Stay Away From Rocket Companies Until It Trades Below Book Value

RKT stock - Stay Away From Rocket Companies Until It Trades Below Book Value

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Rocket Companies (NYSE:RKT), home of Rocket Mortgage and Quicken Loans, is a massive direct-to-consumer mortgage lender. It uses the same business model as Geico uses to sell car insurance without agents. The problem is this feature is not profitable enough to prevent RKT stock from dropping even further.

The problem for the past 9 months is that rates have been rising, especially lately as the Federal Reserve is jacking them up quickly. It makes most of its money by flipping mortgages it generates. This is called “Gain on Sale” (GOS) revenue, and it is down significantly.

If you take out a loan with Rocket or Quicken loans, they sell it within a few days those loans. Rocket keeps the right to service the loan (MSRs or mortgage servicing rights). They collect your mortgage payments, but they do not keep the loan on their books. This MSR revenue is steady but not as fast-growing as GOS revenue. It has been Rocket’s second-largest line of business. But the GOS revenue is dropping so dramatically that the MSR line might actually overtake GOS. That is not a good sign for RKT stock.

On May 10, Rocket Companies reported that its GOS revenue fell to $687.17 million, now lower than its MSR revenue at $796.6 million. This is the first time the GOS fell below the MSR line, as last quarter its GOS line was $993.5 million vs. $926.8 MSR revenue. This implies that over time the MSR line of revenue could tank as well.

Moreover, the underlying reason is that its GOS revenue margins have fallen. In Q1 they fell from 3.74% down to 3.01%. As rates rise, the company can’t cover the increase in its funding cost gains as fast. Moreover, the volume of mortgages it generates is starting to crater. People are stepping back from refinancing and buying homes.

Where This Leaves RKT Stock

I have been consistently negative on RKT stock since mid-2021 when it peaked and it was clear that rates were going to rise. The problem is I don’t see any end in sight of further rate increases.

As a result, it’s very possible that RKT stock could fall further and could easily fall below its book value. As of March 31 that was down to $8.7 billion, down $1 billion in 3 months from the end of Dec. 31, 2021.

Given that its market cap right now is $15.5 billion, that implies that RKT stock could fall 43.8% just to reach a 1.0x price-to-book value multiple. However, since we can estimate that book value may keep falling, I estimate RKT stock might reach a 50% decline before it is worth looking at. Value investors will also want a margin of safety and may want to wait until the stock is at two-thirds of its book value. So for the time being, the defensive investors will take a pass.

On the date of publication, Mark R. Hake did not hold any position (either directly or indirectly) 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.

Mark Hake writes about personal finance on mrhake.medium.com, Newsbreak.com and Beehiiv.com.


Article printed from InvestorPlace Media, https://investorplace.com/2022/05/rkt-stock-avoid-rocket-companies-until-it-trades-below-book-value/.

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