Redwood Trust, Inc. (NYSE:RWT) and iStar Inc. (NYSE:STAR) are the two most active stocks in the REIT – Diversified industry based on today’s trading volumes. To determine if one is a better investment than the other, we will compare the two companies’ growth, profitability, risk, return, and valuation characteristics, as well as their analyst ratings and sentiment signals.
Companies that can increase earnings at a high compound rate over time are attractive to investors. Analysts expect RWT to grow earnings at a 8.00% annual rate over the next 5 years. Comparatively, STAR is expected to grow at a 0.00% annual rate. All else equal, RWT’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 EBITDA margin and Return on Investment (ROI), which adjust for differences in capital structure, as measure of profitability and return. Redwood Trust, Inc. (RWT) has an EBITDA margin of 105.61%, compared to an EBITDA margin of 45.7% for iStar Inc. (STAR). This suggests that RWT underlying business is more profitable. RWT’s ROI is 2.50% while STAR has a ROI of -1.90%. The interpretation is that RWT’s business generates a higher return on investment than STAR’s.
Earnings don’t always accurately reflect the amount of cash that a company brings in. RWT’s free cash flow (“FCF”) per share for the trailing twelve months was -5.57. Comparatively, STAR’s free cash flow per share was +1.13. On a percent-of-sales basis, RWT’s free cash flow was -0.17% while STAR converted 0.02% of its revenues into cash flow. This means that, for a given level of sales, STAR is able to generate more free cash flow for investors.
Liquidity and Financial Risk
Liquidity and leverage ratios measure a company’s ability to meet short-term obligations and longer-term debts. RWT’s debt-to-equity ratio is 3.67 versus a D/E of 2.90 for STAR. RWT is therefore the more solvent of the two companies, and has lower financial risk.
RWT trades at a forward P/E of 10.55, a P/B of 1.08, and a P/S of 5.56, compared to a forward P/E of 8.18, a P/B of 0.74, and a P/S of 1.45 for STAR. RWT is the expensive of the two stocks on an earnings, book value and sales basis. 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
A cheap stock is not necessarily a value stock. Most of the time, a stock is cheap for good reason. A stock only has value if the current price is substantially below the price at which it should trade in the future. RWT is currently priced at a -6.54% to its one-year price target of $17.75. Comparatively, STAR is -13.79% relative to its price target of $14.00. This suggests that STAR 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 2.80 for RWT and 3.00 for STAR, which implies that analysts are more bullish on the outlook for STAR.
Risk and Volatility
Beta is an important measure that gives investors a sense of the market risk associated with a particular stock. A beta above 1 signals above average market risk, while a beta below 1 implies below average volatility. RWT has a beta of 0.90 and STAR’s beta is 1.29. RWT’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. RWT has a short ratio of 7.42 compared to a short interest of 14.89 for STAR. This implies that the market is currently less bearish on the outlook for RWT.
iStar Inc. (NYSE:STAR) beats Redwood Trust, Inc. (NYSE:RWT) on a total of 7 of the 13 factors compared between the two stocks. STAR is growing fastly, has a higher cash conversion rate and has lower financial risk. In terms of valuation, STAR is the cheaper of the two stocks on an earnings, book value and sales basis, STAR is more undervalued relative to its price target. Finally, LADR has better sentiment signals based on short interest.