Even Warren Buffett Can’t Win ‘Em All

On the brink of disaster almost one year ago, Home Capital Group Inc. (TSX:HCG) saw its shares decline to almost $5 each as the company was forced to accept an emergency line of credit at an exorbitant rate, which eventually allowed Home Capital turn the corner to fight another day.

With a liquidity crisis in the rearview mirror, the company increased the share count and accepted both debt (if needed) and an equity investment from none other than Warren Buffett himself. The result was a large move upwards, allowing it to regain lost ground, as many short sellers were carried out of their positions and a certain degree of normalcy returned to the stock.

For those who have stuck with the company (and those seeking opportunity), the good news is that the past two quarters have been rock solid; indeed, the period saw the share price has decline from between $15 to $17 to a current price of $13.10.

Although the Oracle of Omaha is still making money at this level, the truth is that many investors are starting to feel less than satisfied after a gradual decline during the past month. This presents an opportunity for buyers!

With tangible book value closing in on $23 per share, the absence of a dividend will translate to a 100% retention ratio; eventually, the saying, “a rising tide lifts all boats” will again hold true. As cash is retained within the company, the value to a buyer will gradually become apparent.

When reflecting on the past two quarters, investors need to take away a few things. The first is that the company will deliver revenues and earnings that will be fairly consistent in each quarter. Unlike seasonable businesses, an alternative lender such as Home Capital Group Inc. will be consistent. The second takeaway is that with a slowdown in lending (and the overall real estate market), there will be more cash available to shareholders. Although a high amount of liquidity is a good thing, a decrease in new loans will result in a decrease in interest expense (paid to GIC owners).

Given that the new “normal” earnings per share now sit in the $0.35 to $0.40 range, shareholders can expect annual earnings of approximately $1.50 and potentially a multiple of ten times earnings. With a target share price closer to $15 based only on the earnings stream and a tangible book value of almost $23 per share, it’s becoming increasingly difficult to bet against Warren Buffett. After all, this isn’t the first time he’s had to serve as a tow truck, pulling a very valuable asset out of a ditch!

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Fool contributor RyanGoldsman has no position in any of the stocks mentioned.

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