Don't Worry About This Company's Astronomical P/E

Jon is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Walter Investment Management's (NYSE: WAC) price-to-earnings ratio is simply astronomical--it's currently north of 11,000! However, if you think that this company is grossly overvalued, you are wrong. In fact, this company could be a very real value opportunity.

The business

Walter operates in a sector that many investors would like to avoid: mortgage investment. Unlike a high-yield mortgage REIT, this company is a mortgage servicer for high-risk loans. These kind of loans were a contributing factor in sinking banks during the financial disaster of 2008. While banks are steering clear, other companies are specializing in this sector and profiting.

WAC Revenue TTM data by YCharts

Revenue for the most recent quarter was $235.9 million -- more than double last year's $105.4 million. Net income came in at $27.7 million, compared to just $5.1 million a year ago.

With this growth, the company has necessarily taken on considerable debt. Long term debt currently stands at $4.25 billion, and the company also has a cash position of $1.36 billion.

Why the drop?

Shares of Walter are currently down 32% from February highs. The drop is puzzling, since the company issued full year earnings guidance between $650 million-$725 million, handily exceeding analysts' expectations.

Perhaps investors were worried about the Home Affordable Refinance Program coming to an end. Those worries have been laid to rest now that the HARP program was renewed in April and extended to December 31, 2015. The favorable refinance legislation benefits companies like Walter by allowing people to refinance their mortgages who would otherwise be ineligible. It seems the company has at least two favorable years of growth left.

The value

Walter Investment's P/E ratio may be astronomical, but its forward P/E of just 5 (!) forced me to take a second look.

Company Market Cap Forward P/E Debt Cash Debt/Cash Ratio
Walter Investment $1.25 billion 5.37 $4.25 billion $1.36 billion 3.1
Nationstar $3.33 billion 5.8 $5.19 billion $581 million 8.9
Tree.com $193 million 12.51 n/a $102 million 0

Tree.com (NASDAQ: TREE) is coming off of a very solid quarter in which the company realized revenue growth of 17% year-over-year. Continuing with the success, this lender has now upped its revenue guidance for 2013 to 20%-25% year-over-year. Tree.com's cash position coupled with zero debt also look to position the company for solid growth going forward. 

Management did caution investors about thinning margins next quarter due to an advertising campaign. The stock could come under some short-term pressure, in which case it would be a good time to get in.

Mortgage servicer Nationstar Mortgage Holdings (NYSE: NSM) has increased both its 2013 and its 2014 earnings guidance. The company now expects to earn $4.05/share this year and $6.45/share next year. Both of these numbers are on the low end. While the future earnings valuation of Walter and Nationstar are virtually the same, Walter has a much better debt/cash ratio -- 3.1 vs. Nationstar's 8.9 -- which I think puts it in a better financial position.

As it is, Walter compares well to its peers. But Vice President Denmar John Dixon hinted at something even better, saying, "Remember, this guidance is based on only portfolios we've already acquired and it doesn't include an assumption for any new business we might add."

In other words, the company's forward P/E of 5 only reflects current business. Assuming that no new business happens, and assuming no one defaults, we should expect earnings to live up to the guidance of $5.06/share in 2013. Given the number of people who want to take advantage of low interest rates, and who are eligible because of the HARP program, it is very likely that Walter will grow the business even more than it is letting on.

Conclusion

Short-term sell-offs are a value investor's dream come true. This 32% drop looks like the perfect time to get into Walter Investment -- a company with a lot of growth ahead. Investors will definitely want to keep an eye on legislature like the HARP program, as a change in politics can affect this sector. Also keep an eye on jobs, since Walter works mainly with "risky" loans. But all-in-all, Walter's opportunities seem to far outweigh the risks.

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Jon Quast has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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