Why the Home Capital (HCG) Stock Price Fell 4.3% in January

Home Capital Group Inc. (TSX:HCG) stock fell in January, as investors likely pondered valuation and stock price upside potential.

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After a spectacular run-up in Home Capital Group’s (TSX:HCG) stock price, January was a much-needed breather, as investors attempt to reconsider the remaining upside in the stock now that results are strengthening and the company is stepping up its return of capital to shareholders.

Home Capital’s stock price falls on investor apathy

Investor apathy can easily set in when a stock has a sordid history and too many investors were burned. After a dramatic recovery of Home Capital’s stock price, investors are likely skeptically wondering how much upside is left. An improving mortgage market remains positive, but Home Capital Group’s stock valuation has already improved to reflect this. The next step that could take the stock higher would be evidence of further gains in the business, reduced skepticism toward the housing market, and continued returns of capital to shareholders, such as through the reinstatement of the dividend.

Home Capital stock has recovered spectacularly since its downfall in 2017, but more is needed to keep the stock’s rally going, and I think investors are just skeptically waiting. I mean, Home Capital’s business is a risky one, even in the best of times, as its most significant business is providing residential mortgages across Canada to borrowers that do not meet the criteria of the major Canadian banks.

Home Capital’s stock price falls in January despite return of capital

With earnings and cash flow recovering nicely, Home Capital is shifting its focus on returning excess capital to shareholders by buying back shares and possibly re-introducing the dividend very soon. In fact, last month Home Capital announced that it will have repurchased almost 8% of its shares outstanding at a price of $34.15 per share.

Further to this, we can look to Home Capital’s latest earnings report, which showed strength in the company’s fundamentals, with a 21% quarter-over-quarter increase in mortgage originations and steady credit metrics. Going forward, Home Capital can be expected to continue to benefit from improving housing/mortgage activity and a very resilient economic environment in Canada, underpinned by strong immigration trends.

This is all working to bring confidence in the merits of Home Capital stock as a quality stock, which should slowly bring investor confidence even higher and will provide support for the stock price. Although Berkshire Hathaway has sold the bulk of its Home Capital stock and has shifted its focus elsewhere, it did exceptionally well on the trade. The fact that Berkshire sold the shares is a reflection of its belief that there is more upside elsewhere and that the risk/reward trade-off is not as appealing as before.

Foolish final thoughts

While I concede that Home Capital stock really has made much of the gains that we could have expected it to make, I also recognize that management has proven to be far better at recovering from the crisis a few years ago, when the company was reeling from accusations of mortgage fraud, which sent the company into a liquidity crisis as shaken confidence, a run on deposits, and questions about Canada’s housing market had investors running. I would remain cautious on the stock, but if the company keeps going on this path of returning capital to shareholders, we could see significant upside.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Karen Thomas has no position in any of the stocks mentioned. 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 March 2020 $225 calls on Berkshire Hathaway (B shares).

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