If You Are Bearish On the Economy, Then You Need To Own This Stock

Trading is in my blood. I vividly remember, as an elementary school student, trading baseball cards with my classmates. My trading interest blossomed as I learned how to buy low and sell high via various part-time business endeavors. These businesses included selling produce I got for free from my grandparent’s garden door-to-door and a real estate publishing/marketing company. This interest led me to major in business/economics in college.

It was here where I learned about the stock and derivative markets. This knowledge set me on a life-long journey into the trading arena of the financial markets. I quickly realized that I was not alone in this pursuit. Everyone is a trader of one sort or another. Some trade their time, knowledge, talents and skills for a steady salary. Others decide to go at it alone by trading their and others abilities directly for monetary compensation via business. Still others decide to take a hands-on approach by directly interacting with the financial markets. No question about it, trading — in one form or another — is the world’s oldest profession.

#-ad_banner-#A fascinating twist on the trading game is the pawn shop business. These companies make loans on and purchase items of value from people in need of fast cash. These loans are often at exuberant interest rates, and the prices paid directly for items are way below market value. The business works because the customers are in need of immediate cash, and thus are willing to pay nearly any price for the privilege. As you can imagine, the worse things get economically, the more people there will be that will be forced to pawn their valuables for cash. Therefore, this industry is not only recession-proof, but it’s inversely correlated with the economy. So if you are an economic bear, then investing in the pawn shop business is a no-brainer.

These businesses were once relegated to the seedy section of cities and didn’t exactly have the best reputation. However, this perception is changing rapidly.

As even the once wealthy are forced to sell items at pawn shops, the status of these once looked-down-upon alternative finance companies grows. In fact, the second most popular reality show of all time, Pawn Stars, is based on a family-owned, Las Vegas-based pawn shop. Even uber-rich enclaves like Palm Beach, Florida, and Beverly Hills, California, have their share of pawn shops.

Obviously the high profit margins and solid business model of the pawn shop business has attracted major players. The largest pawn shop operator is EZCorp (Nasdaq: EZPW). This Texas-based company runs more than 1,200 pawn shops in North America. About 80% of its revenue derives from the pawn business and the other 20% is from payday-type short-term lending. Pawn volumes are up and margins are improving, with a forecasted 30% growth this year.

EZCorp has grown revenue by 23% during the past three years and has outpaced all of its competitors. In the second quarter of 2012, the company earned $0.73  per share, up by 10 cents a share from the same time last year. What I like most about this company is that it has recently expanded into Mexico and the United Kingdom via the purchase of Crediamigo and Cashgenie. These firms’ organic loan balance is up 12%, creating a powerful opportunity for EZCorp Inc. In addition, the company is valued at slightly over seven times forward earnings, making it highly attractive for fundamentally-based investors.

With these kinds of metrics, why has the stock recently been beat down to such a dramatic extent? The  share price has plunged from a high of just over $33 to a recent $24.19 in the past month.

The answer is twofold. First, stockholders are nervous about legislative risk to the company’s business model. Secondly the company cut its guidance by 6%, due to lower gold prices, igniting the aggressive sell-off to the present level. The market always overreacts to bad news, and this appears to be the case with EZCorp.

Let’s take a closer look at each of these risk factors. While buying gold was easy money for the company, it has other profit centers. And besides, gold could easily regain its uptrend and attract gold selling customers back into the shops. On the legislative front, it’s the newly formed Consumer Financial Protection Bureau that has thrown an unknown into the mix. The large pawn companies are working directly with law makers to obtain federal charters. This means they will only be subject to one set of Federal regulations that will most likely be less stringent than those that may be created at the state and local levels. In addition, the company’s move into Mexico and the United Kingdom assures longevity, even if the worst happens in the United States.

Risks to Consider: As mentioned earlier, the main risk factors in EZCorp Inc. are legislative risks and gold prices. I think the market has overreacted to both these factors, but it’s impossible to know for certain. Remember, even when buying on upward momentum to always use comfortable stops and position size according to your risk tolerance.

Action to Take –>
Although I love EZCorp on many levels, I cannot suggest buying it right now. The price has plunged through the 200-day simple moving average, creating an uncertain technical picture at the present time. My plan is to purchase shares once upward momentum is established. Right now, my buy level is at $26.27. Once this level is broken on the upside, I’ll buy a small position and add to it as price moves in an upward direction.