One of the hallmarks of a market bubble is that the floodgates open for a wave of terrible IPOs. The 2020 IPO roster included plenty of terrible stocks, but Rocket Companies (NYSE:RKT) stock was not one of them.
Not only is Rocket an extremely profitable company, but it reported record profits last year. Unlike other high-growth stocks, it also trades at a reasonable valuation.
RKT stock is already up over 30% from its $18 IPO price back in August. I’ve been recommending that investors avoid most 2020 IPO stocks like the plague. I believe it’s still too early to be buying Rocket at this point. But I definitely believe it should go on your list of stocks to potentially buy on the next market dip.
The Record Profits of RKT Stock
In February, Rocket reported fiscal 2020 revenue of $15.73 billion, up 208% from 2019. Yes, you read that right. The company’s revenue tripled last year. Rocket also reported $9.39 billion of net income in fiscal 2020, up 948%. Yes, you read that right. Rocket nearly increased its net income ten times in a single year.
If those growth numbers make you a bit skeptical, you’ve got sound investing sense. There’s a good reason for what happened to Rocket’s business in 2020.
When the pandemic hit, the Federal Reserve cut interest rates to 0%. Mortgage rates plummeted, and a housing boom was triggered. In addition to historically low interest rates, Americans moved out of major cities and into the suburbs in droves.
Cities known for their high costs of living, like New York and Los Angeles, were slammed by the pandemic. Many people’s jobs permanently shifted to remote work. They no longer had to worry about commute times, and they were no longer tethered to specific regions of the country.
As a result, mortgage companies like Rocket experienced record growth in 2020. The company’s management decided to go public at what will likely end up being the peak of the mortgage cycle. It was a brilliant move.
Rocket may never again put up growth numbers rivaling 2020’s numbers. It sold its shares to the public right when its business was likely peaking.
A quick glance at Rocket’s valuation metrics makes it seem like a screaming buy. The stock trades at just 9.5 times forward earnings and 0.19 times trailing sales. But the reason the market is skeptical of Rocket is because it will soon face impossible year-over-year comparisons starting in the second quarter, since the Fed cut interest rates to 0% exactly one year ago.
In February, Rocket’s Q2 guidance came in above analysts’ average outlook. Bank of America analyst Jason Kupferberg is bullish on RKT stock. However, he is calling for full-year 2021 EPS of $2.24, down 45.5% from 2020.
“Expectations for mortgage originator stocks have weakened recently due to increase in interest rates as investors are concerned about mortgage volumes and margins in a rising rate environment,” Kupferberg says.
But there is a silver lining for the owners of RKT stock .
“We believe this backdrop creates an opportunity for RKT to gain market share and its low cost ‘assembly of mortgages’ business model is better suited to protect margin than many peers,” he says.
In other words, those who invested in RKT stock should brace themselves for the beginning of a cyclical downturn in the mortgage market. If interest rates start rising sooner or more steeply than anticipated, that downturn could be a sharp one. But Kupferberg says Rocket could gain market share during the downturn, potentially positioning it to be an even bigger winner during the next upswing.
Bank of America has a “buy” rating and a $27 price target on RKT stock.
How To Play It
I agree with much of Kupferberg’s take on RKT stock. I like the company, and I like its business. However, I don’t think it’s generally a good idea to invest in a cyclical company right at the potential peak of a cycle.
Rocket also unfortunately captured the attention of Reddit’s r/WallStreetBets community. The pumping from WallStreetBets drove RKT stock up from around $19 to as high as $41.10 and then back down to under $26 in a matter of about two weeks.
It also got the shares unfairly lumped in with so-called r/WallStreetBets “meme” stocks like GameStop (NYSE:GME) and AMC Entertainment (NYSE:AMC) in the media. But RKT stock is not a meme stock. Rocket’s business is booming and the company is growing, while AMC and GameStop are hemorrhaging cash.
It may take weeks or months for the volatility that r/WallStreetBets triggered in Rocket’s shares to fully die down and for RKT stock to settle back to a stable level. The stock may also be subject to headline risk if interest rates start to spike, which many investors see as a real possibility.
The market is at an all-time high, and the mortgage industry is at an all-time high. Don’t pay up for it today in the middle of a buying frenzy.
So put RKT stock on your watch list. But be prepared to scoop it up if it drops back down under $20 in the future.
On the date of publication, Wayne Duggan did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. He is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market.