Two Harbors Investment Corp. (NYSE:TWO) and EdR (NYSE:EDR) are the two most active stocks in the REIT – Residential 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.
The ability to grow earnings at a compound rate over time is a crucial determinant of investment value. Analysts expect TWO to grow earnings at a 2.64% annual rate over the next 5 years. Comparatively, EDR is expected to grow at a 9.30% annual rate. All else equal, EDR’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. Two Harbors Investment Corp. (TWO) has an EBITDA margin of 122.2%, compared to an EBITDA margin of 45.6% for EdR (EDR). This suggests that TWO underlying business is more profitable. TWO’s ROI is 1.80% while EDR has a ROI of 1.60%. The interpretation is that TWO’s business generates a higher return on investment than EDR’s.
Earnings don’t always accurately reflect the amount of cash that a company brings in. TWO’s free cash flow (“FCF”) per share for the trailing twelve months was +0.08. Comparatively, EDR’s free cash flow per share was -0.07. On a percent-of-sales basis, TWO’s free cash flow was 0% while EDR converted -0% of its revenues into cash flow. This means that, for a given level of sales, TWO is able to generate more free cash flow for investors.
Liquidity and Financial Risk
Liquidity and leverage ratios provide insight into the financial health of a company, and allow investors to determine the likelihood that the company will be able to continue operating as a going concern. TWO’s debt-to-equity ratio is 5.73 versus a D/E of 0.46 for EDR. TWO is therefore the more solvent of the two companies, and has lower financial risk.
TWO trades at a forward P/E of 10.25, a P/B of 1.03, and a P/S of 6.07, compared to a forward P/E of 56.21, a P/B of 1.52, and a P/S of 8.59 for EDR. TWO is the cheaper 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
Just because a stock is cheaper doesn’t mean there’s more value to be had. In order to assess value we need to compare the current price to where it’s likely to trade in the future. TWO is currently priced at a -0.2% to its one-year price target of $10.22. Comparatively, EDR is -14.97% relative to its price target of $42.90. This suggests that EDR 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 2.00 for TWO and 2.60 for EDR, which implies that analysts are more bullish on the outlook for EDR.
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. TWO has a beta of 0.66 and EDR’s beta is 0.45. EDR’s shares are therefore the less volatile of the two stocks.
Insider Activity and Investor Sentiment
Short interest, or the percentage of a stock’s tradable shares currently being shorted, is another metric investors use to get a pulse on sentiment. TWO has a short ratio of 5.15 compared to a short interest of 17.55 for EDR. This implies that the market is currently less bearish on the outlook for TWO.
Two Harbors Investment Corp. (NYSE:TWO) beats EdR (NYSE:EDR) on a total of 8 of the 13 factors compared between the two stocks. TWO is more profitable, generates a higher return on investment and has higher cash flow per share. In terms of valuation, TWO is the cheaper of the two stocks on an earnings, book value and sales basis, Finally, TWO has better sentiment signals based on short interest.