Ensemble Capital Client Call Transcript: First American Financial (FAF)
We recently hosted our quarterly client conference call. You can read a full transcript HERE. Below is an excerpt from the call discussing our investment in First American Financial (FAF).
Excerpt (Sean Stannard-Stockton speaking):
While Apple is among our most widely known holdings, I also want to talk about First American Financial, a more under the radar investment of ours. While companies such as Apple generate enormous attention from investors, under the radar companies like First American can generate outstanding returns nonetheless. In fact, so far this year, Apple has returned 35%, while First American has been one of our best performing stocks returning an outstanding 42% year to date.
If you’ve ever bought a house, you know that one of the many things you need to do is buy title insurance. Unlike most insurance policies, which guard against unpredictable future events, title insurance guards against the risk that the property you are buying may not actually belong to the seller, either because of historical problems with how the title has been recorded or transferred or because there are outstanding liens against the property.
Title insurance is mandatory if you take out a mortgage to buy a house. And even if you pay with cash, the downside to finding out that the property you just bought was not actually owned by the seller or there is some debt collector out there who has a claim on the property you just bought, is so large relative to the small cost of the title insurance policy that very few home buyers go with out it.
In order to sell title insurance, title companies like First American need to assemble what is called a “title plant” in the industry. This title plant is a massive database of records showing all of the maps, deeds, mortgages, tax liens, etc that are associated with a property. Since many homes in the United States have histories going back a hundred years or more, the title histories on even a single property can include hundreds of pages of documents, including hand drawn maps and notes about rights of passage granted by one neighbor to another.
In fact, when I bought a new home last year, one of the houses we looked at had an extremely complex title history. A portion of the property had once been part of the adjoining town until it was transferred to facilitate the electric company’s efforts to bring electricity to the neighborhood a long time ago. Earlier in its history, that same odd segment of the property had been allowed a right of way for the neighbor to walk their sheep across. Now given I live in the middle of Silicon Valley, these aren’t the sorts of title issues you’d expect to find. But with people living in the same place for well over a hundred years, these are exactly the sort of issues found by title companies.
In my case, I reviewed the title in depth and believe me the records were not a neat and tidy database that your average computer engineer is used to dealing with. Instead, the title history was made up of scanned records of handwritten agreements and notes.
The complexity of title plants and the need to have records on most every piece of property in a given geographic area to be competitive in the market has led to the consolidation of the industry to a small group of large players. Over half of the title business national is controlled by First American and their main competitor Fidelity National. With title insurance premiums representing a relatively stable percentage of home price over time, title insurers enjoy a steadily increasing revenue stream as home prices appreciate. At the same time, while home prices have recovered since the recession, the number of home sales, especially the sale of new homes is still below what we believe are normalized levels. When you see news reports citing a lack of inventory as being the reason for rising home prices, one way to interpret this is to note that there are more willing buyers than there are willing sellers and thus the current volume of transactions is being inhibited by an imbalance in the market.
Like most holdings in our portfolio, First American does a good job optimizing their capital structure and returning excess cash to shareholders. As earnings have grown, so has the company’s dividend, which currently represents a 3% yield and which the company has increased by 320% over the last four years.
While First American isn’t a particularly sexy company and while they don’t show up in the news all that much, they are the sort of very profitable, dependable company, whose products and services make up important elements of the day to day life of their customers. These sorts of stocks are often overlooked by investors who too often prioritize exciting news flow over strong cash flow generation. In the case of First American, investors who saw through the boring business story could see a rather exciting profit machine, one which the market has spent the year steadily bidding higher.
You can read the full transcript HERE.
Clients of Ensemble Capital own shares of First American Financial (FAF).
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