatorship agreement. It's been tasked with helping to create a mortgage trading platform "of the future" by its regulator FNMA. President Obama is about to appoint a new person to run the FNMA.

They just declared a record profit last quarter and they anticipate being profitable for the foreseeable future. They currently owe the Treasury 117 billion dollars. That amount is a floating amount that goes up and down depending on how much funding the company needs to deal with losses.

As part of the bail-out the government has a warrant to purchase 79.9 percent of the common stock of the company for something like .000001 cents a share. The option is dilutive to current shareholders but does not force them to vacate their shares. There are currently about 1 billion shares outstanding. If the warrant is exercised that amount would change to 5 billion shares outstanding. It is unclear what affect this would have on the preferred shares that already exist. There is no provision to modify those shares if the warrant is exercised.

The Treasury has the option of ending the conservatorship without exercising the common stock warrant.

It does not seem likely that Fannie Mae can reduce its balance sheet to 250 billion by 2017. If somehow they were able to do that they would still be getting the fees from all the mortgages they have guaranteed.

There is also the issue of what Congress intends to do. Legislation by them could seriously alter the housing market. There exists a chance that shareholders of the company could be wiped out completely if legislation passes that somehow forces it. I do not see why they would do that but you never know. I put the odds of common stock holders being wiped out at less than 30 percent. I think the odds of them being wiped out in the next 3 years are zero.

The most likely situation is that they continue to be profitable and their balance sheet is allowed to increase in order to help the FED unmind its mortgage backed securities. I believe some compromise will be made that allows for a more expanded secondary market.

So let's take the very unlikely option where they are able to reduce their balance sheet to 250 billion dollars by 2017 and then the Treasury exercises its option and dilutes the common shareholders. In that situation Fannie Mae should have earnings with its guarantee fee's of at least 2 billion dollars per quarter. I would put their value at that point at 10 x earnings. Because it will be a fresh start for them. That puts a value of the company at about 80 billion market cap at that point. Take 20 percent of that amount and you get a share price of 16 dollars per share in 2017 under that situation.

That situation is pretty much the worst case scenario outside of the shareholders being wiped out. There are plenty of other scenarios that I think are much more likely where the common stock is worth as much as 40 - 100 dollars a share if they happen.

Right now the common stock trades at .81 cents a share. Even if you think there is a 50 percent chance that the shareholders get wiped out you could just reduce the future share price by half to account for the risk. So for that you get a future expected value of 8 dollars in 2017. Let's say you want a really healthy return of 30 percent per year to take the risk of holding the stock for 4 years. That puts the present value of the common stock at $2.80.

Volatility is a stock metric, not a fundamental metric.

Fundamentals:
Sales to enterprise value is horrific.
Earnings to enterprise value is horrific.
Debt to equity is horrific.
Debt to capital is horrific.
Book value per share is horrific (mostly because it has a negative book value).
Sales growth is negative.
All earnings must be paid to preferred share holders (the government).

Could be a fun buy if you live in a state that doesn't have lottery.

The bold is the key to your valuation and seems to involve a lot of hand waiving. How are you calculating this expected income of $2 billion per quarter?

It's interesting how you mentioned at least four statistics that aren't even relevant to the situation. Yes volatility is a stock metric but the reason for volatility is often influenced by the fundamentals. I do not understand your need to make a clarification of something that I had no confusion about. You assumed I did because I mentioned the volatility of the stock as well as the fundamentals of the stock.

I mentioned both things because the volatility of the stock can be influenced by fundamentals and it might be a indication that the stock is mispriced by the market because they can't quantify the risk of it on a fundamental level.

The statistics I mentioned are exactly how you judge whether a stock is overvalued or undervalued using fundamentals.

I mentioned the volatility not being a fundamental thing simply because I thought you didn't know. Mostly because of your choice of wording. Do you get offended often when people tell you things that you already know?

In this case, it isn't likely to be the case. It has had a couple of really big moves recently on news (the big one being the positive change in how they are paying out dividends to the government instead of consistently paying them 10% and getting deeper in the whole). Big moves mean big beta, even if those moves are rare and completely news driven.

On your lengthy analysis of the stock and company, would you like me to critique it or just tell you that it is a for sure 10 bagger?

Positive Factors:

1. Just settled with Bank of America in January for 10 billion. Lawsuits pending against 12 other large banks. Likely outcome are settlements of at least 30 billion.

2. Pending LIBOR related lawsuits. Likely settlements in the 2-10 billion dollar range.

3. Readjustment of the preferred share dividend from 10 percent to a situation where they have to give all of their profits over to the Treasury.

4. As of last quarter they now have a positive book value and achieved record earnings last quarter.

5. Appreciation of REO property and far easier disposition of that property with an estimated current market value of 10-15 billion.

6. Increase in home values in most major cities of about 6 percent on an annual basis means less homeowners underwater.

7. An increase in guareetee fee percentages allowing for a less risky portfolio long term.

8. Extremely stringent underwriting in loans it has retained since 2009 with a net failure rate of under 1 percent.

9. Borrowing costs at 10 basis points above the 5 year Treasury rate. Making their net interest margin very favorable. I estimate their net interest margin is somewhere around 2 percent on their current 3 trillion plus portfolio giving them potential net cash flow of 60 billion dollars per year.

10. Much lower cost basis than Bank of America with almost twice the number of assets. Bank of America trades at 34 times earnings and even with their massive litigation costs they earned over 2 billion dollars last quarter(they just reported earnings).

11. Fannie Mae says that it is likely that they will declare an approximately 62 billion dollar 'tax deferred asset' and will release that money as a dividend to the Treasury.

12. Politically there will be pressure on the congress and the Treasury to modify the terms of the agreement as the obvious profitability and payments to the Treasury make it unfair to continue the conservatorship based on the regulations and spirit of it. The conservatorship has been highly effective in getting the desired result. Fannie Mae easily has the borrowing capacity right now to entirely pay back the government by issuing bonds in the debt market. Housing finance reform does not require for the GSE's to be broken up for reform to happen.

13. Possible lawsuits by shareholders if the amount paid to the government is excessive and undermines the intention of the conservatorship. I expect that within 3 quarters that stockholders and employees will become much more vocal in their opposition to the structure of the conservatorship. The company and employees deserve a payoff for all their hard work. Half the people that work at the company currently are an entirely different group of people than when the conservatorship started.

14. I argue it is impossible,impractical,irresponsible, and unnecessary to reduce the size of Fannie Mae to the point that it has only 250 billion dollars in assets by 2017. The assets they are buying are fully available to other banks in the market. They are going to be absolutely vital as a one way trading partner with the Federal Reserve and the rest of the market for mortgage bonds that the banks and the Fed need to sell. Without the GSEs access to favorable borrowing costs by their affiliation with the government and their willingness and ability to carry loans on their books in a non mark to market pressure situation, paper losses to banks and the FED when interest rates are increased could be substantial.

You still haven't told me whether you just want us to all make you feel good about your bet or not. I'm assuming that you want criticism. If I am wrong, just delete the rest and "it is a ten bagger for sure" is fine with me. It isn't like it is a thinly traded stock, so I can't imagine that you want to try to pump it.

2. Pending LIBOR related lawsuits. Likely settlements in the 2-10 billion dollar range.[/quote]

Both positive. Reduces their debt from approximately 3.1 trillion to approximately 3.1 trillion.

Absolutely agree. That is already priced in. I am sure you saw the jump in share price.

They still have a negative book value and it isn't even close. It was not a records earning season for them. Look back more than 3 years.

3.1 trillion in debt will get reduced (if they sell all of them at book value) to approximately 3.1 trillion dollars. Getting better though.

Huge. Increases like that will eventually (10 plus years from now) get them to positive book value if they are consistent.

They have to sell most of their portfolio.

Untrue.

They are writing 15 and 30 year fixed loans on 5 year borrowings. As long as there is no interest hikes this is fine. With the leverage they have though, any retracement will crush them.

10. Much lower cost basis than Bank of America with almost twice the number of assets. Bank of America trades at 34 times earnings and even with their massive litigation costs they earned over 2 billion dollars last quarter(they just reported earnings).[/quote]

Earnings after paying the government will be zero for the foreseeable future. Their only way out of being under the thumb of the treasury is by paying back principle.

That already happened (they didn't do so). Dividends do not get them out from under the thumb.

Such political pressure will never happen.

Won't happen. Ever. Not in a meaningful way at least (just in case you were going to launch a failed shareholder attack).

It is still going to happen. They will most likely be wound down (Freddie and fannie) and the normal markets will take over. To do otherwise would require an act of congress. Congress doesn't seem to be able to agree on minutia.

****

On the other hand, I could be wrong. I'm not on the current details. It is possible that my view of the future is a bit off. Haven't been in the future yet.

Both positive. Reduces their debt from approximately 3.1 trillion to approximately 3.1 trillion.



Absolutely agree. That is already priced in. I am sure you saw the jump in share price.



They still have a negative book value and it isn't even close. It was not a records earning season for them. Look back more than 3 years.



3.1 trillion in debt will get reduced (if they sell all of them at book value) to approximately 3.1 trillion dollars. Getting better though.



Huge. Increases like that will eventually (10 plus years from now) get them to positive book value if they are consistent.



They have to sell most of their portfolio.



Untrue.



They are writing 15 and 30 year fixed loans on 5 year borrowings. As long as there is no interest hikes this is fine. With the leverage they have though, any retracement will crush them.

10. Much lower cost basis than Bank of America with almost twice the number of assets. Bank of America trades at 34 times earnings and even with their massive litigation costs they earned over 2 billion dollars last quarter(they just reported earnings).[/quote]

Earnings after paying the government will be zero for the foreseeable future. Their only way out of being under the thumb of the treasury is by paying back principle.



That already happened (they didn't do so). Dividends do not get them out from under the thumb.



Such political pressure will never happen.



Won't happen. Ever. Not in a meaningful way at least (just in case you were going to launch a failed shareholder attack).



It is still going to happen. They will most likely be wound down (Freddie and fannie) and the normal markets will take over. To do otherwise would require an act of congress. Congress doesn't seem to be able to agree on minutia.

****

On the other hand, I could be wrong. I'm not on the current details. It is possible that my view of the future is a bit off. Haven't been in the future yet.[/QUOTE]

I wasn't looking for someone to agree with me. Of course I wouldn't mind them being swayed by my argument, but I realize that everyone is going to have their own opinion. What do you think it is worth per share? Does the market have it right?

What do you think it is worth? It would take me awhile to break down my entire reasoning behind that situation. I think that situation is very unlikely anyway because I don't see how it is even possible for them to get their assets down to 250 dollars and still accomplish all their other goals. It almost seems like they are giving them an impossible set of goals just to be sadistic.

It isn't horribly mispriced as far as I can see. With how leveraged it is, it could move quite quickly in either direction.

I got some before it rose and am holding. The question you should be asking is it going to survive, are the bankers going to kill it, and is the government going to let it live? The preferred debt pay 8.25% interest which is very high considering the other bailouts, which makes me think someone wants to kill it.

But I put the price target at $20, or $0 if they decide to kill it. Hopefully they kill it.

Well if you are buying it and holding it why would you want them to kill it?

It is a form of socialism. I don't want the government involved in real estate lending. I'd rather take the loss.

Way to stick to your principles. Idiot. Kidding.

I never try to predict what the markets will do next, but I am predicting that you will get a long article length rant as a reply to this.

The common stock will be worthless at some point.

This is a really good research report by the Congressional Research Service about Fannie Mae and Freddie Mac. that came out in February 2013 and I just found it about 2 hours ago. http://www.fas.org/sgp/crs/misc/R40800.pdf

I disagree but I would like to know why you have this perception.

No. Beta isn't remotely tied with the fundamental health of a business. Fundamentals are about the real world business you want to buy. Beta is the price volatility of the stock of that company. Those two measurements are barely correlated. (and that is literally only because some events that affect the price can also effect the underlying business. But not usually anywhere near to the same degree... Which means when they move together it's usually not close to proportional)

If you're using beta and asking people what a potential investment is worth you need to close all of your positions and learn more about investing and trading. I'm 100% sure that you have some fairly major basic flaws in your understanding of investing.

I never kid about steelhouse being an idiot.

Financial institutions like FNMA are in a totally different class than any other type of stock. They exist in a strange regulatory space where they are able to hide all sorts of stuff with bizarre reporting requirements. Basically the balance sheet, income statement, and pretty much every other part of a financial institutions 10k is highly questionable. Because the people writing these documents have a strong incentive to put their best foot forward you can be virtually certain that reality will be worse than what you see on paper.

I spend a fairly large amount of time reading 10k's and 10q's... So I've seen a few thousand of them. Saying that the banking ones are relatively complex is a huge understatement. There are VERY few people who are qualified to value a large financial institution with complete access to everything, and zero people who are qualified to value one based on their publicly released information. Always remember that SEC disclosures are for little people not the masters of the universe. They hire a lot of great lawyers and lobbyists to make it so.

EDIT: I just want to point out that I'm not suggesting that you don't know any of this Brian. You made me actually lol with "Both positive. Reduces their debt from approximately 3.1 trillion to approximately 3.1 trillion."