If Home Capital Group Inc. was a steal at $6 a share and a deal at $14, its attractiveness to risk-loving investors is now fading at $17.
The alternative mortgage lender, which caters to home buyers who don't qualify for loans from traditional banks, has been on a tear since returning to profitability with its fiscal third-quarter results, released last week.
The shares have surged 26 per cent over the past five trading days, bringing the gains to 185 per cent since early May. The share price closed on Tuesday at $16.68.
The gains suggest that concerns about Home Capital's future, which looked bleak in April and May following a run on deposits, are now shifting into something that looks like optimism.
DBRS Ltd. appeared to confirm this improvement on Tuesday with an upgrade to Home Capital's long-term credit rating.
The credit-rating agency upgraded Home Capital by one notch, to "B," with a stable trend. While that's still considered highly speculative, DBRS added a few upbeat details in its release.
It noted that deposit and liquidity levels have stabilized, adding Home Capital "is now in a steady position with the hiring of a full complement of senior executives who were able to restore market confidence and set clear goals."
But as the share price approaches its book value, the rewards for investors aren't what they used to be. Indeed, the share price has already risen above some analysts' 12-month price targets, suggesting that the upside from here could be more limited – especially when you consider the effects of new mortgage rules.
Here's a quick recap of Home Capital's tumultuous year.
In April, depositors pulled money from high-interest savings accounts, following allegations from the Ontario Securities Commission that Home Capital had failed to disclose isolated problems with its mortgage underwriting properly.
Without sufficient deposits, it was unclear how Home Capital would stay in business. The share price collapsed 65 per cent in one day (April 26), falling to a low closing price of $5.85 on May 5.
But the quality of Home Capital's lending book was never seriously doubted, beyond a few vocal short-sellers who believed that Canada's entire housing market was collapsing, and loan losses were exceptionally low.
For investors who could tune out the swirling fears about a looming homegrown financial crisis, Home Capital shares looked tantalizing. The bullish argument suggested they should be worth something close to book value, or more than $25.
Warren Buffett swooped down in June, not long after the shares began to recover some lost ground. Mr. Buffett's Berkshire Hathaway Inc. provided a financial lifeline and became Home Capital's biggest investor with a sweetheart deal.
Berkshire Hathaway bought more than 16 million shares priced at $9.55 each, or 36-per-cent below the closing price on June 21. Given the gains since then, Mr. Buffett is now up nearly $115-million, or 75 per cent, on his initial investment.
If early investors have done well with Home Capital shares, what can latecomers expect?
Clearly, you can no longer bet on new management or greater financial stability and confidence. These improvements have already occurred and are presumably baked into the share price.
An absurd discount is also no longer a compelling reason to buy the stock. Book value is now $22.20 a share, which means that the shares currently trade at 75 per cent of this implied value – which looks about right for a company facing a lot of market uncertainties that could crimp its growth.
Consider that Equitable Group Inc., a competitor that has not experienced anything close to Home Capital's challenges this year, trades just above book value.
Marco Giurleo, an analyst at CIBC World Markets Inc., believes Home Capital shares should trade at 70 per cent of his estimated 2018 book value – which gets him to a target price of $17.
Geoffrey Kwan, an analyst at RBC Dominion Securities, takes a similar approach to book value, which underpins his target of $16.
"For the stock to outperform, we think greater earnings visibility and early signs of stronger and sustainable growth are required," Mr. Kwan said in a note last week.
It's hard to see the upside here unless Home Capital can get profit gushing again. That's not an outlandish bet, but it means the stock is no longer a golden opportunity just sitting there.