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Shares of Countrywide Financial Corp. (CFC) have slumped about 8 percent over the last three months, as concerns over rising interest rates and a slowing housing market have hit the nation's largest mortgage lender. Although Countrywide's stock appears to be trading at an attractive valuation, those concerns remain.

At first glance, shares of CFC appear to be attractively priced relative to the averages of key metrics for the consumer financial services industry.


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Of course, price is only one part of the valuation process; performance is the other and Countrywide has benefited nicely from the boom in the housing market. Its revenue and earnings growth rates are well ahead of the industry average over the last five years, trailing 12-months [TTM], and most recent quarter [MRQ] periods.


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The National Association of Realtors [NAR] expects home sales in 2006 to be weaker than 2005's record level, yet it has expressed optimism that 2006 will be the third-highest year for home sales. Such optimism is also reflected in Countrywide's earnings estimates. In July, the lender reiterated the upper bound for earnings this year at $4.80 per share, and it also increased its lower bound, from $3.90 to $4.00. Of course, this is still a considerable range. It seems that the analysts who cover Countrywide have become a bit more cautious of late: The consensus estimate for 2006 earnings per share [EPS] slipped from $4.44 two months ago to $4.42 at present. Analysts have also trimmed back their estimates for next year as well: Two months ago, the consensus stood at $5.00 and it now stands at $4.93, for an 11.5 percent increase over 2006's expected results.

While focusing on valuation ratios based on past performance is good for providing a quick comparison, it is also useful to consider Countrywide's price tag taking into consideration expectations of future performance. Given its current share price of about $34 and the mean of analyst estimates for 2006 and 2007, CFC shares are trading at forward price to earnings (P/E) ratios of about 7.7 and 6.9, respectively. These P/E ratios tell us very little by themselves, but once we compare them to the consensus of analyst estimates for a long-term EPS growth rate, we get the PEG ratio, which provides much more insight. Lower PEG readings indicate cheaper valuations, and more-conservative value types typically prefer to focus on companies with PEG readings below 1.00. Analysts in a Reuters poll indicated that they look for Countrywide to grow its EPS at an average annual clip of nearly 11 percent, indicating that the lender's PEG ratio is well below parity.

While value hunters might be salivating at the prospect of picking up a national leader on the cheap, it is important to keep in mind some of the present risks. For instance, renewed fears of inflation and rising interest rates have placed downward pressure on stocks recently. Another concern is the labor market. The economy continues to create jobs and government statistics show that initial claims for unemployment insurance are at their lowest level since July. But just because more people have jobs does not necessarily mean they can afford to buy a home - a topic that is covered in more detail in an article by Marc Gerstein.

Also, when thinking about the labor market, it is important to keep in mind the current easing dynamics. First, planned US layoffs surged 75 percent in August compared with July amid signs that a slowdown in housing was starting to have an impact on employment, according to employment consulting firm Challenger, Gray & Christmas Inc. Further, through the first eight months of 2006, the economy has created nearly 20 percent fewer jobs than it did in the same period of 2005, according to government numbers. Finally, keep in mind the Federal Reserve's interest rate hikes from earlier this year. While they have likely already impacted mortgage rates, the ripple effect on the economy of the Fed's policy can take between six and 18 months. Although it appears that the Fed may be done raising rates for now, this lag still means that the hikes from March, May and June may have yet to really hit home - and home buying.

At the time of publication, Erik Dellith did not directly own puts or calls or shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.

Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.

Source: Countrywide Financial: The Price is Right, The Market Isn't