I love love love stocks involving debt. Even though the American consumer is wisely deleveraging, companies that let people create debt are diversifying, companies that service debt are booming with no risk, companies that provide subprime debt are going gangbusters and companies that buy bad debt are on fire.
Debt is a big part of our economy, and that means you can find stocks that profit from it.
Visa (NYSE:V) and Mastercard (NYSE:MA) essentially own the credit card business. Yes, American Express (NYSE:AXP) has its niche, and Discover Financial Services (NYSE:DFS) has its fans. But the industry’s two gorillas not only own it, they’re making money beyond their core business.
Both companies transfer information and value across financial institutions, businesses, consumer and the government. They have many payment platforms. They have risk-management divisions, fraud services, research services, security services, consulting services and a host of other products. Both Visa and Mastercard trade at 21x earnings on 18% growth. The premium is a small price to pay for a virtual oligopoly.
Bank of America (NYSE:BAC) emerged from the mortgage crisis with a gigantic victory. It purchased Countrywide for a song, realizing that the true value wasn’t in the portfolio of crap mortgages it could write off, but in the mortgage-servicing business Countrywide owned. Today, BofA services 80% of the nation’s mortgages, without having exposure to the paper itself. That’s pure no-risk income.
EZCorp (NASDAQ:EZPW) has massive pawnshop operations both in the U.S. and Mexico. In the latter, 80% of the population is a potential pawn customer vs. 20% in the U.S., and both EZCorp and First Cash Financial Services (NASDAQ:FCFS) are capitalizing on this demographic by expanding rapidly into Mexico.
EZCorp just brought on a new chief financial officer with an expertise in acquisitions, and the company grabbed an online payday lender, which will prove to be a huge revenue booster. The company also purchased a controlling interest in a Mexican payroll lender. That will allow it to lend money to employees and retrieve payment directly from payroll, reducing defaults over the traditional payday loan.
EZPW is the single cheapest stock I’ve been able to find in the market. Fair value is $39, yet it trades at just under $23 — more than a 40% discount to where it should be. It is my single largest portfolio position.
The second-cheapest stock I can find, and I also own, is Portfolio Recovery Associates (NASDAQ:PRAA), which buys up bad debt for literally a penny or two on the dollar and tries to collect on it. It’s doing a great job, too, generating $130 million in free cash flow over the trailing 12 months. Net margins are in-sane: 23%. That’s net, not gross margin.
Porfolio Recovery is the ultimate arbitrage play, able to draw down debt at about 4% and earn multiples on that in exchange. The company will increase earnings 20% this year to $8.79 per share, which should give it a value of around $170. Yet it trades at $108, for a discount of 39%.
All of these are great choices for your portfolio, which is why I own several of them myself.
As of this writing, Lawrence Meyers owns shares of Bank of America, EZCorp and Portfolio Recovery Associates.