Book value

RKT Stock: Avoid Rocket Companies Until They Trade Below Book Value

Source: Lori Butcher / Shutterstock.com

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

The problem of the past 9 months is that rates have been rising, especially lately as the Federal Reserve is raising them rapidly. He earns most of his money by flipping the mortgages he 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 out those loans within days. Rocket retains the right to service the loan (MSR or Mortgage Service Rights). They collect your mortgage payments, but they don’t keep the loan on their books. This MSR revenue is stable but not growing as fast as GOS revenue. This is Rocket’s second line of business. But GOS revenues are falling so dramatically that the MSR line may actually overtake GOS. This is not a good sign for RKT stocks.

On May 10, Rocket Companies announced that its GOS revenue had fallen to $687.17 million, now below its MSR revenue of $796.6 million. This is the first time GOS has fallen below the MSR line, as last quarter its GOS line was $993.5 million against $926.8 in MSR revenue. This implies that over time, the MSR revenue line could also drop.

Moreover, the underlying reason is that its GOS revenue margins have dropped. In the first quarter, they fell from 3.74% to 3.01%. As rates rise, the company cannot cover its increased earnings on financing costs as quickly. Moreover, the volume of mortgages it generates is starting to plummet. People are pulling out of refinancing and buying homes.

Where That Leaves RKT Stock

I have been consistently negative on RKT stocks since mid-2021 when they peaked and it was clear rates were going to rise. The problem is that I see no end to further rate increases.

As a result, it is very possible that RKT stock will fall further and easily fall below its book value. As of March 31, this amount had fallen to $8.7 billion, down $1 billion in 3 months from the end of December 31, 2021.

Given that its market capitalization is currently $15.5 billion, this implies that RKT stock could drop 43.8% just to reach a price-to-book multiple of 1.0x. However, since we can estimate that the book value may continue to decline, I estimate that RKT’s stock could hit a 50% drop before it is worth looking into. Value investors will also want a margin of safety and may want to wait until the stock reaches two-thirds of its book value. So for now, defensive investors will let it go.

As of the date of publication, Mark R. Hake held no position (directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the author, subject to InvestorPlace.com publishing guidelines.