Mortgage Matters...

12/03/2004 12:00 am EST


John Dessauer

President, John Dessauer Investments, Inc.

"The mortgage-refinancing boom is over and we are now in a normal home-purchase market," notes John Dessauer . "In this post-refi world, our housing stocks can shine by proving they are the best in their field." Here’s an overview of his favorites.

"Countrywide Financial (CFC NYSE) recently fell sharply on news of lower earnings. Third-quarter earnings were $0.94 a share, down from 2003’s third quarter, at $1.93. What was ignored was that the third quarter of 2003 had been an anomaly, as the refinancing boom produced extraordinary earnings. What we now see is a realistic base, from which Countrywide can grow earnings into the future. Meanwhile, Wall Street sees no growth prospects at all. As such, Countrywide can beat Wall Street expectations because they are so low. For many years, Countrywide’s p/e was ten or better. When the refinancing boom came along, their p/e shrank. Now that the refinancing boom is over and we see more normal housing markets, Countrywide should trade at ten times earnings or better. That means the stock should be around $40, based on this year’s earnings. Management also raised the dividend 20%, to $0.12 a quarter. Over the next 6–9 months, Wall Street will begin to see Countrywide’s strength, which should generate higher estimates. Countrywide is a Buy.

"IndyMac (NDE NYSE) also recently took a dive. Earnings came in at $0.88 on a pro forma basis, meaning 2004 guidance is now down to $3.38, and 2005 guidance is $3.98. The downward revision in earnings is due in part to changes in the mortgage market, as adjustable rate mortgages are not as plentiful as they used to be. That increases competition and pressures industry profit margins. Meanwhile, IndyMac’s business plan targets increasing market share in a normal home market, and on that score, they had a superb quarter. Earnings near $4.00 in 2005 will mean a 19% compound annual growth rate since 2002. Wall Street is skeptical that IndyMac can achieve its goal of earning $8 a share in 2008. Michael Perry, CEO, and his team have done a superb job over the last several years. Even if they only reach $7 in 2008, that will beat Wall Street expectations. Meanwhile, the dividend has been raised to $0.34 a share per quarter, meaning the yield is a handsome 4.2%. IndyMac is a Buy.

"Unlike our other mortgage plays, First American (FAF NYSE) reported third quarter earnings that were well above Wall Street’s expectations. Better-than-expected earnings are due to its FAST technology—which makes title searches far more efficient—plus acquisitions and diversified credit-related businesses. For the full year, First American could earn $4 a share, far above earlier expectations. Wall Street has a hard time figuring out the company’s ‘base earnings’ and how fast they can grow those earnings. As a result, their longer-term estimates appear way too pessimistic. In my view, First American has a solid business plan and has done a good job executing its plan. As time goes on, core earnings growth will become visible. Book value is $26.79 and rising. There is also a stock buyback program, dividend, and an earnings yield over 10%. FAF is a Buy."

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