Arlington Asset Investment Corp. (NYSE:AI) and Nationstar Mortgage Holdings Inc. (NYSE:NSM) are the two most active stocks in the Mortgage Investment industry based on today’s trading volumes. The market is clearly enthusiastic about both these stocks, but which is the better investment? To answer this, we will compare the two companies based on the strength of their growth, profitability, risk, returns, valuation, analyst recommendations, and insider trends.
Companies that can consistently grow earnings at a high compound rate usually have the greatest potential to create value for shareholders in the long-run. Analysts expect AI to grow earnings at a -9.38% annual rate over the next 5 years. Comparatively, NSM is expected to grow at a 6.18% annual rate. All else equal, NSM’s higher growth rate would imply a greater potential for capital appreciation.
Profitability and Returns
Growth in and of itself is not necessarily valuable, and it can even be harmful to shareholders if companies overinvest in unprofitable projects in pursuit of that growth. We will use Return on Investment (ROI), which adjust for differences in capital structure, as measure of profitability and return. AI’s ROI is -1.00% while NSM has a ROI of 1.50%. The interpretation is that NSM’s business generates a higher return on investment than AI’s.
The amount of free cash flow available to investors is ultimately what determines the value of a stock. AI’s free cash flow (“FCF”) per share for the trailing twelve months was +0.50. Comparatively, NSM’s free cash flow per share was -10.23. On a percent-of-sales basis, AI’s free cash flow was 0.01% while NSM converted -52.19% of its revenues into cash flow. This means that, for a given level of sales, AI is able to generate more free cash flow for investors.
Liquidity and Financial Risk
Analysts look at liquidity and leverage ratios to assess how easily a company can cover its liabilities. AI’s debt-to-equity ratio is 11.36 versus a D/E of 8.64 for NSM. AI is therefore the more solvent of the two companies, and has lower financial risk.
AI trades at a forward P/E of 5.82, a P/B of 0.90, and a P/S of 4.05, compared to a forward P/E of 9.09, a P/B of 1.01, and a P/S of 0.79 for NSM. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.
Analyst Price Targets and Opinions
When investing it’s crucial to distinguish between price and value. As Warren Buffet said, “price is what you pay, value is what you get”. AI is currently priced at a -7.12% to its one-year price target of $14.04. Comparatively, NSM is -25.93% relative to its price target of $23.14. This suggests that NSM is the better investment over the next year.
The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 2.30 for AI and 3.20 for NSM, which implies that analysts are more bullish on the outlook for NSM.
Risk and Volatility
No discussion on value is complete without taking into account risk. Analysts use a stock’s beta, which measures the volatility of a stock compared to the overall market, to measure systematic risk. A stock with a beta above 1 is more volatile than the market. Conversely, a beta below 1 implies a below average level of risk. AI has a beta of 1.17 and NSM’s beta is 1.43. AI’s shares are therefore the less volatile of the two stocks.
Insider Activity and Investor Sentiment
The analysis of insider buying and selling trends can be extended to the aggregate level. Short interest, which represents the percentage of a stock’s tradable shares currently being shorted, captures what the market as a whole feels about a stock. AI has a short ratio of 6.58 compared to a short interest of 17.33 for NSM. This implies that the market is currently less bearish on the outlook for AI.
Arlington Asset Investment Corp. (NYSE:AI) beats Nationstar Mortgage Holdings Inc. (NYSE:NSM) on a total of 7 of the 13 factors compared between the two stocks. AI has higher cash flow per share and has a higher cash conversion rate. In terms of valuation, AI is the cheaper of the two stocks on an earnings and book value, Finally, AI has better sentiment signals based on short interest.