Rocket Companies (NYSE:RKT), the nation's largest mortgage originator and parent company of Quicken Loans, has gotten off to a volatile start since conducting its initial public offering. It started trading in early August around $21.50 per share, briefly dipped below $19 per share, and also got as high as $31.31 per share.

There is a lot of debate among investors over whether the company should be viewed -- and therefore valued -- as a financial technology company or a traditional mortgage originator. But I don't think this is the question Rocket needs to answer.

When Susquehanna analyst Jack Micenko initiated coverage on Rocket in early August, he said in a research note, "the challenge unfortunately is that while EBITDA margins for RKT are comparable to fintech margins today, they are highly dependent on volume and not sustainable through the cycle." And I think this is the question Rocket needs to answer. Right now, the mortgage market is sizzling, but can the company remain profitable when it cools? 

The exterior of a traditional family home.

Image source: Getty Images.

Volume, volume, volume

Perhaps it can further diversify its revenue down the line, but right now, as Micenko mentioned, Rocket's revenue and profitability is heavily based on volume. Although it's the nation's largest mortgage originator, Rocket is not a bank and therefore does not keep a lot of mortgages on its books.

Instead, it sells most of its mortgages into the secondary market. Those sales go to government-sponsored entities such as Fannie Mae and Freddie Mac, as well as the Federal Housing Administration, the Department of Veterans Affairs, and the Department of Agriculture.

In the second quarter of the year, Rocket originated more than $72 billion in mortgage volume, more than double the mortgage volume in the second quarter of 2019. As a result, the company brought in nearly $4.1 billion in revenue from the gain on sale of loans excluding the fair value of mortgage-servicing rights. That alone made up about 81% of total revenue in the second quarter -- Rocket turned an overall profit of about $3.5 billion.

But if you look a year ago when the federal funds rate was over 2%, Rocket only brought in about $667 million from the gain on sale of loans excluding the fair value of mortgage-servicing rights. The company reported a loss of about $54 million in the quarter, so the recent and rapid lowering of the federal funds rate in March certainly has been a huge boon to Rocket's business, primarily because of all of the refinancing activity that resulted from it.

The good news

The good news is Fed Chairman Jerome Powell has recently said he expects the Fed will keep rates near zero for the next five years. There are opportunities in this time frame for Rocket to keep growing its market share.

For one, the housing market is extremely fragmented. As you can see in the chart below, the top two companies in the retail mortgage market only control about 12% of market share. Rocket Companies controls more than a 9% share and is the largest mortgage originator in the U.S.

Market Share by Industry

Image source: Rocket Companies.

Rocket seems to be doing a much better job of adding new customers. The company said in its IPO prospectus that its lenders are completing 8.3 loans per month on average, compared to the industry average of 2.3, citing data from the Mortgage Bankers Association.

There is also ample opportunity among millennials. Rocket said in its prospectus there are more than 67 million millennials between the ages of 20 and 34, but the homeownership rate among this group is only 32%, compared to an overall homeownership rate of close to 68% in the U.S. at the end of the second quarter. Rocket CFO Julie Booth said on the company's recent earnings call that the company's long-term goal is to gain a 25% share of the mortgage market by 2030.

What to look for

With this kind of low-rate environment expected to last several years, it will be important to watch several metrics on Rocket's earnings reports. Is the company able to grow market share and make incremental progress to the 25% market share goal? Will it be able to tap into the millennial market? Can Rocket replicate its success from the U.S. in Canada, another market the company says it wants to grow in?

All this will determine if Rocket can keep volume up after rates have been near zero for a few years, and therefore be successful over a three- to five-year horizon. It will also be a big factor when rates do eventually begin to rise, which will start another big storyline for the company.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.