2 best stocks you can buy on sale
With the stock market trading at record highs, it’s hard to find pockets of value. Almost all businesses have a price for perfection. But investors still find at least one industry unappealing: mortgage origination, the business that allows people to buy homes. Two of the biggest lenders in space-Rocket (NYSE: RKT) and UWM Holdings (NYSE: UWMC) have characteristics that make them leaders in their respective markets. These stocks are the most important in their respective spaces, which gives them the best chance to dominate the market in the future.
Mortgage originators help people finance a home
Mortgage originators assemble the loan for a potential buyer or owner. Unlike banks, which view mortgages as investments, companies like Rocket and UWM Holdings typically don’t hold onto the loans they make. They will make a loan, sell it for more than the amount they loaned – since whoever buys the loan from them will benefit from a constant stream of additional interest payments from the borrower for years to come – and pocket both that profit, and the roughly $ 2,000 in fees they charged the borrower for making the loan in the first place.
In this way, mortgage originators earn their money up front; banks, on the other hand, earn their money in the long run by collecting payments from the borrower. This means that mortgage originators thrive when many people take on new loans or refinance old ones. Right now, investors are worried about rising interest rates, which makes loans more expensive and less attractive to borrowers. The market is concerned that mortgage originators will suffer if fewer people take out new loans or refinance their existing loans.
But even in a tougher environment, Rocket and UWM Holdings (aka United Wholesale) could still hold up. They’ve made massive technological investments in their businesses, which makes it much easier and cheaper for them to issue – and profit from – new loans. The two companies overlap, but Rocket is best known for its direct-to-consumer loan model using its app. UWM Holdings interacts with loan brokers, not individual borrowers.
Rocket’s app allows him to avoid one of the biggest expenses initiators pay
Rocket is best known for his slogan “push button, get a mortgage”. Its secret sauce is its app, which makes it extremely easy for consumers to get a mortgage. While the app is very convenient for the borrower, it also gives the company a big cost advantage over other mortgage lenders. Mortgage originators spend a lot of money – from 0.5% to 1.75% of the loan amount – paying the loan officers who work for them to find clients and set up loans. On a typical mortgage of $ 300,000, this can add up to $ 5,250. When its customers interact with an app instead of a person, Rocket does not have to pay these fees, allowing it to generate more profit per loan than its competitors.
In 2020, Rocket’s pre-tax profit as a percentage of its volume was just under 3%, well above all other listed mortgage bankers. Rocket invests heavily in related businesses such as title insurance, auto loans and real estate sales. These other lines of business will help alleviate the feast or starvation nature of the mortgage industry, which otherwise keeps stocks in this industry at low multiples. Rocket is trading at just under 8 times the expected earnings per share in 2021. Rocket is getting a multiple of premium over its competitors, which are trading in the mid single-digit, but its technology guarantees it. That said, if interest rates rise, its profits in 2022 could turn out to be lower than in 2021.
United Wholesale’s technology works for brokers
United Wholesale has a different slogan: “Brokers are better. These are mortgage brokers – essentially, loan officers who have the ability to work with multiple lenders to find each borrower the best product at the best price. Very few lenders are good at offering the best rates for each product, so a broker who knows which lenders prefer certain types of loans can usually help borrowers find great deals.
United Wholesale’s secret sauce is its technology, which gives the loan broker great visibility into how the loan is put together. Since the broker does not actually constitute the loan (United Wholesale does), the broker is free to spend this time looking for additional clients, which gives United Wholesale another advantage. Its technology also means that the company can issue loans at a much lower price than most of its competitors, which also translates into high profit margins. Last year, United Wholesale’s profit per loan was 1.85%, which was lower than Rocket’s but higher than other major publicly-listed mortgage bankers. United Wholesale trades at 10 times expected earnings per share in 2021, but is expected to increase earnings in 2022.
The low multiples of these two companies reflect the highly cyclical nature of the mortgage banking market. That said, you can buy two of the highest quality companies in the industry for a high single-digit multiple. Their technology investments are hard to replicate, and many lenders haven’t been able to create an app as powerful and popular as Rocket’s “push button, get a mortgage” approach. As for United Wholesale, brokers love its visibility and low costs, and they love the way the business focuses solely on brokers and sees them as its customers. These advantages give both companies an advantage that their competitors cannot easily replicate. Given their sustainable business models, Rocket and United Wholesale appear likely to retain their position as two of the top originators in the United States, which could benefit long-term investors.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.