With rising interest rates over the past year, a lot of rate-sensitive stocks have seen their stock prices fall and their dividend yields rise significantly. Given the right circumstances, that might suggest a buying opportunity.
But not all high yields are safe, and it pays to take a look at the fundamentals of the business before jumping in. As a general rule, a yield that seems too good to be true probably is.
UWM Holdings (UWMC 1.63%), the parent company of United Wholesale, has a pretty high yield. Why is that? And does this stock have the right fundamentals to support that yield?
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Three different mortgage origination business models
UWM Holdings is a mortgage originator that focuses on the wholesale origination business. Basically, mortgage origination has three different business models. The most common model is retail, which is where the lender uses loan officers or technology to find potential borrowers, and then assembles the loan. This is the sort of model that Rocket Companies uses. The second model is correspondent, where the lender buys loans that have already been assembled and then flips them back into the market. This is the type of model that Mr. Cooper Group uses.
The wholesale model is different in that the wholesaler partners with mortgage brokers who maintain relationships with professionals in the real estate business, such as real estate agents, title attorneys, or builders. The broker finds the borrower and then submits the materials to a wholesale lender like UWM. The big difference is that the broker doesn't work for UWM and can therefore find the best deal for the borrower. This is the reason why UWM's motto is "Brokers Are Better."
The mortgage business is highly competitive. The past year has been absolutely awful for the mortgage origination business as the Federal Reserve raised interest rates to get outsized inflation back under control. This effectively shut down the mortgage refinance business (nobody is going to swap a 3.5% mortgage for a 7% one), and it affected the purchase market severely as home affordability declined.
The mortgage origination business is going through hard times
The fallout from this real estate recession was a string of casualties in the mortgage space. Two of UWM's biggest competitors -- Loan Depot and HomePoint Mortgage -- exited the wholesale business entirely. This drop in competition will definitely help UWM Holdings going forward.
UWM is expected to earn $0.23 per share this year, which puts the price-to-earnings ratio at 23 times this year's earnings. Mortgage origination is one of the most highly cyclical businesses out there, which means that business conditions can swing from feast to famine quickly. The market incorporates this effect into the multiple. During good times, a mortgage originator can trade with a P/E ratio of 4 or 5. During bad times, it can trade at a P/E of 20 or more.
To give you an idea of the volatility of UWM's earnings, in 2022 the company earned $932 million. The year before, it earned $1.6 billion, and the year before that, $3.4 billion. The company is expected to see earnings cut in half from 2022 levels.
At current levels, UWM has a dividend yield of 7.6%. Most mortgage originators don't pay a dividend. With an annual dividend at $0.40 per share, it's barely covered by last year's earnings per share of $0.45. With earnings per share expected to get cut in half this year, the earnings won't cover the dividend. There is no law that says companies can't pay out more than they earn, but investors should understand that is unlikely and unsustainable. The risk of a dividend cut is pretty substantial, and potential investors shouldn't get too attracted to UWM's yield.
