Countrywide Financial

[adios]

I'm working up a post on Countrywide Financial (CFC). Their guidance for 2003 is between $16-$18 a share for 2003 and between $12-16 for 2004. In 2002 they earned $6 and change. They have more than a mortgage lending business but the lending business generates most of their earnings. They're trading at around $100 a share. The mortgage earnings are driven by loan production, loan servicing, and loan closing services. Loan production revenue was up big in 2003 due to refis and new loans. Loan servicing was down to the decline in what CFC calls Mortgage Servicing Rights (MSR's). CFC securiterizes a lot of the loans they originate and retain various Mortgage Backed Securities (MBS) which result from these securitizations. In a nut shell this portfolio of MBS declined in value due to mortgage prepays. Going forward as loan production decreases the earnings from the MSR's will increase. At least that's the CFC management take. The thing to do is look at the 10-Q's and determine the exact nature of the MSR's and model mortgage rates going forward to predict earnings. CFC has 20 analysts or thereabouts covering the stock so I submit that the market effeciency is reflected in this stock. For that reason alone I'd be hesitant about buying it. Still my preliminary work indicates that the CFC valuation is just too dad gummed low. Now CFC uses derivatives in hedging their interest rate risk (as do almost all mortgage lenders that I've run across) and methinks the market views this as especially risky thus the seemingly low valuation. Here's the kicker though, CFC has a very low beta which implies that the risk isn't all that great. My initial impression is that CFC has certainly gone through some sort of extraordinary earnings windfall but in the long run is probably a steady grower of earnings. I'm developing a hypothesis that the market is probably over compensating for the risk in declining earnings from a peak in earnings. I'm fairly certain that this happens a lot but don't really have enough data to back it up.

[Horrible Player]

sounds like you have the fundemental down right. Technically, this stock moved up quite fast. I would look at the 96 level (last swing low) if it holds or breaks it on very light volume (<4M) it would be a good buy with a stop sell right below this level. If it breaks it on volume, then the support level will be around 80-83

hope this helps

[adios]

The more I look at the fundamentals and the valuation the more I like it. Actually I would buy some if it did get down to $95 or so again (around the options strike price). Notice too that if it did trade at the $80 level that would be a reduction of next years earnings multiple by about one that is a PE from 6 to 5 which isn't too far fetched. I do appreciate your input btw.

[squiffy]

Hey. Look at the chart. It's at something like a 10 year high. How much longer do you think the housing market is going to be this hot. Do you remember the tech bubble?

This is a housing construction and mortgage lending bubble. I just read an article recently about how many people the mortgage lenders are laying off. Lending is tanking.

If you had bought in 3-5 years ago, yeah it would be a great buy.

But these record earnings from mortage lending are not going to continue. If the economy improves and interest rates rise, you can kiss mortgage lending goodbye.

[adios]

Guidance is between $12 and $16 a share next year giving them a forward PE of approximately between 6 and 8. Apparently you think it should be lower, something like 4 or 5? I don't care what the runnup has been and even if company will shrink in earnings they can be undervalued. I expect that CFC will grow earnings at a steady rate and as the mortgage interest environment stabilizes we'll see their portfolio of MBS generate positive earnings. Again to estimate the impact one should look at the MBS in their portfolio and model mortgage rates going forward. Given the current price of a 30 year treasury, the long term equity risk premium for stocks (if it's lower than what has traditionally been measured it makes CFC more undervalued), and CFC's beta if you extrapolate long term earnings growth at 0.0% I come up with a present value of $170 a share if I use the $12 a share, the lower end of guidance for 2003. If I put any kind of long term growth rate on earnings, the valuation is north of $200 a share. I'm assuming that $12 a share is more or less the same as free cash flow. CFC's cap ex spending is inline with it's depreciation expenses and working capital changes are more or less constant so I think that's a reasonable assumption. I'm trying to get a better handle on their cash flow dynamics.

The fly in the ointment for me is the analyst coverage but I haven't seen the ratings on the stock. Phelps Dodge, the company I posted about regarding copper has a lot of analyst coverage too so that doesn't necessarily mean a stock isn't undervalued. I'm fairly certain that the reasons you give have made investors way overly cautious on this stock. I'm not jumping into buy it yet because I want to complete my dd and I'm quite frankly doing a little market timing here as I expect a market sell off in January.

[squiffy]

I think I see what you are saying. But instead of trying to make money on the last few puffs of a stock which is clearly close to its peak, why not look for something at a record low, or recovering from a record low?

You seem to be very focused on numbers. But from my experience stock picking is 99% QUALITATIVE and 1% QUANTITATIVE.

I mean, if it's the winter time, you are going to sell more mittens. And if it's the rainy season you are going to sell more umbrellas.

I like to keep it simple.

Look at the chart for ODP. Solid company. If you bought it at 8, you would have made a mint. I bought it at 10 back a few years ago. And sold at 17. It just seems much safer to buy a solid company that is stumbling temporarily.

Or better yet, buy a solid company when there is an economic downturn or an industry-wide downturn. So you no there is nothing fundamentally wrong with the company. Just market conditions.

Why try to play with fire and squeeze out the last bit of blood from this overblown turnip.

Sure, you could make money, but why try to market time. You need to be very accurate with Countrywide. Sure they could do well for another 6 months or a year. But the longer the housing boom lasts and the higher and higher Countrywide's profits go, the more and more likely it is this boom will end.

This industry is very very very cyclical. It's not like an amazon or ebay or starbucks that will go crazy for 20 years. You have to look at HISTORY and QUALITATIVE reality.

REALITY dictates the numbers. Not the other way around. The numbers won't predict the future trend. Common sense is the only way to predict the future. And even then, you can't be very accurate.

Here is my future prediction. People will buy more office supplies from ODP, eat more hamburgers at MCD, buy more home repair supplies from HD, and buy more razors from Gillette.

Countrywide is at a peak, not a trough. You buy at a trough, not at a peak.

[adios]

I appreciate your input. Respectfully (truly) though I couldn't disagree with you more about most of your points /images/graemlins/smile.gif. The results of one investment don't justify the correctness of a strategy but with that out of the way let's keep on eye on CFC over the next 6 months to a year and see what happens. It's trading at around 77.50 currently after a 4:3 split (4 shares for every 3). To put my money where my mouth is so to speak I bought a little today.

[squiffy]

Good Luck!!!