The Motley Fool

What Happened to Home Capital Group Inc. Last Week?

Last week, shares of Home Capital Group Inc. (TSX:HCG) surged by over 25%!

For investors who took the higher-risk, higher-reward route and purchased shares, things seemed to have paid off quite well. The company, which is under investigation for knowingly providing mortgages to borrowers with false documentation, has taken a number of steps to deal with the challenges.

While many investors bailed on the stock, the investment, although daunting, is clearly a very lucrative one for those who chose to stay involved. The reason is not surprising at all.

In financial markets, there is a saying: “Buy the rumour and sell the news.” The rumour that the company is nearing a settlement with the Ontario Securities Commission (OSC) has propelled the share price higher, but the actual announcement of a deal being reached may not. Due to the nature of these issues, concrete information is very difficult to come by. In addition, there is now at least one private equity firm that has allegedly approached the company (this has yet to be confirmed) which would lead to new capital being made available to Home Capital Group.

While this is good news, the expectation has to be that the raising of new capital will have to be done at a lower cost than the current credit facility available. In addition, the value added by a private equity firm may translate to a better bottom line for investors.

Looking at the current situation, investors need to stop and ask, “Where is the value being found?”

The response has not changed in several months. Although the company was facing a liquidity crisis due to a run on deposits, the value found on the balance sheet has not changed. The tangible book value per share (found after subtracting all liabilities and goodwill from the assets) is still close to $26 per share.

The potential investment by this private equity firm is being made on the basis of the liquidation value of the company being significantly higher than the current share price. There is “free” money to be had.

While most retail investors have fled what was perceived as a sinking ship many weeks ago, the result has been a tumultuous ride that has begun to stabilize and recover with the “smart money” entering the stock.

With a lot of potentially good things that could transpire for the company, there is a possibility that market sentiment is beginning to turn. Potentially, the bad news is in the past and, as they say, “the future lies ahead.”

Time will tell. As always, it is best to conduct diligent analysis before investing.

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Fool contributor Ryan Goldsman has no position in any stocks mentioned.

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