Why First American Financial (FAF) Stock is a Compelling Investment Case

Lakewood Capital Management recently released its Q2 2020 Investor Letter, a copy of which you can download here. In the letter, among other things, the fund reported a net profit of 10.7% for Q2 2020. You should check out Lakewood Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of the stock market crash.

In the said letter, Lakewood Capital highlighted a few stocks and First American Financial Corp (NYSE:FAF) is one of them. First American Financial Corp (NYSE:FAF) is a financial services company. Year-to-date, First American Financial Corp (NYSE:FAF) stock lost 10.4% and on August 3rd it had a closing price of $52.25. Here is what Lakewood Capital said:

“During the March sell-off, the fund initiated a position in First American Financial, the second largest provider of title insurance in the U.S. We believe the stock’s 50% decline at the lows in March allowed us to purchase a high-quality business with stable competitive dynamics at a deeply discounted price. While First American often gets grouped with financial and insurance stocks, we believe the company is more akin to a capital-light service business deserving of a premium multiple.

First American’s title business, which provides title insurance for residential and commercial real estate purchases or refinancings, accounts for 93% of its earnings while a small specialty insurance business accounts for the remaining 7%. First American issues title insurance directly as well as through a network of independent agents. Between both its direct and indirect channels, First American accounts for roughly 25% of the total U.S. title insurance market (with the top four players accounting for approximately 85% of the market).

Trends for First American’s core residential title business are favorable with new home purchase applications returning to strong levels after the initial lockdown period and industry refinancing volumes recently soaring 100% vs. 2019 levels due to the low rate environment. While First American makes approximately 2.5 times as much on a new home purchase compared to a refinance transaction, the refinancing tailwind will nonetheless help underpin financial performance for the remainder of 2020 even if new home purchase activity is more muted given the economic backdrop. We also believe First American will be in a great position to capitalize on the better-than-expected activity levels since the company chose to largely avoid making substantial workforce changes during the initial lockdown period.

In addition to volumes coming in better than originally feared, we also think industry losses will remain subdued given improved underwriting and resilient housing prices. As we saw with other financials in March, the knee-jerk reaction of the market was to look back to what happened during the financial crisis. Back then, the title insurance industry suffered loss rates of up to 10% compared to 4% to 5% during a typical year (largely due to the pervasive fraud that existed during the housing bubble). With improved underwriting at both the mortgage originators and the title insurers, we do not foresee losses returning to financial crisis levels, especially given the recent stability of housing prices.

We expect normalized U.S. mortgage activity to be in the low- to mid-$2 trillion range per annum, a bit higher than the $2.1 trillion in 2019 but still well below the 2001 to 2007 average of $2.8 trillion. At margins similar to the average of the past few years, we expect First American to generate around $5.70 of 2022 earnings. We value the stock at 14x earnings, similar to where it has traded for much of the past ten years, resulting in a total value of $82 per share (including dividends), roughly 50% above recent levels.”

Last month, we published an article revealing that Ensemble Capital is bullish about First American Financial Corp (NYSE:FAF)  stock. The investment firm believes that the real estate market is likely to return to growth going forward.

In Q1 2020, the number of bullish hedge fund positions on First American Financial Corp (NYSE:FAF)  stock decreased by about 5% from the previous quarter (see the chart here), so a number of other hedge fund managers don’t seem to agree with First American Financial’s growth potential. Our calculations showed that First American Financial Corp (NYSE:FAF)  isn’t ranked among the 30 most popular stocks among hedge funds.

The top 10 stocks among hedge funds returned 185% since the end of 2014 and outperformed the S&P 500 Index ETFs by more than 109 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds’ poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Below you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.

Video: Top 5 Stocks Among Hedge Funds

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Disclosure: None. This article is originally published at Insider Monkey.