One of the key elements of our bullish thesis on TWO Harbors (TWO) beyond dividend coverage is buying when the stock is at a discount-to-book. Here is the thing. With interest rates rising, all REITs have been sold off hard. TWO has been no exception. While short-term fluctuations in rates matter and can weigh on performance in the near-term, it is the long-term that you should be focused on.

Book value drives the share price of mREITs in conjunction with the dividends, and of course, momentum in the sector. More importantly we like to examine book value to determine if an mREIT is at a discount, at a premium, or fairly valued.

TWO saw book value fall slightly from $16.44 in Q3 to $16.31. The stock is on a major sale here, and in many cases, the mREIT sector is offering opportunities to pick up shares at a hefty discount. TWO is one them. At the current share price of $14.30, the discount has widened pretty heavily in recent weeks. The stock now trades at a $2.01, or a 12.3% discount. That is a strong discount, even if the key metrics are under pressure and there is fear over interest rates.

Our view on the stock

TWO, along with the sector in general, is facing some pressure. As the discount-to-book widens, we become more intrigued, especially with a discount-to-book that is double digits. Make no mistake: when we see a discount being baked into prices we have to recognize why this is happening.

Right now, TWO is being taken down with the entire sector, so the Street is factoring in future hits to book value. However, we need to watch the critical metrics, and most importantly, dividend coverage. If the dividend continues to be covered, then our yield rises as the stock falls. We buy mREITs for the dividend. That is what matters most.

So with the name trading at an attractive discount, and the dividend being covered, we continue to recommend accumulating the name. We feel this discount is an opportunity. Do not buy all at once. Pick your spots and recognize that fear over rates can give us better prices. Going forward, continue to watch for dividend coverage.

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