Why I Bought More of This Growth Stock While It’s Cheap

Live Oak‘s (NASDAQ: LOB) stock has been down recently more than 60% off its high, however, in this video clip from “The Rank” on Motley Fool Live, recorded on July 27, contributors Matt Frankel and Jason Hall make the case that it could be a prime opportunity to invest in the best-in-class small business lender.

Matt Frankel: I was shocked at how much this one has been beaten down lately.

Jason Hall: Yeah [laughs].

Frankel: Down 64, it’s priced like half of its loans are going to default. Not half, but it’s priced like it’s going to see a ton of defaults, which is odd being that almost half of its loans are government guaranteed. Forty-five percent of its loan origination is Small Business Administration or SBA-backed loans.

They do a great job of underwriting. They’ve done a great job of keeping their default rate low even compared to peers over time because they loan to industries that they know very well and nothing else. Great returns on equity, great capital structure. It’s a bank that doesn’t have branches, so that’s an inherent cost structure.

It does a really good job of growing. It’s grown its loan production at a 21% annualized rate for five years in a row, including in the first quarter of this year. We’re going to see that slowdown, loan volume is going to slow down in 2022. I’m not saying it’s immune to the recession fears and higher interest rates and things like that, but interest rates could end up being a net positive for Live Oak.

It pays a lot less on its deposit base than it charges in loans, so the spread should rise as interest rates rise. If it can keep defaults in check, this stock is an absolute bargain right now. So I may have given away some of the reasons you just bought it, but what can you say about it?

Hall: So I’m going to build off what you said. I think all of those things are very, very true, but I think it’s also, it’s best-in-class. I really want to hit on that because you think about a lot of the big banks, they’re the big banks because they do a lot of mortgage lending. That’s just a huge market. It’s a great way to build a good loan [business]. The economics of that industry makes sense. They learn it, they build a business there, and then they scale that up. They’re just really good at that and they’re disciplined at doing it.

At 10 times earnings and you say, well, what if earnings fall OK, still it’s 10 is pretty cheap if we go through a weak period, you hold it long enough and it works out. Just over two times book value for a branchless bank that’s best-in-class, it’s less than $9 billion dollars in total assets. This is one that I took a very tiny position that I had.

Another one of those rising stars stocks that I bought years ago and I haven’t really added to and say, this is a perfect opportunity that for I think a best-in-class misunderstood bank to buy and I think the misunderstood part is to me the biggest reason why it’s valued the way it is.

Frankel: I mean, a lot of the results you’re seeing from other companies are scaring people away for investing in anything to do with small business. Shopify (NYSE: SHOP), for example.

Hall: There you go.

Frankel: Laying off 10% of its workforce just released earnings that were disappointing. Consumer spending slowing down, that usually works for small businesses than it is for large ones, as a general rule.

Hall: They’re not as well capitalized.

Frankel: They’re not as well capitalized, they are more sensitive to recessions and things like that. So it is misunderstood in that sense. It’s looked at as these businesses are going to fail. Live Oak has historically done a great job of avoiding businesses that are going to fail. Really, really well compared to other business lenders.

Their default rate even in normal times has been well under 1%, well under and if they’re getting 6% or 7% on their average loan then they have a lot of wiggle room for things to go wrong and them to be OK. So I like this one. It’s one that I don’t own yet. I actually hadn’t been following it as closely as I should’ve lately.

Hall: Something tells me that’s changed.

Frankel: The 65% from down from its highs has earned it a spot toward the top of my watch list.

Jason Hall has positions in Live Oak Bancshares and Shopify. Matthew Frankel, CFP® has positions in Shopify. The Motley Fool has positions in and recommends Live Oak Bancshares and Shopify. The Motley Fool recommends the following options: long January 2023 $1,140 calls on Shopify and short January 2023 $1,160 calls on Shopify. The Motley Fool has a disclosure policy.

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