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"Be greedy when others are fearful" goes part of the often quoted phrase from legendary investor Warren Buffet. It's great advice, but perhaps easier to give rather than to live. The problem is that fear, much like the virus rattling global markets today, is contagious. It can be all-consuming and paralyzing all at the same time. Extreme volatility can also unnerve even the most seasoned of investors.
The best anti-dote to fear is conviction. Increasing conviction increases the probability that investors can be "greedy" when the market is fearful. Credit Acceptance Corporation (NASDAQ:CACC), a leader in the auto finance industry, is one such company that I have high conviction will produce superior long term returns on capital and may even benefit from a downturn in the US economy. To explain why, I will first explain industry dynamics and the company's unique business model before turning to valuation.
Industry Overview
The auto finance industry is large with over $1.2 trillion in outstanding loan balances as of year-end 2019. It is also fragmented with a mix of banks, captive finance companies, credit unions, auto finance companies and "BHPH" (buy here, pay here where dealers themselves extend credit) all competing for market share. The market is most often subdivided into credit quality segments, since the credit quality of the borrower has the most significant impact on yield and expected loss. The main segments in descending order of credit quality include Super Prime, Prime, Nonprime, Subprime and Deep Subprime. The figures below shows the approximate market share of each segment as well market share by lender type, according to Experian:
