Three Stocks to Benefit from the 2013 Housing Recovery

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A month into 2013, it is becoming apparent that the housing recovery is real and likely to continue.  According to a recent Forbes article, the Case Shiller home price index shows prices are up over last year, growing at the fastest pace year over year since mid-2006.   Home prices rose 4.5% for the 10-City Composite and 5.5% for the 20-City Composite in the 12 months ending in November 2012. And Barclays expects home prices to jump 6% to 7% this year, and then another 5% to 6% in 2014.

Housing starts are expected to increase and home sales are picking up across the nation.  There is still some residual recovery that needs to occur, but that just means that there is more upside to housing related stocks in 2013. In addition, the Federal Reserve is attempting to further stimulate the market by buying residential mortgage backed securities at record low interest rates.   Accordingly, I have identified several stocks that I believe will benefit from the continuing, albeit slow, recovery in the housing market in 2013 and beyond.

The first of my 3 picks is Stewart Information Services Corporation (NYSE: STC) Stewart, as they like to call themselves now, is really a family of companies originally established in 1893 with corporate headquarters in Houston, TX.  The company’s primary business is to provide title insurance and real estate related services.  But they also own related businesses like Stewart Business Information, a subsidiary of PropertyInfo Corporation, another Stewart company.

Title insurance is where Stewart began, and now they provide a broad spectrum of services for all aspects of real estate and housing-related transactions.  In 2010, they were ranked #34 on the InformationWeek top 500 list of the country’s most innovative users of business technology.  The company operates primarily in the United States, Canada, the United Kingdom, central Europe, Mexico, Central America, and Australia.

Over the past 52 weeks the share price has nearly doubled, yet its valuation is still relatively inexpensive.  With a trailing P/E of less than 12 and a Price/Sales ratio of 0.29 the stock still appears to have good earnings growth potential.  In addition the Enterprise Value/EBITDA is only 4.17 (all figures according to Yahoo! Finance).  Year over year quarterly earnings growth is over 600% as of the last quarter reported.

Like a lot of companies impacted by the 2008 crisis, Stewart needed to do some restructuring.  But at least according to their CEO, Matt Morris, in a recent interview with SNL Financial, the company has nearly completed the restructuring process and is poised to benefit from the continued housing recovery.

The effort really allowed us not just to reduce our cost but also to change our face to the customer and hopefully become more customer-centric. The company historically was structured more geographically, and as the world got flat and end customers were not as geographically constrained, that model didn't work anymore. So we realigned our management team around our delivery channels.

It seems to be working so far.  The next earnings report is scheduled to take place on Feb. 14, 2013 and it will be interesting to see whether or not they can keep up the earnings growth.  Stewart is forecast to earn about $2.62 a share in FY 2013 (versus $2.25/share last year). 

PennyMac Mortgage Investment Trust (NYSE: PMT) is a specialty finance company that invests primarily in residential mortgage loans and mortgage-related assets. The company is established as a REIT, and thus distributes at least 90% of taxable income to shareholders. The annual dividend yield equates to about 8.5% at the current share price.  The share price for PMT has risen just over 50% in the past 52 weeks.  Yet despite the sharp rise shares are still trading at a reasonable level.

The company reported 96% year over year earnings growth in the latest quarter.  With an expected earnings growth of about 11% in 2013 (or $3.42/share versus $3.12 in 2012) the stock is still a good value at less than 8 times forward earnings.  The Price/Book ratio is also attractive at 1.34 (as of Sept 30 2012).

PennyMac specializes in troubled mortgages and has demonstrated expertise in working with lenders to maximize recovery from the foreclosure process.  The company seeks to maximize the value of the distressed mortgage loans that it acquires through loan modification programs, special servicing, and other initiatives focused on keeping borrowers in their homes. They also invest in and retain mortgage servicing rights on the newly originated prime-quality mortgage loans purchased from other mortgage originators as part of the correspondent lending business.

The trust was founded in 2009 at the height of the financial crisis.  Distressed loans available for purchase are likely to remain elevated through 2013 as the housing industry continues its recovery.  PMT is uniquely positioned to benefit from that trend.

Another relative newcomer to the mortgage service industry is Ellie Mae, Inc. (NYSE: ELLI).  Elli reported an outstanding 87% sales growth rate for the latest quarter.  The company provides software to help mortgage professionals and lenders process the reams of documents involved with loan applications.  With the overall industry trend towards cloud computing and by offering the software as a service (SAAS), the company is likely to increase sales even more as their customers realize the benefits of the SAAS model.  The company estimates that more than 20% of all mortgage originations in the United States flow through their Encompass360 mortgage management software and the Elli Mae Network.

Founded in 1997 and based in Pleasanton, CA, Elli Mae has been recognized with numerous awards and accomplishments, including most innovative and one of the fastest growing private companies prior to going public in 2011.  In 2012 they were named one of the Top 50 service providers in Mortgage Technology Magazine.

The recent growth in Elli Mae’s business has not gone unnoticed in the stock market.  The share price has more than doubled in the past 52 weeks as revenue and earnings growth have skyrocketed.   But the company has virtually no debt and a decent operating margin of nearly 20%.  With a 5 year expected PEG ratio of 0.59, the growth is expected to continue, although I would expect it should slow down somewhat as the software market matures and competition increases.  An analyst recently downgraded the stock, stating that he believes Elli Mae will have a challenging time trying to drive new growth because they already have significant market penetration.

Nonetheless, I believe that Elli Mae will continue to benefit from the housing recovery in 2013 as additional mortgages are initiated and new regulations, such as the Qualified Residential Mortgage rule, drive changing software requirements, which makes the SAAS model even more attractive to those mortgage service providers who need to adapt quickly to the changes.

EnigmaDude has no position in any stocks mentioned. The Motley Fool recommends Ellie Mae. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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