When Stocks Plummet, Opportunities Abound

The 1,000-point-or-so Dow Jones drop that we saw on Friday felt bad, but often drops like these provide excellent chances to establish positions in great stocks at attractive prices. When over 95% of all stocks drop in unison, the declines generally have nothing to do with the actual values of those shares. Title insurance specialist First American Financial dropped almost 2% last Friday in the absence of any company-specific news. The shares had already declined from a Jan. 12 peak of $81.54 before last week's selloff. At $56.78 FAF was down by 30.4% from this year's peak. Since year-end 2013, though, the company posted excellent gains in all major metrics as shown below. Continuous shareholders had made almost 186% in total return over exactly nine years. Normally that would be good. Looking at the percentage gains in earnings per share and dividends, though, the pullback has placed FAF shares at a huge discount to where they would be if they'd merely matched cumulative growth in those keys areas. That suggests a nice catch-up move higher can't be too far away once the market mood improves. FAF sports a solid balance sheet, and earns high grades in both price growth persistence and earnings predictability. After a recently announced dividend increase to 52 cents per share quarterly, FAF now pays a well-covered and higher than average 3.66% yield to boot. What should FAF really sell for? In the eight year stretch from 2013 through 2020, First American Financial averaged a 12-times multiple accompanied by around 2.94% in yield. At present FAF's price-to-earnings on Value Line's 2022 estimate is just 6-times. Simply reverting back to its normalized P/E it appears reasonable to think FAF could rise to north of $116 by Dec. 31, 2023. Reverse engineering the annual dividend of $2.08 to normal delivers a present-day fair value of $70.75 per share, implying a 24.6% undervaluation at today's quote. FAF has rarely traded at as low a multiple as it does right now. At its Covid-panic nadir it fetched 4.8-times that year's EPS. Smart traders who bought near that bottom saw the shares skyrocket from south of $30 to almost $60 in just three months. Another solid buying opportunity came in March of 2021 when FAF sold for what turned out to be a watershed $11.14 EPS tally. The stock then climbed from under $49 to over $81 in about 10-months. All other best buying opportunities (green-starred below) launched rallies from P/Es well above today's. Yahoo Finance call FAF undervalued. They see it rising to $71.67 by this time next summer. If it only does that you'd see total return of about 30% by then. Research house Morningstar is more enthusiastic about FAF than Yahoo Finance is. It now labels First American Financial as a 5-star (top-rated) Buy. Morningstar deigns to provide year-ahead goal prices but does let us know what it sees as present-day fair value for each stock they cover. For FAF that figure is $74.27, almost 31% plus dividends above the current quote. Quantitatively based FastGraphs thinks 12.47-times is the average P/E for FAF. As such it projects a move to $80.56 by Dec. 31, 2023. If they prove correct total return would run around 46.4% over the coming 16-months. Owning high-quality, good-yielding shares that could rise by 30% to 42% by the end of 2023 seems like a good idea to me. Option traders could benefit by also selling some naked puts out to Apr. 21, 2023 at strike prices of $60 to $70. Actual pricing on those, with FAF at $56.78, is shown below. Worst-case forced purchase prices dropped to between $53.50 and $55.20. Any of those would represent extremely attractive entry points if FAF is destined to perform as I expect. The margins of safety are modest as almost nobody believes FAF will be down in price over the coming 8 months. Buy some FAF shares, sell some FAF puts or consider doing both.

When Stocks Plummet, Opportunities Abound

Let me show you what I mean with the shares of First American Financial, which are undervalued, ready to rebound, and yield 3.66%.

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