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Warren Buffett Exited This Canadian Growth Stock in 2018

Shares of Canada-based mortgage lending company Home Capital Group (TSX:HCG) have been pretty volatile in the last five years. The stock fell from $42 per share in January 2015 to $8.04 in April 2017. Since then, the stock has gained momentum and is trading at $33.5 currently.

Back in 2017, Home Capital Group was suffering from a liquidity crisis. It was then the Oracle of Omaha, Warren Buffett, pumped in about $400 million into the company to keep it afloat. A Berkshire Hathaway subsidiary also provided $2 billion as a line of credit. Buffett’s investment led to a turnaround in fortunes, and the stock doubled between April 2017 and December 2018.

This was when Buffett exited Home Capital Group. However, investors continued to remain bullish, resulting in a stock appreciation of a staggering 123% this year.

Is Home Capital Group a good bet for 2020?

Home Capital Group’s sales plummeted from $582 million in 2016 to $291 million in 2017. It ended 2018 with revenue of $419 million. Analysts expect sales to reach $451 million in 2019, $498 million in 2020, and $531 million in 2021.

In the third quarter of 2019, HCG managed to grow sales by 11% to $116.6 million. Its total loan portfolio stands at $16.99 billion, up 6.4% year over year. Loans under administration were up 0.7% at $22.97 billion.

However, its net non-performing loans as a percentage of gross loans rose 15 basis points to 0.49%. Despite the rise in non-performing loans, Home Capital has claimed that they are within internal risk tolerance limits.

HCG continues to progress on its IT roadmap initiative. It launched a fully mobile and responsive broker portal as well as a new CRM system for the greater functionality of its sales team. The company has implemented robotic process automation with 70% of mortgage discharges being automated.

Home Capital is focused on healthy volumes and pricing in its major markets. It successfully launched the first cross-border residential-mortgage-backed securities. Driven by disciplined, risk-based loan pricing and higher rates on new loan originations and renewals, HCG has been able to increase its net interest margin from $1.91% in the third quarter of 2018 to 2.22% in the third quarter of 2019.

Home Capital Growth will slide in a recession

For investors who believe that a recession will hit global markets in 2020, investing in HCG makes little sense. In an economic downturn, the unemployment rates move higher, which will mean the demand for mortgage loans will fall drastically. There is a good chance for the company to be impacted with higher default rates, too.

During the last recession, Home Capital Group saw its stock price decline from $22 in December 2007 to $8.5 in January 2009. It then soared to a record high of $55 by August 2014.

Despite its stellar run in the last two years, HCG stock is trading at a forward price-to-earnings multiple of 10.6. Comparatively, analysts expect earnings to rise by 42.8% in 2019 and 32.9% in 2020.

While Home Capital Group shares are trading at an attractive valuation, the macro outlook for 2020 might deter investors to buy the stock at the current price.

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The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and short January 2020 $220 calls on Berkshire Hathaway (B shares). Fool contributor Aditya Raghunath has no position in any of the stocks mentioned.

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