The housing industry has been slowly recovering from the post financial crisis slowdown that left a glut of homes on the market. Existing home sales have been trending higher, and new home sales have been improving slowly over the past decade. As home sales have improved, the need for mortgages has increased. As a result of an increase in mortgage lending, the need for private mortgage insurance (PMI) has increased and that has benefited MGIC Investment Corp. (NYSE:MTG). MGIC Investment is the largest PMI issuer in the United States.

MGIC has been around since 1957 and provides PMI for various types of lenders. PMI is required on a mortgage that exceeds more than 80% of the value of the property. If a loan goes into the foreclosure process and the property sells for less than what is owed on it, PMI makes up the difference to the lender.

The nature of MGIC’s business makes it dependent on the housing industry growing and mortgage growth. The current global health crisis took a toll on housing starts at the end of the first quarter and beginning of the second quarter, but they started to improve in April and May.

Personally I think the housing industry could end up seeing a boost from the health crisis. The demand for single-family homes is likely to increase as people reevaluate their living arrangements. Some people will likely look to leave the more densely populated cities and move out to the suburbs. I also see more people working remotely for the long term, not just on a temporary basis, and that could lead people to look at bigger houses that provide them with a work space.

Obviously these types of changes won’t happen immediately, and it will be a gradual shift, but I see the housing industry changing permanently as a result of the pandemic. With those changes, there will be an increase in mortgage lending and an increase in the need for PMI in the coming years.

Looking at MGIC’s earnings and revenue over the past few years, we see that earnings have been growing faster than revenue. Over the last three years, the company has averaged EPS growth of 21% while revenue has grown by 5% per year. Revenue was up 5% in the most recent quarterly report, but earnings were flat compared to the previous year.

The management efficiency measurements for MGIC are pretty good with the return on equity at 17% and the profit margin at 69.4%. That profit margin is one of the highest I have seen recently. The current valuation indicators for the stock are very low with a trailing P/E of 4.4 and a forward P/E of 7.0. Earnings are expected to slip this year and thus the reason the forward P/E is higher than the trailing P/E. It is also worth noting that MGIC pays a quarterly dividend of $0.06 per share and that works out to a yield of approximately 3.2%.

A New Upward Trend Has Formed

MGIC’s stock fell sharply with the rest of the market back in February and March. In fact, it dropped far more sharply on a percentage basis. From the high in early February to the low in March, the stock fell over 71%. Even with where the stock closed on Friday, it is still almost 50% below the February high.

There is some good news from the daily chart and that is the formation of a new upwardly sloped trend channel. Connecting the lows from March, April, and May gives us the lower rail of the channel while the highs from March and June form the parallel upper rail.

The lower rail is just below the 50-day moving average and the stock is sitting between the rail and the moving average. We see that the daily stochastic readings are in oversold territory and are at the lowest levels since the March low. I expect the stock to turn higher in the next few days. We might not see a 100% gain like we saw from early April through early June, but I do think we get a substantial move.

The weekly chart shows how MGIC has turned lower over the last three weeks, but you can also visualize the lower rail of the channel shown on the daily chart. Something that stood out to me was how neither the weekly stochastic indicators nor the 10-week RSI moved back up to overbought territory, even though the stock moved up so sharply.

Many other stocks and indices saw their overbought/oversold indicators jump from oversold to overbought after rallying off the March lows.

The Sentiment Toward MGIC is Neutral

If you have read my articles before, you know I like to include sentiment analysis in my overall outlook for a stock. When stocks are priced under $10, the sentiment analysis becomes a little different. A lot of times we won’t see a great deal of analyst coverage, and because of the low prices on the stocks, they can be hard to borrow, making short selling difficult. On the options front, there are a limited number of strike prices below the current price and there are an infinite number above the current stock price.

That being said, the sentiment toward MGIC is pretty balanced at this time. There are 12 analysts covering the stock with nine “buy” ratings and three “hold” ratings. This gives us a buy percentage of 75% and that is at the top end of the average range.

The short interest ratio is at 2.7 and that is in the average range when compared to all other stocks, but it’s a little higher than most stocks priced below $10. Short interest fell from 21.11 million shares to 19.45 million shares in the most recent short interest report. This suggests that the bearish sentiment is shifting to a more neutral position.

The put/call ratio was one sentiment indicator that surprised me. There are 16,252 puts open and 10,205 calls open at this time. This gives us a put call ratio of 1.59, and that is much higher than I expected for a stock trading at $7.59. The ratio is higher than the average stock and considerably higher than the low-priced stock.

My Outlook for MGIC Investment

Obviously I am bullish on MGIC, otherwise the title of the article would be different. I like how the company has seen consistent earnings growth over the last few years, and I think 2020 is simply a bump in the road for the company. The consistent revenue growth is also a plus. Like I said before, I can see the housing industry actually benefiting from the current health crisis. Obviously, if we see a deeper or longer-lasting recessionary period, it could delay the growth in new and existing home sales. But I do believe we will see a change in the housing market as a result of the pandemic.

I can see MGIC getting back up to the $11 area by the end of the year and that would be a 45% gain from the current level. If we see the virus numbers continue to spike and another economic shutdown becomes necessary, it is possible that the stock could drop along with the rest of the market. If the economy and market weaken, MGIC could drop back down below $6, but I don’t see the stock dropping back below the $5 level.

Stocks priced below $10 tend to be a little more volatile than higher-priced stocks in the same industry and with similar back stories. I normally try to keep any losses on my investments at 10% to 15%, but with low-priced stocks like MGIC, I tend to expand that target stop. With MGIC, I would be concerned if the stock fell back below the $5.50 level and would have to consider shutting the trade down at that point.

If you would like to learn more about protecting and growing your portfolio in all market environments, please consider joining The Hedged Alpha Strategy.

One new intermediate to long-term stock or ETF recommendation per week

One or two option recommendations per month

Bullish and bearish recommendations to help you weather different market conditions

A weekly update with my views on the market, events to keep an eye on, and updates on active recommendations

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MTG over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source link

2020-06-28