Add This Oversold High-Yielder To Your Watchlist
If you’ve spent a lot of time staring at your screen over the past two weeks looking at the market with dismay, you’re not alone. I’ve spent a lot of time covering what’s happened, but more importantly, I’ve been focusing on what we can do about it.
On Monday, I gave an overview of the dire circumstances we find ourselves in due to the Covid-19 outbreak. But I also offered some hope:
There are dislocations all over the market, pricing discrepancies we never see during normal trading. Investors that keep their heads during this panic will be able to exploit them for hefty profits.
On Tuesday, I told you that rather than dwell on the negatives, I’m hard at work developing a watchlist (even offering a few preliminary names):
I’ve got my eye on oversold leaders in many sectors, from pharmaceuticals to defense contractors. There are attractive closed-end fund bargains, preferred stocks, and even municipal bonds.
In the spirit of that sentiment, I want to spend a little time today on another name you might want to add to your watchlist.
A Toll Collector For Real Estate Transactions
There is a silver lining to this market crash. The Fed has dropped short-term rates to near zero. Investors seeking safe havens have driven yields on the 10-year treasury to record lows.
You know what is linked to this benchmark instrument? Mortgage loans. Average rates for a 30-year loan recently plunged to 3.29%, a new all-time low. There has never been a better time to borrow money for a new home – or simply to refinance an existing one.
Referring to demand, the Wall Street Journal used the word “deluged”. That puts a company like Fidelity National Financial (NYSE: FNF) in the catbird seat.
This is no bank lender, so it isn’t being pinched by thin margins. Rather, FNF is the No. 1 provider of title insurance and escrow services, accounting for a 33% share of the market. If you’re a homeowner, there’s a one-in-three chance that you did business with FNF or one of its subsidiaries when you closed on your home and signed that stack of settlement documents.
Title insurance helps indemnify buyers and lenders (up to the value of the property or loan) in the event of a real estate dispute. This is one of those miscellaneous closing cost fees tacked on to the bottom of your mortgage loan. But they add up.
Inside The Numbers
At the current pace, there will be 5.46 million existing homes sold over the next 12 months. Meanwhile, another 1.3 million or so will be built. And just about every time a home is built or changes hands, title insurance will be part of the transaction.
Between title premium, escrow fees, and investment income, FNF takes in about $800 million in revenue each quarter. And this lean operation has maintained the highest profit margins in the industry for 19 consecutive years.
FNF is first and foremost an insurance company. That means damage claims must sometimes be paid. But given the extensive title search and examination process that precedes a policy, they are relatively uncommon (accounting for 3% to 4% of premiums). Most arise from unrecorded liens, incorrect property legal descriptions and hidden “defects” involving fraud and forgery.
The company maintains adequate loss reserves at all times to cover potential claims payments. Like other insurers, it also sees a lag (often several years) between the time premiums are collected and when a payment is disbursed. In between, the proceeds are invested in a diverse portfolio of interest-bearing bonds and dividend stocks that help supplement fees and underwriting profits.
Action To Take
Like a toll collector, FNF takes a small piece from every residential property sale. Could the Covid-19 outbreak put a damper on new home sales? Very possible. But as I said, FNF is also frequently called in for mortgage refinancings, which are quite popular given plunging interest rates.
As I told my High-Yield Investing readers back in December, FNF is prone to profit-taking on a market pullback. Well, that’s just what we got. And now FNF is a steal.
In terms of earnings yield (net income/market cap), FNF is trading at roughly half its five-year average. Just a few weeks ago, a $10,000 investment in this industry leader would have gotten you about 200 shares. Today, the same outlay would buy 440, more than twice as many.
Thanks to strong mortgage originations and refinancings, the company just lifted dividends last quarter to $0.33 per share – which was supported by earnings of $0.95 per share, for a sustainable payout ratio of 35%. Thanks to this selloff, that puts the yield north of 5%.