Cherry Hill Mortgage Investment Corporation's (CHMI-A) preferred shares are currently trading at a 9.45% yield, which might seem appealing at first glance. However, a deeper analysis reveals that these shares carry the highest risk rating (5) among similar investments. The current market price of CHMI-A is significantly inflated, reaching 117.5% of its recommended buy target. This valuation discrepancy, coupled with a meager common equity cushion (0.92x preferred liquidation), suggests inadequate protection for preferred shareholders in adverse scenarios. Investors are advised to exercise caution and consider other, more prudently valued preferred shares and baby bonds that offer better risk-adjusted returns.
Detailed Investment Assessment of CHMI-A Preferred Shares
Our recent financial scrutiny of Cherry Hill Mortgage Investment Corporation's (CHMI) Series A preferred shares (CHMI-A) highlights a crucial paradox in the investment landscape. While the 9.45% stripped yield initially appears highly attractive, a comprehensive risk assessment, conducted by our team of expert analysts, reveals a critical overvaluation and substantial underlying risks. This assessment is based on a detailed comparison with 64 other preferred shares and baby bonds within the mortgage REIT sector.
As of recent market data, CHMI-A shares were observed trading at approximately $21.97. Despite being below their $25.00 call value, our valuation model indicates that these shares are trading at an astounding 117.5% above our recommended buy target. To be considered a viable investment, CHMI-A would need to fall to at least $18.69. Any price above $20.43 is deemed excessively high given the associated risks.
A significant factor contributing to this high-risk designation is CHMI’s relatively small size within the mortgage REIT sector. While size alone does not dictate investment quality, it is an important consideration. Among agency and hybrid mortgage REITs, Cherry Hill is the smallest entity we track. Furthermore, CHMI-A carries a risk rating of 5, which is notably higher than the common shares (4.5), reflecting the more stringent evaluation criteria applied to preferred shares due to their generally lower volatility.
A critical component of our risk evaluation is the common equity cushion, which serves as a protective buffer for preferred shareholders. In the event of financial distress, preferred shareholders have precedence over common shareholders. A robust common equity cushion indicates a company’s ability to absorb losses before impacting preferred share value. Unfortunately, CHMI’s common equity relative to preferred liquidation stands at a mere 0.92x. This is starkly contrasted with peers like Annaly Capital Management (NLY), where the ratio is a much healthier 7.02x, underscoring the inadequate protection offered by CHMI-A.
Recent corporate developments also warrant attention. On , CHMI and TPG Mortgage Investment Trust (MITT) announced a definitive merger agreement. Under this agreement, each CHMI-A share is slated to convert into a newly issued share of MITT’s Series D preferred stock. However, our analysis indicates that MITT preferred shares are also significantly overpriced and carry an equally high-risk rating of 5, suggesting that the merger may not mitigate the inherent risks for CHMI-A investors.
Our investment philosophy advocates for dynamic portfolio management, involving strategic swaps between preferred shares and baby bonds as market conditions and relative valuations evolve. This approach ensures optimal risk-adjusted returns and capitalizes on market inefficiencies. For most investors, particularly those with a conservative risk profile, the current valuation and risk level of CHMI-A make it an unsuitable choice. Even if the price were to align with our buy target, the elevated risk profile would still necessitate a very high-risk tolerance.
The current market offers a plethora of preferred shares and baby bonds that provide superior value and more robust protection. We strongly recommend investors explore these alternatives rather than committing to CHMI-A at its current inflated valuation and inherent high risk.
The present assessment of Cherry Hill Mortgage Investment Corporation's preferred shares offers a poignant lesson in investment due diligence: a high yield does not automatically equate to a sound investment. The critical takeaway is the imperative to look beyond superficial attractiveness and delve into the fundamental risk factors. Investors are constantly bombarded with opportunities promising significant returns, but without a thorough understanding of the underlying risks, these opportunities can quickly turn into pitfalls. This situation highlights the importance of comprehensive research, comparative analysis, and a disciplined approach to valuation. It underscores that true investment wisdom lies in discerning not just what to buy, but also what to avoid, particularly when better-valued alternatives exist with more favorable risk-reward profiles. Ultimately, this scenario reinforces the timeless principle that capital preservation, especially in volatile market segments like mortgage REITs, should always precede the pursuit of outsized, but precarious, returns.
