Rocket Companies (NYSE:RKT) was briefly one of the hottest meme stocks out there. In early March, powered by countless rocket emojis on Reddit’s wallstreetbets, RKT stock catapulted as much as 85% in a single day to a high of $43. A few days later, shares tumbled back to $25, and they’ve continued sliding lower ever since.
The downturn in RKT stock has accelerated over the past week, with shares hitting a new 52-week low near the $15 level today. The surprising thing is that the company is still reporting strong quarterly earnings results. However, analysts expect that to change in a hurry.
RKT Stock Is Incredibly Inexpensive
The main bullish thesis for RKT stock is its seemingly ludicrous valuation.
The company’s diluted earnings per share for the past 12 months stand at $2.81. With the stock price near $15.20, that amounts to a P/E ratio of just 5.4. You don’t need me to tell you that’s highly unusual, especially in this stock market.
Normally, the S&P 500 trades at a historical median P/E of around 15. Lately, however, the market’s earnings multiple has climbed to a lofty 25 thanks to the huge runup in stocks over the past 18 months.
On that basis, Rocket is selling at a breathtaking discount to the average company in the S&P 500. Normally, outside of structurally declining businesses such as, say, shopping malls or coal mines, you simply don’t see stocks going for a sub-6 P/E ratio.
So it’s time to buy RKT stock, right? Not so fast.
Why Rocket’s Earnings Are Set to Plunge
The big drawback is that Rocket is a highly cyclical business. Specifically, it is tied to interest rates and the housing market.
When interest rates are low, it helps companies like Rocket in two ways. One, people can afford to take out bigger mortgages since the interest cost is less as a portion of the total payment. Two, people like to refinance mortgages when interest rates decline to either cut their monthly payment or take some cash out of the property.
Rocket has been enjoying a best-of-both-worlds scenario. The pandemic caused the Federal Reserve to slash interest rates, which stimulated refinancing activity. And many people decided to upgrade their living situations as a result of being stuck inside for so long. These factors led to a massive housing boom.
However, these tailwinds are likely to turn into headwinds in the not-so-distant future. With inflation on the rise, the Fed has said it will tighten monetary policy by raising interest rates, likely starting in early 2022. That will make mortgages less affordable and particularly ding Rocket’s refinancing business. Furthermore, on the housing market front, the initial pandemic-driven boost is fading, a trend that is likely to continue as the economic recovery slows.
How Much Will Rocket’s Revenue and Earnings Fall?
Rocket nearly quadrupled its revenue from around $4 billion in 2018 to $15.7 billion in 2020. Even with the company’s ambitious expansion plan, it still couldn’t have achieved anything like that simply from standard organic growth. Rather, Rocket managed to cash in on a super-charged housing market.
It wasn’t just them, either. Chief mortgage rivals such as UWM Holdings (NYSE:UWMC) and PennyMac Financial Services (NYSE:PFSI) also saw their revenue more than triple in recent years.
So, how far will revenue and earnings recede once the good times end?
Analysts see Rocket pulling in around $12.5 billion in revenue this year, with that number dropping to $9.8 billion in 2022. That decline in revenues, in turn, is expected to cause earnings to plunge 47% this year and another 30% in 2022. That puts RKT stock trading at 7x estimated 2021 earnings and 10x estimated 2022 earnings.
Now, to be clear, 10x earnings is still a cheap stock. However, it’s far less inexpensive than the valuation based on the past year’s record-breaking results.
In short, as the housing market cools, Rocket is likely to see a dramatic decline in business activity that will result in RKT stock growing more and more expensive. Given this, you can start to understand why investors have been aggressively dumping shares.
The Bottom Line on RKT Stock
Now, if the analysts are wrong and the housing boom isn’t over yet, Rocket should see its shares recover. It’s possible the Fed will lose its nerve and delay its planned tapering and interest rate increases. Or maybe the housing market will continue to soar even in the face of higher interest rates.
That said, RKT stock seems like a fairly priced offering at this level, rightly balancing the reward of a cheap security with the likelihood that earnings rapidly deflate.
Additionally, it should be noted that key mortgage rival PennyMac is trading at 4x this year’s estimated earnings and less than 5x next year’s. If you like RKT stock because it’s cheap, you should absolutely love PennyMac.
Rocket has little to recommend it versus either PennyMac or UWM Holdings on a valuation or business outlook basis.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.
