High dividend stocks – Analysis of AGNC’s income account Part 1

 August 23rd, 2010

 

AGNC’s income statement must present a fair and undistorted picture of the year’s operating results if we are to use it as a basis for investing our capital.  We all still remember the lies of Enron, MCI WorldCOM, and the entire banking industry’s loan write-downs.  You can’t just trust the income statement just because they were audited.  Enron was audited by the spineless liars such as Arthur Anderson.  You may need to critically examine and adjust the numbers with respect to three important elements:

·         Nonrecurrent profits and losses

·         Operations on subsidiaries or affiliates

·         Reserves

 

Remember that our purpose of analyzing the income statements is to learn:

What are the true earnings of AGNC for the period studied (May 2008 – present)

What indications does the earnings record carry as to the future earning power of AGNC?

What elements in their earnings exhibits must be taken into account, and what standards followed, in endeavoring to arrive at a reasonable valuation of AGNC’s shares?

 

AGNC’s management has considerable leeway in the method of treating nonrecurrent items.  Accounting procedure allows this.  Transactions applicable to past years (2008 and 2009 for AGNC) should be excluded from current 2010 income and entered as a charge or credit direct to the surplus account.  However, there are many kinds of entries that may technically be considered part of the current year’s results, but are nonetheless of a special and nonrecurrent nature.  Accounting rules permit AGNC’s management to decide whether to show these operations as part of the income or to report them as adjustments of surplus.  The following are a number of examples of entries of this type:

1.       Profit or loss on sale of fixed assets.

2.       Profit or loss on sale of marketable securities.  (This surely applies to AGNC.  We will have to examine this portion of their income statements carefully.)

3.       Discount or premium on retirement of capital obligations.

4.       Proceeds of life insurance policies (This is probably not applicable to AGNC).

5.       Tax refunds and interest thereon (We’ll check to see if they received any tax refunds and interest)

6.       Gain or loss as a result of litigation (We’ll find out if there is any).

7.       Extraordinary write-downs of inventory (Maybe).

8.       Extraordinary write-downs of receivables (I don’t think this has happened yet.  But, definately if Fannie and Freddie can’t guarantee MBS principal and interest payments to AGNC)

9.       Cost of maintaining nonoperating properties (not applicable – this happens more with manufacturing and mining)

 

Our object is to segregate all these items from the ordinary operating results of the year.  We really want to learn from the annual report and 10-K filings what AGNC’s indicated earning power is under the given set of conditions.  All these extraordinary items need to enter properly into our calculation of earning power as actually shown over a period of years in the past.  AGNC started operating its business in May 2008, so there isn’t much history for this company.  One of its competitors Annaly Capital (NLY) has been around much longer.

 

AGNC has no controlled or affiliated companies, so we don’t have to adjust reported earnings for this category of analysis.

 

Lastly, we must give critical attention to the matter of reserves for depreciation and other amortization, and reserves for future losses and other contingencies.  If the government changes the laws regarding Fannie Mae and Freddie Mac or the FED buys or sells MBSs, then AGNC can suffer huge future losses on the value of their agency securities.  We need to check this out carefully.

 

If you missed the beginning of the analysis of AGNC, then please visit www.myhighdividendstocks.com to read the last couple of posts.  I selected AGNC for high dividend stock analysis because it has a whopping 20% dividend yield.  Should you buy it, sell it, or stay away?  You’ll find out if you stick around for the next few weeks.

 

Be seeing you!

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Published in: on August 23, 2010 at 7:02 pm  Leave a Comment  

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