Boring Value Stock = 60% in Two Months

I have to admit, we had some help with the stock price.

Last month, in Hollywood, California, one of the most popular up-and-coming hedge fund managers, Mohnish Pabrai, gave a convincing presentation on a small mortgage lender, Delta Financial. Pabrai's presentation must have resonated with attendees of the Value Investing Congress... the stock rose 11% that day alone!

I was particularly interested in what Pabrai had to say about Delta... we added the company to our Extreme Value recommended buy list in the second week of April.
 
Back then, the stock was right around $8.23 a share. Today, it's hovering around $13.13 a share, 60% in less than two months. 
 
Some of that 60% gain is likely the effect of Extreme Valuereaders pouring their money into Delta shares (along with a good deal of confidence, so it would seem). 
 
But the value of our advice on Delta Financial is still unmistakable. We found an $8 stock that we thought was worth between three and four times its share price... and it has taken off. Given that we think it's worth $20-$30 a share, it's arguably still a good buy at $13.
 
Delta Financial is a subprime mortgage lender... a dirty word these days. "Subprime" simply means that it's lending to folks who have trouble getting loans. This can happen to perfectly creditworthy individuals. For example, if someone is self-employed, his income may be more difficult to document. 
 
Subprime lenders have had a horrible year. And I found a lot I didn't like about other subprime stocks. But Delta is different... 
 
The main thing I like about Delta is that roughly 90% of its loans are fixed-rate loans. Other subprime lenders make mostly adjustable rate mortgage loans. When the mortgage rate adjusts upward after awhile (usually two years), many borrowers have trouble making the higher payments.

Since many subprime lenders lend close to 100% of the value of a home, their cash-strapped borrowers have no skin in the game, no incentive to not walk away. Delta's loan borrowers average 22% equity in their homes. That's more than enough incentive to not walk away, so they're better at paying off their loans. 
 
Another good thing about Delta is that it's headquartered in New York, and its loans are spread evenly around country.

The center of the subprime-lending universe is Irvine, California. A lot of subprime loans have been made in the state of California. Inland real estate in California has slowed down, and prices have fallen. Since it's expensive to live on the coast, and most subprime borrowers aren't rich, it's easy to see why companies that made lots of subprime loans in California are having a bad time. The property values fell, and suddenly the borrowers owe more than their house is worth, so they drop the keys in the mailbox and move out.

As of the fourth quarter of 2006, Delta had originated only 3.5% of its loans in California. 
 
Another thing I like about Delta is that it's run by the founding family, which owns a big stake in it. The Miller family owns about one-third of the outstanding common stock. 
 
In the most recent issue of Extreme Value, we raised our maximum buy price from $9 to $11 and listed six major attributes we thought would cause Delta's stock price to go up. If you really want to do your own due diligence on Delta Financial (and you should), our list is a great place to begin. 
 
We're not always going to make our readers 60% in two months, far from it... we're much happier safely compounding our money at around 25% per year.

But when you focus only on finding the safest, most undervalued stocks you can find, every now and then, you're going to get a really pleasant surprise... like Delta's two-month run from $8 to $13.