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Bull of the Day: Rocket Companies (RKT)

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There’s a theme to today’s Bull and Bear of the Day. The Bull is a company that’s priced at deep value level and the Bear is a company trading at nosebleed highs. The common thread between them is that their current prices seem to be a reflection of expectations that market conditions in both industries will change dramatically in 2021.

Personally, I’m betting on something closer to the status quo. That would make Rocket Companies (RKT - Free Report) an incredibly cheap way to capitalize on the low interest rate environment.

The term “disruptor” has been so overused lately that it has become an almost meaningless cliché in financial reporting. The concept certainly makes sense, but it’s far from new. Disruption has been the way that new companies have displaced old ones as long as the concept of investing has been around.

Improved technology and more efficient ways of delivering it have been improving our lives for as long as there have been opportunities to invest in the efforts of others. Efficient automobile manufacturers like Ford (F - Free Report) “disrupted” the buggy and blacksmith trades over a hundred years ago. Technology companies didn’t invent disruption, they’re simply part of the natural evolution of human innovation.

The lending industry – especially in residential mortgages – has been dependent on a great deal of human effort for a long time, but that’s changing fast. The traditional model is that a salesperson explains the available loan products to a customer, collects all the necessary information and documentation and turns the loan over to underwriters who determine that the credit of the borrower and the value of the collateral fit the risk standards of the lender.

Mortgage originators tend not to hold the loans on their own books, but rather pass them on to a federal agency or aggregate them into securitized bond products for institutional investors. The commission paid to that initial salesperson is often up to 1% of the value of the loan. The process is ripe for the savings that can be provided by technology. Computers can crunch numbers and make algorithmic decisions much faster than humans.

Mortgage products and the application process used to be more complicated than the average home buyer could readily understand. They needed that salesperson to explain it. Those times are gone. Consumers are now vastly better educated and more access to up-to-the-minute data about interest rates – as well as their own credit report. The broker is becoming less necessary and Rocket Companies is capitalizing on that trend.

Applying for a mortgage online has become extremely easy, the approval process is fast and efficient and the savings can be passed along to the consumer – or to the bottom line.

The parent company of Quicken Loans and Rocket Mortgage went public in August and saw a quick rally in share price, but has since retreated to just barely above the offering price of $18/share. Despite the fact that the housing market is extremely healthy and historically low interest rates mean that there are millions of customers who would benefit from refinancing, investors are giving RKT a 12-month forward P/E Ratio of just 6X.

That’s much lower than the S&P 500 at 28X and even well below traditional financial institutions like JP Morgan (JPM - Free Report) and Citigroup (C - Free Report) which both trade at multiples in the mid-teens.

Earnings estimates have been rising lately, but investors still expect 2021 revenues that are much lower than 2020 - and that seems to be holding the share price down.

There are a lot of macro-economic factors that will effect the housing markets, interest rates and the mortgage markets. It’s impossible to know exactly what environment we’ll be in in a year, but especially in the bond markets, it's usually a good bet to assume that the future will be similar to the present. With the US Federal Reserve committed to continue buying huge amounts of debt market assets for the foreseeable future, long -term interest rates are unlikely to rise quickly.

That’s good news for the housing markets and the mortgage business. The continued growth in the housing markets and opportunities to refinance existing properties to save money will keep mortgage customers showing up. Or, more accurately – clicking. In an environment in which people prefer online transactions to those that are conducted in-person, an efficient operation like Rocket ought to thrive.

With a rock-bottom valuation and a sustainable and scalable advantage over old-fashioned lenders, Rocket Companies is poised to exceed expectations for the foreseeable future.

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Rocket Companies, Inc. (RKT) - free report >>