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I Love Payday Lenders

I don't need 'em and haven't used 'em, but I have an affinity for payday lenders. Whenever an industry is under attack from the government, regulators, or various do-gooders, the strong libertarian streak in me wants to defend them. Of course, it also doesn't hurt that investing master Peter Lynch considers industries with a high "ick factor" ideal sources of good investments.

Payday lenders are simple businesses to understand. A customer with short-term cash flow problems walks into an Advance America (NYSE: AEA  ) store, hands over a postdated check as collateral, and walks out with a fistful of cash. Most of the time, these loans are for a two-week period -- just until the next paycheck arrives (hence the industry name) -- and the borrower pays a fee for the service.

That fee, however, gets everyone riled up. A $15 fee per $100 borrowed doesn't seem particularly onerous, but consumer advocates want to liken it to the annual percentage rate you'd be charged on a regular loan. When you do that, it equals a 391% APR.

There are a couple of reasons why the fees are so high. Payday customers can be bad credit risks, and default rates can run high. First Cash Financial (Nasdaq: FCFS  ) had loss provisions of 23% in 2006, while Cash America's (NYSE: CSH  ) were 30% last year. And there's the convenience issue. Customers simply can't get small, short-term loans from their local bank. Folks in need of short-term financial solutions have been abandoned by traditional lending sources.

Though many associate bad credit practices with the poor, EZCORP (Nasdaq: EZPW  ) has found that the typical customer in Texas using its maximum $1,500 payday loan service has an individual income of around $60,000 to $70,000 annually.

While Advance America and QC Holdings (Nasdaq: QCCO  ) have remained solely payday lenders, the others have branched out into related fields. EZCORP runs pawn shops, as do First Cash Financial and Cash America, while Dollar Financial (Nasdaq: DLLR  ) does payday loans, check-cashing, bill payment, and money transfers. Buy here/pay here used-car dealerships are another new area payday lenders are beginning to explore.

In a very Lynchian way, payday lenders are good investments. They're disliked by large swaths of people, and they have a high ick factor, but they provide a necessary and highly profitable service. Despite attacks from regulators, payday lenders will survive and thrive. That's good for investors, and it's why I love 'em.

Advance America is a recommendation of Motley Fool Inside Value. Check out why this payday lender is considered a bargain with a 30-day free trial subscription.

What's setting Fools' hearts aflutter? Go back to our intro page to see what else we have a crush on.

Despite the love, Fool contributor Rich Duprey does not yet own any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.

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