Financials Roundup with a new PSG Ratio: Part 2 of 3 $FOA, $JXN, $SEZL, $SOFI

The PEG Ratio (Price to Earnings divided by Growth) is an odd sort of metric. To get a PEG of 1, for example, it could be a business with a PE of 10 and an annual growth rate of 10%, or it could be a business with a PE of 40 and an annual growth rate of 40%. And it isn’t immediately obvious which of the two would outperform in the years ahead. Looking out three years, the company with the 10% growth rate would be 33% larger, while the one with the 40% growth rate would be 174% larger. But if the market re-rated the PE 10 company to a PE of 15 or 20 due to its acceptance as a quality compounder, and diminished the future prospects of the PE 40 company down to a PE of 30 or even 20, then the tortoise really could beat the hare.

If each company started with a stock price of $10, after three years the 10% growth rate company could have a $22.63 share price due to a re-rating from a PE of 10 to 17. But the 40% growth rate company could have a share price of $20.58 after falling from a PE of 40 to 30, or worse. The ultimate share price destination would be based on the future growth prospects of the businesses three years from today, which companies had saturated their markets, and which still had a growth runway. And those hypothetical companies currently have identical PEG scores.

Accepting that PEG is flawed, it’s still useful. The convention is that a company with a PEG below 1 is cheap, between 1 and 2 is somewhat fairly valued, and above 2 is expensive. Imagine a company with a PE ratio of 10 and a 20% annual growth rate, that would give a PEG of 0.5. Meanwhile, a company with a PE of 15 and a 10% growth rate would give a PEG of 1.5. And a company with a PE of 15 and a 5% growth rate would give a PEG of 3. Even with those scores in hand, it’s still important to consider what their competitive positions would look like in three years, otherwise multiple compression can destroy returns.

Moving from Price to Earnings to Price to Sales, I’m shifting the decimal over by one place so that the values can be mapped from PEG to PSG. For example, a price to sales ratio of 1 and a 20% growth rate would give a PSG score of 0.5x and I would consider it to be cheap. A price to sales of 1.5x and a 10% growth rate would give a PSG score of 1.5x and be somewhat fairly valued. And a price to sales ratio of 1.5x and a 5% growth rate would give a PSG score of 3x and be expensive.

In Part 1 of this series, from 21st to 16th place all of the companies had a PSG score over 2.0x, falling into the overvalued category. Today’s companies have a PSG score between 1.0x and 2.0x, making them somewhat fairly valued.

In Part 1, the only company I was actively adding to was BMNR due to two embedded and somewhat unique lottery tickets that I wanted in my portfolio. But here in Part 2, there are plenty of reasons why someone might want to buy a fairly valued company instead of being a value degen and trying to buy dips. If retirement is decades away and you are cathartically squirreling away nuts for your winter years, buying high quality companies at reasonable prices is an admirable strategy. Alternatively, if you believe that the market is wrong about future growth, it might be fairly valued by historical growth metrics, but be cheap by your own estimated future growth estimates. Companies in this Part 2 are not as easy to pass on compared to Part 1, but they aren’t screaming buys either.

Finance of America Companies (FOA) 15th place:

I am very fond of FOA, they were the second component of my silver tsunami thesis, and a reverse mortgage will still likely be critical for the median Baby Boomer. But I believe that FOA’s management botched the M&A integration, and I can only diagnose it in hindsight. By consolidating brands, 42% market share fell to 24% market share, although it has since rebounded to somewhere around 29%. I suspect that financial advisors selling a reverse mortgage get three quotes for their clients, and they are somewhat indifferent which originator the client chooses. Before brand integration, FOA controlled two out of the three market leaders. But by consolidating brands they became one out of three and Mutual of Omaha swooped in to fill the vacuum.

I am somewhat optimistic about FOA’s partnership with Onity Financial (ONIT), essentially white labeling FOA’s reverse mortgages so that Onity can sell them. This allows FOA’s products to potentially cover two quotes again in the sales process, although ONIT was never a top three originator, it will take time to regain lost market share, and Mutual of Omaha won’t go gently into that good night. Meanwhile capital allocation policy is to retire debt, even while the share price is so depressed that a little bit of share buybacks would go a long way.

FOA is a great example of a company that isn’t cheap, and it isn’t expensive. You can buy it here if you want, it will probably do well over the next few years, but it isn’t degen value according to my new PSG ratio. Personally, I am trying to get into the habit of rewarding management teams that don’t make mistakes. Should I really wait around to see if the team at FOA bungles some other initiative, or should I just give more of my money to the folks at ABX, OPEN, or even SOFI who seem to wake up every morning, eat their wheaties, and push the ball farther down the field?

Sezzle Inc (SEZL) 14th place:

I really enjoyed learning about the Buy Now Pay Later space, and I really enjoyed finding SEZL. I had heard enough bears call it “buy now pay never,” that I had some trepidation. When I found out that the loans are only for six weeks, unlike credit cards which keep on rolling, I was shocked but not that shocked that the talking heads on television didn’t know what the heck they were talking about.

I bought a bit of SEZL, but the valuation never quite seemed compelling enough to size up aggressively. Their 50% annualized growth rate is impressive, but it’s already somewhat priced in, as I would expect from a company that is a bit of a Twitter darling. Since I bought a small amount, it has more than doubled, and it highlights the strategy that some investors use, which is to only buy stocks that other investors like, because other investors’ buying causes the stock to go up. It’s an investing thesis that works in moderation, but can be taken too far once valuations get silly. SEZL’s valuation hasn’t gotten silly yet.

The problem with buying companies that are fairly valued at a 50% growth rate, is that if they were to decline to only a 30% growth rate, which is still aggressive, the valuation would collapse from multiple compression. The analyst consensus seems to be that the growth rate will drop to around 30%, but SOFI and NU have been able to maintain their 40% and 50% annual growth rates for more years than I had thought possible, maybe SEZL can too, despite aggressive competition from Paypal, Klarna, and the others.

Even among companies that have the same PEG or PSG score, if I am not confident about future growth prospects, it’s hard for me to buy the company with the trailing PE ratio of 40. In my bones I am not a growth investor by nature. For me, SEZL just isn’t cheap enough to get excited about, I didn’t buy enough, but I haven’t sold the little bit that I bought, it’s too early to get off this rollercoaster.

Jackson Financial (JXN) 13th place:

Jackson Financial was one of my early successes, even from before I started this Substack. My wife has some shares in her Roth IRA with a $26 cost basis, they represent her largest single unrealized gain. I still think JXN is on its way to $300 a share within the next five years. It isn’t expensive here, but it isn’t cheap either, it’s in that sort of middle valuation area.

I even like the management team, although I like them more in the sense that I trust them not to make mistakes, which is different than trusting them to conquer new worlds. Compared to FOA’s mishandling of their M&A, JXN hasn’t bungled anything. And FOA is at a PSG score of 1.68 compared to JXN’s 1.36, if I were in the mood to stack fairly valued companies, I would choose JXN over FOA easily. I wouldn’t fault anyone who takes a little money out of every paycheck and buys some JXN for their retirement.

Their capital allocation policy is excellent as well, buying back as much stock as they can get their hands on. From a valuation / quality tradeoff, JXN is an amazing company for anyone who isn’t as degenerate as myself. But when I think about adding more shares to my 13th best idea, the marginal dollar always runs out before I make it this far down the list.

SoFi Technologies (SOFI) 12th place:

I have finally arrived at the spot in the ranking where I am actively buying. At 12th place with a PSG score of 1.17, SOFI has grown at a 40% rate for the last five years, and it isn’t as expensive as a typical company with that growth rate. The CEO, Anthony Noto, is targeting 40% growth for the year ahead, although doesn’t give guidance more than one year forward. There is still a growth runway due to the “land and expand” strategy, where new clients can make use of newly rolled out services such as home equity loans. Customer Acquisition Cost is calculated off of one loan transaction, refinancing student debt, for example. If clients then use SOFI for their mortgage as well, internal rate of return numbers on customer acquisition go absolutely bananas, and banking clients are sticky once direct deposit is established.

Also of note is that SOFI has two very interesting potential catalysts. Their stablecoin, SOFIUSD, is being used by Mastercard to facilitate 24/7 settlements for the first time in Mastercard’s history. There are many stablecoins, but SOFI is the only chartered bank to issue one, which allows them to access FDIC insurance, and to deposit the funds at the Federal Reserve in order to pay a money market interest rate instead of manually going to the treasury market and taking duration risk like their competitors.

If SOFIUSD becomes the dominant stablecoin, then $20 billion is too cheap for the company. But it’s very hard to predict which competitor will win the network. But with a 40% growth rate outside of their stablecoin, the stock price doesn’t really reflect the lottery ticket opportunity here at all.

The other potential catalyst is direct exposure to home equity loans. I suspect that the Federal Reserve is going to cut the overnight rate, even if the 10-year treasury rate stays mostly flat. That wouldn’t stimulate the 30 year mortgage, but it would stimulate home equity loans. I scoured the mortgage origination companies looking for exposure to home equity loans, but I was never happy with the exposure that I could find. But now SOFI has launched new home equity loan products, and stands to be one of the most direct beneficiaries of a cut to the overnight rate.

The incentive alignment is good as well, Anthony Noto has been aggressively buying SOFI stock in the open marketplace, although he was buying closer to $13 a share, and the stock price has recently been closer to $17.

Conclusion:

There are only these four companies in the “fair value” range according to the new PSG metric, and only one that I am actively adding to, SOFI. But I wouldn’t throw stones at anyone who found themselves drawn to JXN, FOA, or SEZL either. Over time I find myself being drawn to management teams that win, and are dominated by entrepreneurs over bureaucrats. FOA’s management team flubbed something major, so they are in my penalty box. JXN’s management team are bureaucrats, but they are the good sort of bureaucrats who take pride in managing the company well as opposed to fleecing the shareholders dry. SEZL’s management team does have entrepreneurs, and it ticks a lot of boxes on my checklist, but something I can’t describe still held me back from adding more aggressively. It took me a while to warm up to SOFI, but after following the company for long enough, I finally recognized that the CEO has a grand strategy and is executing on that strategy very well, all while buying more stock in the open market. It’s hard to ask for more than that.