Stick With a Proven Winner in Countrywide

This column was originally published on RealMoney on Nov. 17 at 10:36 a.m. EST. It's being republished as a bonus for TheStreet.com readers.

Quick question: What do you ask yourself about a stock in your portfolio that has gone up 18.5% year to date and has appreciated at a compound annual rate of more than 20% for the past 25 years? Well, besides wondering why you don't own more of it, two ideas come to mind.

First, after the stunning price appreciation, how expensive is it? Second, is the underlying growth likely to continue?

You may be surprised to learn that, despite the heady share-price gains, Countrywide Financial (CFC Quote) trades at only 8.4 times consensus 2007 EPS estimates. This is well below the 2007 P/E multiples of 13.2 for Wells Fargo (WFC Quote), 10.5 for Washington Mutual (WM Quote) and 12.0 for J.P. Morgan Chase (JPM Quote). These are, in order, the top four U.S. residential mortgage originators for the first half of 2006, from Countrywide at No. 1 to J.P. Morgan Chase at No. 4.

Of that group, Countrywide is the most sensitive to housing, but it even trades at a discount to most of the homebuilders. Unlike the homebuilders, though, for which Wall Street is projecting huge earnings declines in 2007, Countrywide is expected to increase earnings per share by more than 10% next year. Its current 8.4 multiple is well below its historic growth rate of earnings (29% compound net earnings growth for the past 10 years) and is below its targeted long-term growth rate of 15%.

The Housing Factor

It might not be surprising that Wall Street questions the sustainability of Countrywide's earnings. It seems like everyone has proclaimed that the housing market is set for a significant decline, if not an outright collapse. A decline in housing doesn't necessarily cause a major problem in the mortgage market, but it will likely slow the volume of originations and possibly disrupt the subprime mortgage market.

Countrywide looks well prepared for a slowdown in mortgage originations. It has enacted a $500 million annualized expense-reduction campaign, which it said would be complete by the end of 2006. This is a significant effort, as it represents around 7% of 2006 noninterest expenses.