First American Financial (FAF)

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Key Statistics

Enterprise Value = $3.245 billion

Operating Income = $689 million

EV/Operating Income = 4.7x

Earnings Yield = 12%

Price/Revenue = .84x

Debt/Equity = 22%

The Company

First American Financial is a California based insurance company. Their focus is title insurance, from which roughly 92% of their revenue is derived. Title insurance is simply insurance which protects against losses if a title is deficient.

FAF is paid when mortgage transactions closed. With the real estate market in the United States steadily growing over the last decade, the company has benefited from real estate activity. Since 2013, earnings are up 119%.

The title business improves due to volume and the premium paid for title insurance is derivative of the home’s value. Therefore, FAF benefits from a rising real estate environment. The stock has been punished over the last year due to concerns that this real estate expansion is slowing down.

FAF also maintains an investment portfolio, which is mostly concentrated in fixed income instruments. Currently, they have $4.7 billion in fixed income instruments and $467 million in equity. For this reason, the pressure experienced by the markets in recent months has weighed upon the price. From 2016 to 2017, the investment portfolio increased in size by 157%. If we entered a serious downturn, it is unlikely that that this would persist.

Side note: In the summer of 2001, I had a job working for a title insurance company. My task was simply to spend all day calling title abstractors across the country. I would order title reports from the counties in which the properties were purchased, they would fax it to me, and it was my job to regularly follow up with them. I had a lot of fun doing it! I’m sure the operation is more sophisticated these days, but back then obtaining the reports from the local abstractors was like pulling teeth.

My Take

I owned this back in 2017 and made a 50% profit on it. It is one of my few successes over the last couple of years. I bought it around a P/E of 12. When I sold it, the multiple was around 20, and I made a 50% profit, so I got out. The stock is way down from those lofty levels, and it is now at a P/E of 8.

From a relative valuation standpoint, FAF looks like it is at an attractive level. The P/E of 8 compares to a 5-year average for the stock of 15. The average for the industry is also 15. On a price/revenue basis, the stock currently trades at 84% of revenue compared to an industry average of 125%.

With an F-Score of 6 and a low debt/equity ratio of 22%, the company exhibits a high degree of financial quality. Indeed, FAF is a well run company and this has buoyed its ability to consistently grow over the last decade. Additionally, while title abstracts and insurances looks like an area ripe for disruption, to truly streamline this industry would require many local governments throughout the country to upgrade their technology and systems used to track title information. I don’t think this will happen any time soon.

I expect that FAF will continue to perform well and I don’t think there will be a recession in the next year as many pundits are predicting right now. With that said, even in the midst of the 2008 real estate meltdown, FAF only lost 81 cents per share and quickly recovered to profitability in 2009. I would be shocked if the US entered a real estate meltdown of that magnitude. By all indications, the quality of mortgage loans has improved and household mortgage debt looks sustainable when compared to the disposable income of households.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.