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Why Home Capital Group Inc Could Be the Stock of the Year

Over the past week, investors in the stock of Home Capital Group Inc (TSX:HCG) had a lot to follow. On Thursday, shares slid close to 20%, closing at a $17.71. The good news for long investors was Friday’s recovery. On Friday, shares reached a high price of $20.69 and closed the week at $19.25.

What happened?

Starting with the bad news first, the Ontario Securities Commission (OSC) indicated in a statement a number of issues with the company and senior management which include statements that they (the OSC) call “materially misleading”. While this statement and the notice of a hearing were unfavorable news developments for investors, it doesn’t stop there. On the same day, the Premier of Ontario announced new rules around the real estate industry.

The announcement which is good news for many first-time home buyers may have the effect of cooling the housing market. While this may not have a material effect on existing mortgages held by Home Capital Group Inc, the challenge faced by the company is the assumption from many short sellers that the Canadian real estate market (and the company) will implode. Many investors (or short sellers) believe the Canadian housing market is a bubble which will pop imminently.

Only time will tell.

What happened on Friday?

Before the open of trading on Friday, the company “pre-announced” earnings for the quarter. As the full earnings release is expected for May 3rd (for the three months ending March 31st), this is a highly unusual thing for any company to do. The good news is the earnings per share (EPS) and the accompanying statement were enough to calm investors at least temporarily. Diluted earnings came in at a profit of $0.90 per share. For the same period in the previous year, the diluted EPS were $0.92.

While this is fantastic news for investors who own the stock, we will still have to wait a few weeks to get a full picture of the company’s financials.

So why is Home Capital Group Inc the stock of the year?

For new buyers looking for the ultimate dividend machine with the potential for capital appreciation, Home Capital Group Inc is it. At close to $20 per share, investors will receive a yield of 5.2% while the company pays out approximately 30% of earnings in the form of dividends. The remaining 70% can either be reinvested into the business or the company’s share buyback can continue.

From 2015 to 2016, the company reduced the total number of shares outstanding from 69.98 million to 64.39 million translating to a reduction of shares outstanding by almost 8%. That’s huge!

With the lower share count and continued profit, the shares appear to be a complete steal. Tangible book value per share was $25.12 at the end of fiscal 2016 while the profit machine has continued to churn along nicely. With first quarter profit of $0.90 per share, the tangible book value per share has increased further, potentially in addition to the continuation of the share buyback program. For those unwilling to look for themselves, the total cash on the balance sheet as of December 31st, 2016, was nothing short of $1.2 billion.

The potential to continue the share buyback is there!

The last metric to point out is the return on equity. Over the past six fiscal years, the average return on average shareholder’s equity has been nothing short of 22% (calculated as Average Net Income / Average Shareholder’s Equity). The number for fiscal 2016 was 15.28%.

Doing the math, the current shareholder’s equity multiplied by 15% translates to a profit per share close to $3.75 assuming no share buyback.

Conclusion

For investors willing to take on a lot of headline risk and wait it out, this opportunity may be highly lucrative. After close to two years of bad press from a number of short sellers, the company has continued to turn out profits and dividends.

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Fool contributor Ryan Goldsman has no position in any stocks mentioned. The Motley Fool owns shares of HOME CAPITAL GROUP INC.

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