A Safer Way to Bet on Housing

 | Aug 20, 2013 | 4:00 PM EDT
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We all know why the housing market is so crucial to the U.S. economy. A healthy and growing housing market has tentacles that reach everywhere, playing a major role in the overall health of the economy. If builders are building, that creates jobs, demand for building products, appliances, and so forth. When houses are being bought, it creates demand for mortgages, furnishings, cable television, and more. All that increased demand creates growth in those markets, and that leads to stronger employment, which leads to increasing consumer confidence and, ultimately, spending.

The home-buying process requires dotting lots of i's and crossing many t's. That diligence usually comes with fees that can sometimes be avoided or negotiated. But one expense that is absolutely required by every lender is title insurance. No bank will lend money to a buyer until there are reasonable assurances that the seller has a clean title to the property. The lender protects itself and the buyer by requiring title insurance.

One of the providers of that service is a nimble small-cap, Investors Title Co. (ITIC). With a market cap of $150 million, Investors Title is relatively small compared to its two main rivals, Fidelity National (FNF, $5.5 billion) and Stewart Information Services (STC, $700 million).

But being the smallest has its advantages. While all three companies are doing well thanks to the improving housing market, Investors Title generates the most attractive margins. The company just has over 2 million shares outstanding, with insiders controlling 27% of the shares. So there aren't many shares available to the public especially if someone decides to pick up a healthy position. Along with the $72 share price comes $20 in cash per share and no debt. Earnings are on a strong rebound and the company currently changes hands at a very attractive 11x earnings.

Before the housing crash, annual premiums earned were $70 million and declined to $61 million over the next three years. Even then, Investors Title still managed to generate more than $6 million in net profit. In fact, in the past 10 years, the company only lost money once: $1.2 million in 2008. In 2012, the company generated more than $100 million in premiums and $11 million profit.

Given the cautious view that housing will continue stabilizing in coming years, premium volume should continue to remain attractive for Investors Title. Currently, the company pays out $0.32 a year to shareholder, equivalent to a 0.4% yield. As the cash continues to pile up, you can count on the company to do something for shareholders. In the past six years, the company has retired 20% of shares. Dividend increases have been modest but long-term shareholders have not been disappointed. The industry could also look to consolidate, in which case Investors Title is a very attractive target for both Fidelity and Stewart.

The title insurance business has proven to be a very resilient and profitable endeavor. The growth potential is nothing like that of property and casualty insurance, but title insurance is enormously profitable; in 2012, underwriting margin at Investors Title was more than 90%, and since 2005 has averaged more than 85%.

Title insurance has a lot to offer those looking for a smart and profitable way to bet on housing.

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