Finding value when the stock market is setting new records tends to be difficult. Investors have to be careful that they are not buying stocks as earnings are peaking. This is often the difference between a value stock and a value trap. Sometimes a stock is cheap because the market is giving the company no credit for a line of business or some sort of asset.
One such stock is New Residential (RITM -2.37%) which is a mortgage REIT, however the company also has an operating business which generates cash and is given little credit for the business in the market.
Image source: Getty Images.
New Residential is more than just a mortgage REIT
New Residential has three main areas of operation: mortgage investing, servicing, and origination. I recently wrote about the company's servicing portfolio and how it could help mitigate the effects of the Federal Reserve's impending reduction in asset purchases. Here, I will touch on another aspect of New Rez, which is its mortgage origination business.
New Residential should be thought of as a sum-of-the-parts story. In these situations, the company often has an asset that is overlooked, and therefore not reflected in the share price. This makes the parts worth more than the current valuation in the market. In these circumstances, the company may find it attractive to do some sort of corporate transaction, say a spin-off or initial public offering in order put a value on that asset. New Residential discussed such a possibility last year.
New Residential has historically been mainly a mortgage REIT, and like most mortgage REITs, it trades on dividend yield and book value. At the end of June, the company had a book value per share of $11.27 and is trading at a 3% discount to book.
New Residential vaults into top echelon of mortgage lenders
New Residential has been beefing up its mortgage origination business, and recently completed its purchase of Caliber Home Loans. This transaction puts New Rez in the top five nonbank lenders in the U.S., and on a pro forma basis they funded $45 billion in origination in the second quarter.
At the end of 2020, New Residential estimated there was between $2.90 and $6.52 per share in hidden value with the mortgage origination business, which was prior to the announcement of the Caliber deal. With the acquisition of Caliber, that number should increase, given that Caliber has a strong retail footprint and presence in the purchase market, which is worth more than the typical correspondent-type lender that New Residential had prior to the acquisition.
Mortgage originators trade at a premium to mortgage REITs
Unlike mortgage REITs, mortgage originators generally trade well above book value, especially those that interact primarily with the borrower as opposed to those who purchase completed loans from smaller lenders. If you look at the other top non-bank originators (Rocket, UWM Holdings, Loan Depot, and PennyMac Financial), you will see these stocks generally trade around three times book value per share.
New Residential will probably update shareholders on the combined mortgage bank's projected earnings and book value when it announces third-quarter earnings in October. At that point we will have a better indication of the embedded value in the mortgage origination operations.
The company just increased its dividend to $0.25 per quarter, which gives the stock a dividend yield of over 9%. This is well above the typical mortgage originator, and more in line with mortgage REITs. With New Residential, you get the steady income of a mortgage REIT along with the operating company which provides growth potential down the road. New Residential is the sort of stock that would appeal to both a value investor and an income investor.
