For the second quarter in a row, Wallace Weitz added to his position in Redwood Trust Inc. (RWT, Financial), which brings his firm's ownership to 7.4% of Redwood Trust's outstanding shares. Other gurus who own Redwood Trust include NWQ Managers (Trades, Portfolio) and Arnold Schneider (Trades, Portfolio).
Redwood is a somewhat unique REIT that has both a securities portfolio and a taxable securitization business. The investment portfolio owns a variety of consumer and commercial mortgage securities that generate interest income and may provide price appreciation. The securitization and whole loan platform earn fees from RMBS securitizations and residential and commercial whole loan sales. This business also generates securities that are purchased internally for the securities portfolio. The firm is internally managed and is flexible in the securities they can own, strategies they can initiate and how they want to generate fees through their securitization/whole loan platform.
Recently the stock has performed poorly, having dropped from a 52-week high of $20.43 to $12.78 as of Nov. 13. This has made the valuation much more attractive and is a significant reason why Weitz has been purchasing the stock. As he mentioned in the Q3 commentary, "We believe, however, that the market valuation of less than book value now overly discounts Redwood's future earnings capabilities."
With a book value per share of $14.69 and stock price of $12.78, Redwood Trust is currently trading at less than 0.9x price-to-book. At times within the last year, it has traded at a price-to-book multiple of greater than 1.3x. If it were to reach a 1.3x P/B multiple again at the current book value, that would imply a price of about $19.10. Also, Redwood Trust provides a high level of income generation. The stock pays 28 cents per share in quarterly dividend, which generates an 8.7% dividend yield at current prices. Assuming it takes one year for the company to trade at a 1.3x multiple again plus the 8.7% dividend yield, an investor would expect a return of over 58%. Of course it may take much longer than one year, but it does provide an estimate of the potential upside.
The stock is trading cheaply because volatile interest rates and competition have reduced profitability. Also, the company has not been able to create the desired profitability from securitizations, which have forced them to sell whole loans that are currently more profitable. With fewer securitizations, the firm has not been able to produce as many home made investments. Despite the headwinds Redwood has continued to pay its dividend and is likely to do so going forward. In the future I expect that the current industry dynamics are likely to change, which will allow Redwood to make greater profits and more home-grown investments going forward.
