Give credit where due
So far I've talked about a company that makes electronic scoreboards for athletic complexes and a generic drug company that helps rid you of foot fungi and other assorted ailments. Now I'll switch gears again and focus on a consumer financing company that specializes in purchasing, securitizing, and servicing auto loans. The company is AmeriCreditCorp.(NYSE: ACF) -- a fascinating company to study. Let's take a look.

In June of 1996, shares of the company were trading at $7. Today they sit at $53.21, sporting a 660% return on investment or 50% annualized over the five years. Not too shabby. So, what do they do? Well, their business model can get complicated, but I'll do my best to make it easy to understand. Basically, they purchase car loans, resell the loans in the form of investment securities, and collect the difference between what the consumer pays in interest on the car loan and what the company pays investors on the investment securities. It works something like this:

  • Joe goes into a car dealership and buys a new car for $12,500.
  • Cindy's Auto Heaven sells Joe the car and floats him a car loan at 9.9%.
  • AmeriCredit steps in and buys the loan from Cindy's Auto Heaven.
  • AmeriCredit turns around and then resells Joe's loan in the form of an interest-bearing security (unit trusts, generally) to investors like you and me and pays out 6.9% interest to us.
  • AmeriCredit also receives a 2.5% bounty on the principal for servicing the loan (sending monthly statements, processing payments, etc.)

As this shows, AmeriCredit can take in 9.9% interest from the consumer and only pay out 6.9% interest to its investors, leaving it to collect a fairly easy 3%. To make it easier to sell the 6.9% unit trusts, AmeriCredit purchases insurance policies that guarantee the trusts' underlying assets. This allows these securities to achieve AAA status, which is the highest form of investment grade and means greater safety to the investor.

No credit? No problem!
To make things even more interesting, AmeriCredit specializes in purchasing loans on used cars and modestly priced new cars. They target customers with a limited credit history or problems with their credit in the past. When you hear the loud guy on the radio screaming "EVERYTHING MUST GO! EVERYONE IS APPROVED! NO MONEY DOWN AND NO PAYMENTS FOR THREE FULL MONTHS!" the loans for those cars may well be financed by AmeriCredit.

The beauty of this business for AmeriCredit is that they are able to charge higher interest rates to these customers because the customer probably doesn't have the option of a conventional car loan from a bank or credit union. Of course, the flip side for AmeriCredit is that by doing business primarily with consumers who may default on their loans at a greater rate than more secure prospects they have to be especially careful about figuring out to whom they will lend money. AmeriCredit says that they employ "sophisticated risk management techniques" and the use of a "proprietary credit scoring method" that helps them to figure out who is most likely to pay them back.

Is this company a keeper?
The company seems to have a solid little model of capturing the spread between what they charge and what they pay. It also serves a market that doesn't have a lot of alternatives for financing in a business -- cars -- that's a necessity, not a luxury, for most Americans. AmeriCredit continues to do a great job growing earnings and revenue, logging a 75% growth in sales over the past five years. It has fat profit margins of around 26% and operating margins in the low 40% range. In this kind of business, it's to be expected that the company will carry some debt, but long-term debt seems manageable at just 42% of equity. Short-term debt is 173% of equity, but that's not alarming to me given that this business has constant short-term financing needs.

Estimates for June of 2002 EPS are $3.63, versus June 2001 estimates of $2.57. This is a 41% growth rate for a company trading at only 22 times trailing EPS. The company has beaten expectations in each of its last four fiscal quarters. Even if we use a lower, 30% estimated growth rate, the company's shares would trade at $77 using this year's estimates and $109 using next year's.

On the risk side, you have to understand that the financing business is incredibly dependent on market conditions, especially interest rate trends. In order for AmeriCredit to make any money, they have to be able to borrow money (through the sale of those securities) at a lower rate than they are getting from the auto loans they buy. Any flattening or inversion of the yield curve would make it very difficult to manage this spread effectively. The current interest rate environment is very favorable for them, but this is an important element to watch if you keep this company on your radar screen.

Also on the risk side, AmeriCredit's revenues and earnings will be heavily dependent on the consumer market for automobiles. If the economy were to weaken more and consumers tighten their belts and wait to buy a car, that would hurt AmeriCredit significantly. They would also be hurt if insurance premiums rose so much that it made it difficult or unfeasible to continue insuring the loans. One of the things that keeps insurance premiums low is the belief of the insurer that AmeriCredit can collect on the underlying loans.

Bottom line, this is a pretty sweet setup that will bring in huge dollars when the interest rate environment is favorable, but it could be absolutely brutal when the relationship between long-term and short-term rates tightens up. It can happen. AmeriCredit had employed its business model with mortgages instead of car loans, but had to close that business when the market for repackaged mortgage loans deteriorated. That said, the current relationship between long and short rates is very favorable, the consumer continues to spend, and AmeriCredit is pretty much printing money right now. Should these conditions continue, investors will be rewarded.

Three great non-tech businesses 
Not one of these three businesses is in the tech field: Yes, I'm sure each company benefits in its own way from technical innovation -- Daktronics' signs might use new technology to be brighter or use less power, for example -- but none is a "tech" stock in the way we think of Microsoft(Nasdaq: MSFT), JDS Uniphase (Nasdaq: JDSU), or Cisco Systems (Nasdaq: CSCO). The point here is that there are many investment opportunities available to you outside of the tech group in companies that aren't terribly difficult to understand. You just need to look. One place to start is The Motley Fool Select, where you can get our best stock ideas each month.

At any rate, there are still plenty of ideas out there, even while the broader market has been in the doldrums. So, get digging!

David Forrest (TMF Bogey) does not own shares of any stocks discussed in this article, and the only used cars he has ever owned were clunkers donated by family and friends of the family. He can remember that one time, driving home from the movies in sub-freezing temperatures where the passenger side door wouldn't close and he had to use his tie from work to secure the door and... er... never mind. To see his stock holdings, view his profile

Three Great Unknown Stocks represents the opinion of one Fool and should in no way be taken as the opinion of either The Motley Fool, Inc. or the company in question, or as representative of anyone or anything other than that specific Fool's thoughts. Which can be way out there, so do your homework, and review The Motley Fool's disclosure policy