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Tuesday, December 3, 2013 - 08:30

This Stock Soared 6,000% This Spring -- And Still Has Triple-Digit Upside

Tuesday, December 03, 2013 8:30 AM

Just as every fisherman has stories about the big one that got away, every investor has "woulda, coulda, shoulda" tales of investments that would have been wildly profited wildly if they had only purchased.

I myself have one such tale from the past year. It gnaws at my insides to think about the massive profits that I missed out on, even though I felt a strong conviction to buy. The good news is that it's not too late to jump on board.

This stock was trading near $65 in 2007 before the financial crisis knocked it down below $5. The price wallowed in the nowhere zone under $5 for several years before slipping into penny-stock territory below $1. Although this company was (and is) majority owned and controlled by the U.S. government, most investors had written it off as not viable. At one point, the stock price fell to less than a dime a share. The price collapse caused the company to be delisted from the New York Stock Exchange, relegating its shares to the over-the-counter market.

I considered buying shares in the $0.15 area, thinking that there was no place for this once-mighty quasi-government agency to go but up. All the bad news was already reflected in the price, the housing market had improved, and there was no longer chatter about the government shutting down the company. I noticed the volume picking up and the price rising -- but fear and doubt kept me from buying.

Between late March and late May, this stock rocketed from a low of $0.09 to nearly $5.50. I watched the entire 6,000% moonshot in amazement. Every $100 investment near the lows would have skyrocketed to more than $6,000 in around 60 days, an incredible return by anyone's standards. The price has since dropped back to about $2.70, but it could easily double or even triple from here.

If you haven't guessed, I am talking about the Federal National Mortgage Association, commonly known as Fannie Mae (OTC: FNMA). A $15 billion-plus company by market cap, Fannie Mae provides liquidity and stability services in the secondary U.S. mortgage market. In other words, it guarantees and securitizes mortgage loans originated by lenders in the primary mortgage market.

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Over the past five years, Fannie Mae has facilitated $3.9 trillion in mortgage credit, supported 3.4 million home loans, 12 million mortgage refinances, and 2 million units of rental properties.

Fannie Mae's financial condition has improved dramatically since the housing crisis. Over the past five years, Fannie Mae has facilitated $3.9 trillion in mortgage credit, supported 3.4 million home loans, 12 million mortgage refinances, and 2 million units of rental properties. By the end of this year, it will have paid back $114 billion to taxpayers.

After posting this type of performance and rebound, why are there lingering concerns about Fannie Mae? The U.S. government still owns nearly 80% of both Fannie Mae and its sibling firm, Freddie Mac, and most of Washington's Republicans and Democrats want the firms dismantled (and their shareholders wiped out) as part of a broader overhaul of the housing finance industry.

But at least two large hedge funds disagree with Washington's assessment and are fighting to keep Fannie Mae a viable, ongoing concern: Fairholme Capital Management (Nasdaq: FAIRX), led by Bruce Berkowitz, and Bill Ackman's Pershing Square Capital Management.

Currently Fannie's largest stockholder outside the U.S. government, Berkowitz wants to restructure Fannie and Freddie through negotiations with their stakeholders, with the goal of freeing them from government control. Ackman's firm owns a nearly 10% stake in Fannie Mae's common stock and has earned a return of 44%.

Put simply, Berkowitz wants to design a new mortgage insurer by jettisoning the old mortgages, including those in foreclosure. This book of old business would be transferred to common shareholders such as Ackman, who doesn't seem concerned by this possibility. He has said the mortgage insurers should keep the foreclosed assets, rehabilitate the homes and rent them out -- basically, become a large residential REIT.

Judging by Ackman's statement, I expect that should Berkowitz's plan be instituted, Ackman will lead the charge in turning what's left of the common shareholders' holdings into a gigantic REIT. This would be a win-win for everyone involved. Ackman has gone as far as saying that it would instantly stabilize the housing market.

Risks to Consider: The hedge funds fighting for Fannie Mae's survival are no match for the powers of the U.S. government. Although I firmly think that a proposal similar to Berkowitz's will prevail, there remains a high risk of Fannie and Freddie being dismantled, leaving the common shareholders with nothing. Always diversify and use stop-loss orders when investing.

Action to Take --> I am convinced that Fannie Mae will reach $8 within the next 12 months. Dismantling Fannie and Freddie would be too much of a headache for Washington, not to mention the shareholder blowback should such an idea become reality. Politicians usually take the path of least resistance, and that path is to maintain Fannie Mae by following a Berkowitz-type proposal. Buying the stock between $3 and $2.25 with a 12-month target of $8 and an initial stop-loss just below $1.75 makes solid investment sense.

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David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.