Earnings

Should You Buy Two Harbors Investment Corp. (TWO) or Equity Residential (EQR)?

Two Harbors Investment Corp. (NYSE:TWO) shares are down more than -3.44% this year and recently decreased -0.95% or -$0.15 to settle at $15.70. Equity Residential (NYSE:EQR), on the other hand, is down -5.25% year to date as of 01/12/2018. It currently trades at $60.42 and has returned -3.62% during the past week.

Two Harbors Investment Corp. (NYSE:TWO) and Equity Residential (NYSE:EQR) are the two most active stocks in the REIT – Residential industry based on today’s trading volumes. Investors are clearly interested in the two names, but is one a better choice than the other? We will compare the two companies across growth, profitability, risk, valuation, and insider trends to answer this question.

Growth

The ability to consistently grow earnings at a high compound rate is a defining characteristic of the best companies for long-term investment. Analysts expect TWO to grow earnings at a -1.02% annual rate over the next 5 years. Comparatively, EQR is expected to grow at a 2.70% annual rate. All else equal, EQR’s higher growth rate would imply a greater potential for capital appreciation.



Profitability and Returns

Growth doesn’t mean much if it comes at the cost of weak profitability. To adjust for differences in capital structure we’ll use EBITDA margin and Return on Investment (ROI) as measures of profitability and return. , compared to an EBITDA margin of 58.04% for Equity Residential (EQR). TWO’s ROI is 1.80% while EQR has a ROI of 4.50%. The interpretation is that EQR’s business generates a higher return on investment than TWO’s.

Cash Flow 




The amount of free cash flow available to investors is ultimately what determines the value of a stock. TWO’s free cash flow (“FCF”) per share for the trailing twelve months was +0.25. Comparatively, EQR’s free cash flow per share was +0.45. On a percent-of-sales basis, TWO’s free cash flow was 0.01% while EQR converted 6.82% of its revenues into cash flow. This means that, for a given level of sales, EQR is able to generate more free cash flow for investors.

Financial Risk

TWO’s debt-to-equity ratio is 6.64 versus a D/E of 0.88 for EQR. TWO is therefore the more solvent of the two companies, and has lower financial risk.

Valuation

TWO trades at a forward P/E of 8.61, a P/B of 0.78, and a P/S of 4.42, compared to a forward P/E of 43.91, a P/B of 2.17, and a P/S of 9.08 for EQR. TWO is the cheaper of the two stocks on an earnings, book value and sales basis. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.

Analyst Price Targets and Opinions

A cheap stock isn’t a good investment if the stock is priced accurately. To get a sense of “value” we must compare the current price to some measure of intrinsic value such as a price target. TWO is currently priced at a -7.65% to its one-year price target of 17.00. Comparatively, EQR is -12.54% relative to its price target of 69.08. This suggests that EQR is the better investment over the next year.

The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 1.90 for TWO and 3.00 for EQR, which implies that analysts are more bullish on the outlook for EQR.

Risk and Volatility

Beta is a metric that investors frequently use to analyze a stock’s systematic risk. A beta above 1 implies above average market volatility. Conversely, a stock with a beta below 1 is seen as less risky than the overall market. TWO has a beta of 0.57 and EQR’s beta is 0.44. EQR’s shares are therefore the less volatile of the two stocks.

Insider Activity and Investor Sentiment

Short interest is another tool that analysts use to gauge investor sentiment. It represents the percentage of a stock’s tradable shares that are being shorted. TWO has a short ratio of 3.23 compared to a short interest of 4.73 for EQR. This implies that the market is currently less bearish on the outlook for TWO.

Summary

Equity Residential (NYSE:EQR) beats Two Harbors Investment Corp. (NYSE:TWO) on a total of 7 of the 14 factors compared between the two stocks. EQR is more profitable, generates a higher return on investment, has higher cash flow per share, has a higher cash conversion rate and has lower financial risk. In terms of valuation, TWO is the cheaper of the two stocks on an earnings, book value and sales basis, EQR is more undervalued relative to its price target. Finally, APTS has better sentiment signals based on short interest.

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