Investing in Consumer Finance Stocks

Traditionally, when you needed a mortgage, a loan, or a credit card, you went to a brick-and-mortar bank branch. The consumer financing industry has changed that. Consumer finance companies allow customers to bypass traditional banks and connect with loans and credit cards tailored to their needs.

What Is Consumer Finance?

A consumer finance company is a non-bank company that provides financial products to individuals. Some examples of consumer finance products include:

• Mortgages
• Automobile loans
• Student loans
• Personal loans
• Credit cards
• Payday loans and other alternative credit products

The industry isn’t just limited to companies that originate loans or issue credit cards. Payment processing companies, loan servicers, credit reporting agencies, third-party platforms that connect customers with lenders, and fintech companies could all fall under the consumer finance umbrella.

Consumer finance has evolved in recent years. No longer are companies simply competing for your business when you apply for a loan or credit card. Increasingly, consumer finance companies are seeking to get you to use their day-to-day money management tools such as budgeting apps and credit-monitoring services. They get access to even more data about you. Later on, when you are shopping for financing, they’ll use that information to target offers to you.

4 Top Consumer Finance Stocks for 2021

Like banking and fintech stocks, consumer finance stocks tend to be cyclical. In general, they perform well when spending is strong. But some unusual patterns have emerged during the COVID-19 recession. For example, mortgage and auto lending remained strong. Investor enthusiasm for contactless payments sent share prices soaring for some fintech companies such as Square (NYSE:SQ).

If you want to invest in consumer finance stocks, here are four top stocks to consider for your investment portfolio.

Rocket Companies

Rocket Companies (NYSE:RKT) is part of a surge in mortgage companies that have recently gone public, fueled by record refinancing and home-buying activity and soaring home prices. The parent company of Rocket Mortgage and Quicken Loans is the largest home mortgage company in the U.S., with a 9% market share. It originates mortgages and then sells them on the secondary market, which means it doesn’t retain the risk that the customer will default. In the fourth quarter of 2020, it originated almost $108 billion in home loans, a 111% increase over Q4 of 2019.

Rocket’s mojo is its digital-first business model. Customers can complete the entire mortgage or refinancing application using the Rocket app. Not only does the convenience appeal to customers, particularly those who are younger, but Rocket saves money on loan officers and their hefty commissions. For customers who keep the app, Rocket has an easy way to market to them by sending them push alerts about when they might benefit from refinancing.

As of mid-February, Rocket’s share price was little changed from its first day of trading in August 2020. But with a growing market share, increasing rates of homeownership, and the likelihood that interest rates will stay low in the near-term future, Rocket is a worthy contender for your portfolio.

Capital One

You may be surprised to learn that Capital One (NYSE:COF) operates physical bank branches since it’s primarily known for its consumer finance products. Credit card revenue makes up about 64% of its revenue, and it’s the second-largest auto lender in the U.S.

In good times, credit cards are a lucrative business, given that the average annual percentage rate for customers who carry a balance is 16.61%. But it’s highly cyclical. During a recession, consumer spending drops, which translates to less credit card revenue. Plus, credit cards are often the first bills customers stop paying in times of financial stress.

Capital One is especially cyclical because of its heavy credit card focus and the fact that many of its customers have subprime credit. Even during normal times, Capital One has a history of setting aside money to cover a higher percentage of potential losses than its peers.

Still, the company sustained losses during the first two quarters of 2020 after the Federal Reserve increased the amount of capital it needed to have set aside. It significantly improved its common equity Tier 1 (CET1) ratio, which measures a bank’s capital against its risk-weighted assets and is considered a key measurement of a bank’s financial strength and ability to withstand stress. In February 2021, its CET1 ratio was 13.7%, well above its 11% long-term target.

Capital One shares were up about 15% year over year in mid-February. By comparison, the Dow Jones U.S. Banks Index was down by 4%.

Intuit

Intuit (NASDAQ:INTU) is best-known as the parent company of TurboTax and small-business accounting software QuickBooks, but it’s pushing to become part of the broader consumer finance landscape. In December 2020, it completed a $8.1-billion acquisition of Credit Karma, a credit-monitoring service that provides personalized credit card and loan recommendations to 110 million customers. Intuit also owns budgeting app Mint, which it acquired in 2009. Both platforms earn affiliate commissions whenever a user signs up for a product it recommended.

The Credit Karma acquisition will create a treasure trove of data for Intuit. Creditworthiness is only one factor in determining whether an applicant will be approved for a credit card or loan. Having both credit report and tax return information, including income and employment history, makes for more accurate predictions about a person’s likelihood of getting approved for any given product.

As of Feb. 15, 2021, Intuit stock was up 36% year over year. But shareholders could still enjoy healthy growth ahead. Management estimated in 2020 that the Credit Karma deal would nearly double its total addressable market to $57 billion.

Square

Square got its start in 2009 making portable card readers that allow merchants to swipe credit and debit cards via their smartphones. But Square is becoming a force in the consumer finance space. In 2020, its Cash App was the big growth driver, generating 69% of the company’s revenue in Q4 of 2020. It’s one of the most downloaded financial apps, with 36 million active users.

At its core, the Cash App is a peer-to-peer payment app. But it’s evolving into a one-stop shop for financial services. Users can link a bank account to the Cash App, but for those who don’t have one, the account itself can function a lot like a bank account.

You can receive direct-deposit funds, withdraw money at ATMs and use a Visa debit card (NYSE:V). The app also allows you to invest in stocks, ETFs, including fractional shares, and buy and sell bitcoin.

Square is already a player in small business lending through Square Capital. Later this year, it will begin offering banking to small businesses as well. But Square also seems interested in pushing further into the consumer lending space. In 2018, it launched Square Installments, which allows customers of the merchants that use its products to split purchases of $250 to $10,000 into fixed monthly payments. Last year, it started testing a short-term loan feature with a small number of Cash App users. It also recently acquired Credit Karma’s tax business, which about 2 million people used to file tax returns in 2019.

Square shares rose 252% in 2020, leading many investors to worry that it’s overpriced. But as Square continues to innovate in the small business and consumer financing spaces, it remains a solid investment.

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