No. of Recommendations: 16
Hi Collective,

Here it is at last, I could write a whole bunch more but decided this
was long enough! Please make comments/suggestions/additions as this is
only the start of the research.

MGIC Investment Corporation (MTG)
MGIC Plaza
250 E Kilbourn Avenue
Milwaukee WISCONSIN 53202
Phone: +1 414 347-6480
Company Website:

The Group's principal activities are to provide private mortgage
insurance to lenders throughout the United States. The Group operates
through Mortgage Guaranty Insurance Corporation and other subsidiaries.
The Group provides various services for the mortgage finance industry,
such as contract underwriting and portfolio analysis and retention. The
Group covers lenders to protect against loss from defaults on low down
payment residential mortgage loans. The mortgage insurance coverage are
provided to home mortgage lending industry in all 50 states of the
United States, the District of Columbia and Puerto Rico.

Why I am Interested – Consistent Earnings Growth and Valuation

MGIC Investment is quite a story on both growth and also on volatility,
just look at this chart

The share price has appreciated 500% in ten years which is a CAGR of
17.5% despite a huge drop of about $15 or about 27% in a few days after
a recent earnings warning. One concern here is that loan loss
provisions are trending up and could eat further into earnings. However
I expect to be able to show that even with an earnings growth reduction
the intrinsic value of the company is considerably higher than today's
stock price (wow a bias before I start!).

The marketcap for MGIC Investment (MTG) is $4.1b as there are 100.5m
shares outstanding and the stock price is around $41 - $42. For an
updated price look here:

I'm also interested as I've bought a small position in MGIC Investment
and hope to find very good reasons for adding more when I can afford it!

MGIC a Brief History
In 1957, Max Karl, a real estate attorney, amassed $250,000 in capital
from enthusiastic investors, many of whom were S&L executives, and he
founded a company known as "MGIC."

Mr. Karl had become increasingly frustrated with the process of closing
loans with 100 percent government guarantees, which he believed was
rife with red tape and bureaucracy. He believed that a private company
that insured only the top portion of a mortgage, instead of 100 percent
of the mortgage, would present lenders with a less costly and easier
way to provide low-down-payment financing to borrowers not able to make
20 percent or larger down payments.

Mr. Karl's idea led to the creation of modern-day private mortgage
insurance and the "old" MGIC. Today's MGIC bears the same name as Mr.
Karl's original company, but it is a different corporate entity.
Founded in 1985, today's MGIC acquired the well-known corporate name
and operating assets of "old" MGIC. The management of "old" MGIC led
the "new" MGIC in its early years.

The last half of the 1980s was a tumultuous period in the home mortgage
finance industry. The decade was marked by home price stagnation and,
in some markets, depreciation. The ranks of private mortgage insurers
dwindled from 14 to seven in the late 1980s, yet MGIC remained a market

As the dust settled on the 1980s and a new decade dawned, MGIC saw
opportunity in a housing market about to benefit from the pent-up
demand of the 1980s and the aging of the Baby Boomer Generation.

On August 7, 1991, MGIC Investment became a publicly traded company in
a successful initial public offering (IPO). Adjusted for subsequent
stock splits, the IPO price of MTG was $6 per share.

Private Mortgage Insurance (PMI)

So what is Private Mortgage Insurance (PMI) and how does it work? Well
with the internet one doesn't have to go far to find out as here is an
excellent description from MGIC Investments own website at
Private mortgage insurance (PrivateMI) is a financial guaranty business
in which an insurer assumes a portion of a lender's risk in making a
mortgage loan. For that risk, the insurer collects a premium from the
lender, which then typically recovers the cost of the premium from the
borrower. The "risk" in private mortgage insurance is that a borrower
will default on a loan and ultimately result in the insurer having to
pay a claim.

Here's how it generally works:
• A borrower buying a $100,000 home makes a 5 percent, or $5,000, down payment.
• The lender then obtains private MI on the borrower's $95,000
mortgage, reducing its exposure to loss from $95,000 to $66,500.
• The private MI covers the top portion of the mortgage - usually the
top 25 to 30 percent. In this case, the MI will absorb 30 percent, or
$28,500, of any ultimate loss.

At MGIC, our success is dependent on three factors - our ability to
grow revenues, our ability to minimize credit losses, and our ability
to control operating expenses. Management's ability to balance these
three factors - growth, quality and productivity - is vital to success
in our business. Growth, or more specifically, revenue growth, is
driven by our insurance in force and investment portfolio.

Quality of our insurance in force is measured in many ways. One way is
the loss ratio which represents an insurer's ratio of incurred losses
to net premiums earned; in other words, the amount of money an insurer
has lost and thinks it could lose on existing mortgage defaults as a
percent of money it has received in premiums. Since 1988, MGIC each
year has reported a loss ratio lower than the rest of the industry.

Productivity at MGIC has improved in recent years through the
application of technology. Automated underwriting, electronic data
interchange, groupware, credit and mortgage scoring, and the Internet
all have transformed business processes, communications among co-
workers, and the ways in which MGIC reaches its various constituencies.
Application of these technologies in part has allowed MGIC to
significantly increase the amount of new insurance it writes annually
without having to incur commensurate increases in related expenses.
This gap between revenues and operating expenses is one measure of

Further information on the PMI business from

Some MI Terms
FICO = A credit rating system administered by Fair, Isaacs & Co, hence
the name.
The FICO score ranges from 400 to 900 and somewhere in the region of
620 is considered the cut off for sub-prime

LTV ratio = Loan to value ratio. The % of the mortgage amount to the
initial value of the home. If the house price appreciates it does not
affect the LTV.

FHA = Federal Housing Administration. Also in the business of mortgage
insurance but they insure 100% of the mortgage. Private MI's typically
insure the top 25-35% of the mortgage and have cheaper rates.

VA = Veterans Affairs. Provide similar mortgage insurance to FHA but
for veterans

Fannie Mae = Federal National Mortgage Association (FNMA)
Freddie Mac = Federal Home Loan Corporation (FHLC)

PMI = Private Mortgage Insurance

The PMI Industry and Competitors

The PMI Industry has a trade association called MICA which has a very
detailed web site for potential mortgagees. There is also a fantastic
20 page fact sheet which goes into great detail on how PMI works which
you can read here

According to Hoover's the top competitors are,2163,13750,00.html
GE Mortgage Insurance, Old Republic and PMI Group

Morningstar has a much bigger list but obviously not all mortgage

Note that PMI & MGIC Investment are extremely highly rated by morningstar.

So faced with these differences in who's who in PMI I went back to the
MICA site and listed here are it's members & all are MGIC Investment

Market Share
• Mortgage Guaranty Insurance Corp. 25.6%
• PMI Mortgage Insurance Co 18.5%
• Radian Guaranty 18.0%
• GE Mortgage Insurance Corp 12.8%
• United Guaranty 12.2%
• Republic Mortgage Insurance Co. 9.2%
• Triad Guaranty Insurance 3.6%

Market share based on new insurance written. Source: Inside Mortgage Finance.

Just to get a flavour of some comparative figures I looked at the
competitors. GEMICO and United are part of GE and AIG respectively so
no figures were available. Republic is just 20% of Old Republic's sales
and therefore comparisons are not meaningful.

MGIC PMI Radian Triad

Market Cap $4.14b $2.75b $3.53b $542m

Sales $1.5b $1.1b $1.1b $114m
5 yr Sales Growth 11.1% 13.4% 32.7% 19.8%

Net Income 652.7m 335.9m 415.5m 43.3m
5 yr Income Growth 18.3% 16.6% 24.2% 19.8%
Net Margin 43.3% 30.3% 37.3% 38.0%

P/E 6.3 8.5 9.0 12.9
P/FCF 6.6 9.1 7.3 12.4
P/S 2.8 2.5 3.2 4.9

ROE 19.6% 15.8% 15.6% 14.4%
ROA 12.7% 9.7% 9.1% 9.3%
ROC 16.4% 13.2% 12.9% 15.0%
Debt/Equity 0.19 0.20 0.20 0.12

Not too much to choose between the companies. MGIC has higher margins
and investment returns and the lowest price ratios overall. Radian's
sales growth stands out in the group.

How Does MGIC Investment make Money?

Well they make money if premiums earned exceed total costs + loan
losses and loan loss provisions. Simple really :-) The Insurance
Industry always measures the “Combined Ratio”

Combined Ratio = (Operating Costs + Loan losses & loan loss
provisions)/premiums earned expressed as a %. Most insurance companies
are doing really well when the combined ratio is less than 100% as most
insurance is a commodity market and they make money investing
the “float” or the money taken in premiums. In other words their
margins are low and they make money investing premiums. This is where
Warren Buffett makes so much of Berkshire Hathaway's money with GEICO
and he's been trying to get the combined ratio down at General Re since
he bought that company too.

What's the point of this discussion? Well according to MICA the PMI's
combined ratio have rarely been above 75% for the last few years which
makes it a very profitable insurance business with excellent margins.
MGIC makes 77% of it's profit from net premiums which is as a result of
their excellent combined ratio, 15% from investment income and 8% from
other sources. The Other income mostly comes from 2 companies whose
results are not consolidated. Gross Profit Margins for the last 3 years
have been 70.5%, 75.3% and 70.1%, although the TTM figure is down to
65% on higher loan loss provisions . Net Profit Margins have been
equally impressive at 47%, 48.8% and 47%, with TTM at 45.3%. These
figures bear watching but are right up there with software companies.

Conference Call Notes
A lot more can be learnt from the Conference Call – These are my notes
from the 2002 3Q CC


As I have said before I find this the most difficult to assess for a
retail investor. We can look at any negative news, such as SEC
investigations or personal wrongdoing, but I've seen none of that for
MGIC Investment. Other than that we can look for:

1. Attitude to shareholders
2. Attitude to employees
3. Attitude to community
4. Corporate governance
5. Innovation
6. Financial performance.

Webcasts are a good way to assess management. Here is the link to MGIC's webcasts

I will deal with 5 & 6 elsewhere in the report. Let's first look at who
we are talking about by introducing the principal officers & directors
of the corporation.

So much has been written over the last year about Employee Stock
Options (ESO's), executive compensation and pension provisions that I
had to include it here.

Pensions: MGIC's pension obligations are about $91m and the
plan's fair value $90m. MGIC has consistently used 7.5% for estimating
pension returns although the fund did lose 4.8% in 2001. I personally
do not consider their pension plan a concern.

Employee Stock Options (ESO's):
A summary of activity in the stock option plans during 1999, 2000 and
2001 is as follows:
                                                                                                                      Average     Shares  

Outstanding, December 31, 1998 $ 24.87 3,193,924
Granted 42.29 791,750
Exercised 8.74 (413,930)
Canceled 45.94 (25,480)
Outstanding, December 31, 1999 30.52 3,546,264
Granted 45.40 954,000
Exercised 16.91 (1,080,208)
Canceled 37.96 (35,060)
Outstanding, December 31, 2000 38.96 3,384,996
Granted 57.90 533,750
Exercised 29.28 (555,952)
Canceled 44.15 (25,107)
Outstanding, December 31, 2001 43.56 3,337,687

The exercise price of the options granted in 1999, 2000 and 2001 was
equal to the market value of the stock on the date of grant. The
options are exercisable between one and ten years after the date of
grant. At December 31, 2001, 1,270,959 shares were available for future
grant under the stock option plan.

So in the last 3 years MGIC has granted an average of 760,000 options
per year in their ESO program which 0.72% of outstanding shares.
Options exercised in that period amount to an average of 683,000 per
year or a dilution rate of 0.64%

One encouraging sign was that options granted decreased and exercised
during 2001 decreased to 533,750 and 555,952 or about 0.5% of the
outstanding shares. Of these 175,000 went to the 5 senior executives.
Cancellations are negligible.

Executive Compensation

Executives are well compensated at MGIC Investment. Curt S. Culver, the
President & CEO, received the following compensation in 2001

Base salary $550,000. MGIC Investment has a bonus plan which allows up
to a maximum of 200% of base salary. Culver was awarded 200% but
requested a lower amount so got $850,000 instead of $1.1 million. He
was also awarded 75,000 options strike price $57.88.

Other executives, 4 of them, had a base salary of between $217,000 and
$287,000 and bonuses of around 80% of their base salary. Each of them
got 25,000 options at a strike price of $57.88.

Shareholder Attitude
I have to say that I'm not particularly perturbed by the executive
compensation levels or the ESO plan. May be the CEO's compensation is
on the high side but he has to improve the current stock price by a lot
more than 50% to make those options worth anything.

I think that dividend policy could be improved as the yield is
negligible and despite the company's growth is rarely increased. On the
other hand MGIC has bought back nearly 6 million shares (6% of shares
outstanding), far exceeding the dilution of the ESO's and may be the
best way of returning shareholder value. I would have dripped my
dividends anyway. This way the company does it for me and I get no
taxes! MGIC is continuing to buyback shares as they got approval at the
Fall 2002 board meeting.

I was impressed with the management's performance in the Q&A session of the CC

On Corporate Governance they were ranked in the Above Average
group of the S&P500 on this link

From what I can find out I am satisfied that MGIC passes on both
Shareholder Attitude and Corporate Governance. Just for Ro: A woman,
Mary K. Bush is Chair of the Audit Committee :-)

For Employee Attitude I have not found anything negative. Here
are the reasons to work for MGIC as listed on the website:


Why Work For MGIC
o Leading-edge technology
o On-site fitness center
o Included in the S&P 500
o Business casual dress policy
o Milwaukee based, national leader
o Excellent benefit package including 401k savings, profit
sharing and pension plans

MGIC is helping to put people in homes across America by providing
mortgage insurance on more than 1.4 million home mortgages. As an
industry leader, we're known for the regard we show our customers and
the respect given our experienced professionals. Join our environment
of excellence and reach your potential.

In checking the SEC 10K footnotes I noted that the pension is a non-
contributory pension, that is only the employer makes the contributions.

MGIC employs about 1220 people so it is not that large. I did not find
out anything in relation to MGIC's Community Attitude as yet,
certainly no reference in the Presidents message.

Here's the latest press release that I received via email from MGIC
Investment. It concerns mortgage comparison software called "Defender"
which is used by 25% of the industry. This release is about adding
voice capability.

Here is an extract of the release
Defender, a leading edge interactive voice-response and web-response
system helps mortgage lenders to prioritize and manage call volume by
offering customers timely, accurate responses to questions 24 hours a
day, seven days a week. Mortgage customers will be able to compare
their existing payment and rate information to current market rates and
loan products using simple voice commands. Defender clients will have
the option to upgrade to the speech- enabled version.
Currently, Defender handles 12 million loans representing 25 percent of
the country's outstanding mortgage loans.
"Speech-enabling Defender is a great way for lenders to reinforce and
promote their brand," said Mike Zimmerman, Vice President - Mortgage
Banking Strategies, at MGIC's Capital Markets Group. "In the business
of mortgage lending, customer retention is a real challenge and the
opportunity to enhance brand image is crucial."

Other innovations include:

· MI on the WEB is MGIC's web-based mortgage insurance
application. All MGIC master policyholders can submit loans through
this Internet process.™ is an open, neutral business-to-
business website which allows originators to quickly and easily order
mortgage-related products (including MGIC mortgage insurance) and
services, track orders and manage loan status and flow. For more
information on
· MGIC/Link Servicing: a life-of-loan servicing tool, from MI
commitment through MI cancellation and everything in between.
· Self-Employed Borrower: MGIC's Evaluating the Self-Employed
Borrower software leads users step-by-step through the evaluation of a
self-employed borrower tax return.
· Tele-Education: this program is a streamlined, easy,
comprehensive way for lenders to provide homebuyer education to their
· Events : special training sessions sponsored by MGIC.

MGIC offers a customer retention and relationship building program
(CRM) that utilizes e-commerce technologies, predictive models, and
consumer-direct marketing to identify new customers and to better serve
existing customers, while building brand recognition and loyalty. This
program incorporates several distinct, yet complementary strategies,
for reaching and retaining customers and improving profitability.

· MGIC's CRM Strategies: a discussion: Questions and Answers.
· Defender®: a program especially designed to help increase
customer retention by identifying those consumers most likely to prepay
and ensures all customers receive the proper level of attention.
· EQUIX Financial Services: a program, formerly Customers
Forever, that has been enhanced to offer mortgage lenders more flexible
alternatives for outsourcing mortgage origination and fulfillment.
· Building Customer Loyalty: a turnkey direct-mail program which
helps lenders keep their names in front of their customers for 5 full years.
· Neural-Net Prepayment Model: modeling technique which
identifies consumers who are likely to prepay their mortgage within the
next six months, allowing lenders to target these customers who may
have new mortgage financing needs.
· Lender Landscape: a lender portfolio reporting tool that
focuses on customer retention.

So from my point of view I see MGIC hooking their clients with web-
based business software that adds value for the client and builds
loyalty relationships and increases switching costs that benefit MGIC.

Financial Performance and Growth

CAGR 2001 2000 1999 1998 1997
Sales 11.82 1357.3 1110.3 996.8 971.7 868.3
Gross Profit 19.51 962.5 840.7 701.5 573.2 471.8
Gross Margin 70.9% 75.7% 70.4% 59.0% 54.3%
Net Income 18.53 639.1 542.0 470.2 385.5 323.8
Net Margin 47.1% 48.8% 47.2% 39.7% 37.3%
EPS 21.1 5.98 5.10 4.35 3.44 2.78
Cash From Ops. 14.52 626.1 551.0 455.0 420.9 364.0
Free Cash Flow 14.89 615.4 540.4 444.2 409.7 353.0
Debt (All LT) 18.74 472.1 397.4 425.0 442.0 237.5
Debt/Equity 0.16 0.16 0.24 0.27 0.16
R.O.E. 21.2% 22.0% 26.5% 23.5% 21.8%
R.O.A. 14.0% 14.0% 15.1% 12.6% 12.4%

From these figures I can deduce the following:
1. MGIC Investment has had tremendous & consistent growth over the 4
years tracked. All metrics were above 11% CAGR
2. Cash based growth figures were nearly as good as earnings which is
good as we like to see cash, particularly FCF, up there with earnings.
3. In most years there was insignificant difference between Net
earnings, Cash from Ops and FCF. This indicates that earnings are
generating equal amounts of cash. There is very little capex, therefore
nearly all cash from ops is FCF.
4. Gross & Net margins look like those of a successful software
company. For example Microsoft's 5 year averages are 90% for the gross
margin and 33.6% for the net margin.
5. Generally MGIC Investment's figures are significantly better than
the competition. When figures are this good I'm interested but I had
better look for where the downside risks are.

All these figures look good so where are the clouds & why has the
company's stock price recently dropped? Well you may have read my
quarterly CC notes (linked at the bottom). Because of expected loan
losses over this year and next the company expects earnings growth for
the full year 2002 to be just 3% over 2001 and is forecasting just 4%
growth for 2003. If I project these growth rates forward net earnings
in 2003 will be $684.6m. Now if I calculate the CAGR of earnings from
1997 to 2003 it is 13.3%, still excellent but not the giddy 18.5% of
the last 4 years.

The company is expecting low double digit growth to return in 2004 so I
can make an educated assumption of growth rates going forward. If I
assume 10% for 2004,5,6 & 7 I can get a reasonable idea of the returns
that I may expect. At this rate earnings in 2007 would reach $1.002b
which would indicate a December 2002 to December 2007 5 year growth
rate (CAGR) of 8.8%. Of course "low double digits" could be higher than
10% but I like to err on the conservative side.

RM Financials

The RM Criteria including the Financials are contained in this link

As MGIC Investment is an insurance company not all the RM financials
will fit. The ones that I will assess are:

1. Cash King Margin
2. Sales volume and growth
3. Cash greater than 1.5 x debt
4. Return on Invested Capital (ROIC)

I will also use a couple of other TMF metrics used for financial

5. Asset Turnover
6. Leverage Factor

You will note that the Foolish Flow Ratio is missing as it not possible
to calculate for MGIC Investment as current assets and liabilities are
not available.

1. Cash King Margin (CKM) >10%
Cash King Margin = FCF/Sales, where FCF = Net Cash From Ops - Capex.

Although MGIC Investment has reported 3Q earnings as yet they have not
filed with the SEC so I will use the Trailing Twelve Months (TTM)
figures up to June 30th 2002 (June 30th 2002 SEC 10Q and 2001 SEC 10K )

The Cash Flow Statement is cumulative so that the June 30th figure is
for 6 months, Sep 30th 9 for months etc etc. So I have to start with
Dec 31st annual figure, subtract 1st 6 months of 2001 and add first 6
months of 2002 to get the TTM figures.

From June 30th 2002 SEC 10Q
Net Cash From Ops 1st 6 months of 2002 = $320.62m
Net Cash from Ops 1st 6 months of 2002 = $276.43m

From Dec 31st 2001 SEC 10K
Net Cash From Ops for 2001 = $639.14m

So TTM Net Cash from Ops = $639.14 - $276.43 + $320.62 = $683.33m

Now MGIC Investment had no Capex for the period so FCF = $683.33
according to TMF's definition of FCF.

Sales 1st 6 months of 2002 = $759.4m
Sales 1st 6 months of 2001 = $660.0m
Sales for 2001 = $1,357.84m

TTM Sales = $1357.84 - $660m + $759.4m = $1,457.24m

So CKM = 683.33/1457.24 = 46.9%

Well as CKM requirement is >10% MGIC Investment easily passes and in
any case with no Capex the CKM = Net Margin for MGIC Investment.

2. Sales Volume & Sales Growth

MGIC Investment does not meet the minimum annual sales requirement of
$4b as annual revenues are currently $1.457b.

From the table above MGIC Investment has been growing sales at just
under 12% over the last 4 years so passes this test

3. Cash Greater than 1.5 * Debt
Well here MGIC Investment doesn't meet the criteria having Cash &
Equivalents of $434.13m and ST & LT Debt of $613.85 so the ratio is
0.707 however I'm not too concerned here as I believe that MGIC has
taken on debt to take advantage of some very attractive rates and could
easily reduce debt if so desired.. One years FCF is greater than total
debt and total investment portfolio is now up to $4.64b and increasing.
In addition MGIC Investment is repurchasing common stock.

A better risk measure used for PMI coverage is Risk/Capital ratio and
MGIC's is 8, the industry average 11 and statutory requirement 25.

Return on Invested Capital (ROIC) >11%
There are several articles on ROIC from TMF but perhaps the easiest to
understand is this one by Andrew Chan a Fav Fool of mine

As this is an insurance company and investing the “float” is part of
their business we will not be subtracting investment income as outlined
in Andrew Chan's article

ROIC = NOPAT/Invested Capital
NOPAT = Net Operating Profit After Taxes.

It seems easy but what we have now to decide is what's included in
NOPAT and what's in Invested Capital. From Andrew's article:

NOPAT equals:

Start with:
+ Reported Net Income

Add back:
+ Goodwill amortization
+ Non-recurring costs
+ Interest expense (not added back for MGIC)
+ Tax paid on investment and interest income (not added back for MGIC)

- Investment and interest income (not subtracted for MGIC)
- Tax shield from interest expenses (not subtracted for MGIC)

As for invested capital, the denominator, it represents all the cash
that debtholders and shareholders have invested in the company.
Invested capital can be calculated by subtracting cash and equivalents
and non-interest bearing current liabilities (NIBCLs) from total
assets. Cash is being subtracted because it does not yet represent
operating assets. As for NIBCLs, which include accounts payable, income
tax payable, accrued liabilities, and others, they are subtracted from
capital because they bear absolutely no cost (interest-free). Note that
to calculate ROIC, we use the average invested capital for the period.

Invested Capital equals:

Start with:
+ Total assets

- Cash, S-T investments
- L-T investments (excluding investments in strategic alliances) (not
subtracted for MGIC)

For simplicity I will use the 2001 Annual Report

Net Income = $639.137m
Goodwill Amortization = 0
Non-recurring costs = 0

Subtract realized Investment gains of $37.352m

NOPAT = $639.137 - $37.352 m = $601.785m

Total Assets = $4567m
Cash + equivalents - $434.13m
Income Tax payable - $80.9m
Loss Reserves - $613.664m

So Invested Capital = $4567m - $434.13m - $80.9m - $613.664 = $3438.3m

So ROIC would equal 601.785/3438.3 or 17.5%

4. Asset Turnover > 0.16
Asset Turnover = Revenues/Total Assets

Revenues = $1357.84m
Total Assets = $4567.01m

Asset Turnover = 1357.84/4567.01 = 0.297

MGIC Investment passes this easily.

5. Leverage Factor < 15
Leverage Factor = Total Assets/Equity

This ratio is more suited to banks than insurance companies. For an
insurance company I would use the risk/capital ratio which as
previously mentioned is 8 to 1 for MGIC Investment. As an aside in the
CC MGIC Investment's management said that they would be comfortable up
to a factor of 15 provided that their other fundamentals remained the
same and ratings agencies approved.

So apart from sales volume and cash/debt MGIC Investment stacks up
extremely well against these criteria IMO.


There are the usual disclaimers in the SEC 10K, page 99 (blue numbers)

1. A general downturn in the volume of first time buyers and low down
payment mortgages. Affected by national and local economies, population
trends & rate of household formation, mortgage interest rates,
affordability and government policies toward first time buyers

2. Alternatives to PMI including the use of FHA & VA programs,
increased self insurance by mortgage investors and the increase of
mortgage packages designed to avoid PMI. For example an 80% first
mortgage and 10% second mortgage (an 80-10-10 mortgage) instead of a
90% first mortgage (a 90-10 mortgage)

3. Competition from other PMI's

4. Change in the business practices of Freddie Mac and Fannie Mae. In
fact the whole PMI business is to a large extent reliant on the
fortunes of these two government backed companies. Another risk is
change in government policy towards these two.

5. Litigation Risks. What company in the US doesn't have it? I don't
think that MGIC's are anything unusual.

To my mind the major two risks are the reliance on Freddie Mac and
Fannie Mae and the potential increase in loan losses. The total value
of mortgages covered by MGIC is $183,904 million, of this total MGIC's
risk covers $42,678m so a 1% increase in the default rate would be
$426m by my calculation. It would appear to me that the stock market is
expecting loan losses to increase in the short term.

Intrinsic Value

I usually use a discounted earnings model for stable companies rather
than the FCF preferred by TMF. One has to be pretty sure that the
company is honest in it's reporting otherwise we shouldn't be investing
and should be not even considering a valuation using discounted
earnings or DCF in my opinion.


Normalised earnings (TTM)
Discount rate
Growth rates
Terminal rate
Shares outstanding

For MGIC Investment there are no "one-time" items so the normalized
earnings = net income. The TTM earnings for MGIC Investment are $652.7m
and normally I would use this figure as the basis for valuation.
However in the latest 3Q earnings report MGIC forecast a lower figure
for the 4Q in 2002 of between $133m & $143m which would give an annual
net income for 2002 of between $625m and $635m which is essentially
flat to slightly negative compared to 2001's net income of $639m. So
one figure that I will use is $630m.

When valuing companies a lot depends on the starting figure for
normalized earnings so I like to look at what could reasonably happen
on the downside to look for a worst case scenario. In this case I might
take the 4Q guidance and say "What if it extended for a full year
rather than just one quarter?" Well in this case I would have annual
revenues for 2003 of between $535m and $575m so I might do some
calculations with $535m as the base "normalized earnings".

Incidentally the company is forecasting around $665m for 2003

For growth rates and discount rates I will draw up a table with
differing rates to see the effect of the input changes. LeBean has a
13% discount rate and growth rates of 9% first 5 years, 6% years 6-10
and a terminal rate of 3%. He used the TTM earnings which gave an
intrinsic value of $90. Shares Outstanding 102,686,000.

Table of Intrinsic Value/share - Normalized earnings $630m

Discount Rate ------> 13% 14% 15% 16%
Growth Rates 9/6/3 87 79 71 66
8/5/3 81 74 67 62
6/4/3 73 66 61 56
3/3/3 63 57 53 49
0/0/0 47 44 41 38

So if the company is right on 2003 earnings then this stock is priced
as though it will have zero earnings growth for 100 years at a discount
rate of 14.5%. This distinctly suggests that the stock is undervalued
IMO so why is it priced as such? Well I think that it is because there
is a fear that loan loss provisions could increase and the net earnings
decrease at least in the short term. So I could reduce growth rates
further or use a higher discount rate if I think that there is a
greater risk. Another way is to do a "what if the earnings were lower"
scenario and stick with the same discount rates and growth rates.
Personally I get a better "feel" for the risk or at least possible
alternate valuations this way.

Table of Intrinsic Value/Share - Normalized earnings $535m

Discount Rate ------> 13% 14% 15% 16%
Growth Rates 9/6/3 74 67 61 56
8/5/3 69 63 57 52
6/4/3 62 56 51 47
3/3/3 54 49 45 41
0/0/0 40 37 35 33

OK so what do I get from this table? Well my worst case scenario has
the normalised earnings dropping 18%, zero growth for 100 years and a
discount rate of 16% and the Intrinsic Value/share is still $33, only
$9 below today's price of $42. For a company with excellent sales and
earnings growth over several years I think that this is highly unlikely
and although the share price can go below $33 this suggests that the
value is unlikely to be below this figure.

So bearing in mind the reduction that I made in the assumed net
earnings for next year (therefore it would be easier to achieve growth
rates from that lower basis) I should confidently estimate a
conservative valuation in the $70 region. So if I were to buy today my
margin of safety would be (70-42)/70 = 40%

All the figures were calculated using the StockWorth program

Historical Price Ratios

Although for a company like MGIC Investment I prefer to use Discounted
Earnings for valuation I also think that it is very instructive to look
at simple historical price ratios to see what investors have been
willing to pay for a company in the past. So here are a few going back
10 years:

P/E P/S P/B Net Profit Margin
Today 6.80 2.80 1.27 43.3
12/01 10.80 4.82 2.17 47.1
12/00 10.20 6.49 2.92 48.8
12/99 10.80 6.39 3.58 47.2
12/98 14.60 4.47 2.65 39.7
12/97 18.50 8.15 4.76 37.3
12/96 14.80 6.01 3.28 34.6
12/95 13.50 5.15 2.84 33.6
12/94 11.00 3.85 2.31 31.8
12/93 14.00 4.23 2.39 31.5
Average 12.50 5.24 2.82
Average* 11.83 4.91 2.60

Average* excluding 12/97 figures

The price of the stock today is around $41 to $42. The effect of a
return to average ratios would be:

P/E - $72
P/S - $73
P/B - $85

As to the net profit margin that has gone up in recent years as MGIC
got into sub-prime leading where the premiums are higher to offset
expected defaults. The effect of defaults does not start right away and
we are now seeing MGIC increase loan loss provisions. I expect margins
to reduce but they are still ahead provided they remain above 40%.


In my opinion MGIC Investment is undervalued when looking at the long
term and historical viewpoints. The current stock price is some 40%
under my intrinsic value calculation and represents a good purchase for
the long term, again IMO.

Historical price ratios support the premise that MGIC is currently
undervalued as they are at their historical lows and lower than the

There is some significant risk of loan losses increasing in the short
term and if that happens then we might expect the stock price to fall
further, possibly to the low $30 range. However IMO this will have
minimal effect on the long term value of the company.

I would recommend purchasing MGIC Investment for the FC Investment
Portfolio at any price under $50

BTW TMFSelena wrote an article on MGIC Investment in February 2001

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No. of Recommendations: 2
Of Course now I want to steal MGIC from LeBean for the 2003 FunPort :-)

Just Kidding

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No. of Recommendations: 2
Hi Collective,

I would like some feedback on the MGIC Investment report please

Please comment on format (too wordy, too many tables, disjointed etc etc) or the content as it's only by being challenged that we can improve our research.

I fully appreciate that those of you in North Carolina chopping up the Louis Quatorze furniture just to keep warm are otherwise occupied!

I'm glad that you are all safe and hope that life will return to some sense of normalcy before Holidays begin in earnest

Best Regards
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No. of Recommendations: 2
hi philip,
i'm just doing a quick check-in on the board before leaving for work today- saw your report and printed it out (18 pages!)-
using up all my ink :)

i'll take it with me to a doc. appt. tomorrow to read while i wait for the doc.-
also, i read the article you referred to by TMF Selena from 2/01- and without having read your report, the first question that comes to my mind is that if this is a good company, and the stock price at the time of Selena's article was about $54 (if i remember correctly), why has the stock price dropped so much? (a naive question, right?)
hopefully your report will answer that for me-
anyway, you sure did put a lot of work into this!
have a good day-

p.s.hope all those in NC are beginning to fare better- i spoke to my daughter yesterday via her cell phone because they still have neither power nor phone service- poor thing, she sounded really worn out from this ordeal and said it's gettig "old" - their power and phone are supposed to be back on thurs. morning, which means they will have been without it for a whole week-
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No. of Recommendations: 1
Hi admiral,

Read it, then printed it out for further digestion. Need to think further about this company and do a little more research on this business type in general before feeling comfortable, but your report went a long ways toward fulfilling that. Very impressive. Liked your two different intrinsic value tables with the two different sets of assumptions (one much more conservative than the other).

Format seemed well layed out and flowed smoothly (at least for me). Hope to be able to comment more upon it after reading it a couple more times.

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No. of Recommendations: 3
Quite simply an outstanding report, Philip. Thanks.
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No. of Recommendations: 1
Philip: a very delayed answer, but just recently got interested in this company and saw your excellent research.
I am writing this with fresher numbers, but they still look pretty much like yours, so nothing substantially wrong seems to have taken place.
The only caveat I have found is that MTG has put strong limits on the amount of "bulk" insurance it will accept, and analysts are predicting a substantial loss in market share/new business. It is also admited that since bulk insurance is less profitable, then MTG will lose revenue, but increase profit margin.
How do you see this risk ?
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Hi Vizcacha,

Actually this is the right board as I did my research here so here is the link to my answer on the MGIC Investment board

I think that MGIC will reduce only a certain type of bulk insurance where they are being asked to increase the % of their coverage for virtually no increase in premium

Here is a link to my 4Q CC Notes

Here's the relevant part
Culver very briefly outlined the highlights of the 4Q Earnings announcement and particularly the following:

1. Wrote record new insurance of $92.5b in 2003, driven by re-fi and bulk business

2. Record low persistency of 56%. This increases costs of underwriting. (Persistency = Policies still in place 1 year later). Expect this to go lower before improving as re-financing boom slows 2H 2003

3. Investment portfolio up $500m to $4.7b. Excess cash $500m despite buying back 6,374,000 shares during the year.

4. Risk to Capital Ratio improved to 8.7 to 1. Well below industry average of approx. 11.

5. Loss reserves increased by $68m in 4Q as delinquencies increased (Delinquent policy = one that is one month or more in arrears). Much of this due to their book ageing and was expected. Expect deliquencies to increase in 1Q & 2Q and reduce in second half of 2003.

6. Bulk business was 21% of business in 2002 & expected to be 25% in 2003. Expense ratio on Bulk is just 5% compared to 20% on regular business. This more than offsets higher deliquency.

7. Expects Real estate prices to continue to rise but at a slower rate. No housing bubble especially in their market where median house price is $150,000. Favourable demographics and Federal policy towards home ownership make us feel good about our business & the real estate market.

8. Major lenders in the "captive re-insurance" markets are asking MI's including MGIC to take on 40% of the risk at rates that make no sense as we lose on every policy. MGIC have given notice that they will not accept this business. May lose some market share to competitors who will write the business.

9. 2003 will transition to higher persistency and lower underwriting costs in the 2H. Expect diluted per share earnings of between $5.85 and $6.10 for 2003. This is substantially reduced from the 2003 guidance given at the end of the 3Q of $6.05 - $6.20

So margins are really good on most bulk business as costs to MGIC of doing the business 5% expense ratio compared to 20% for regular business. Also premiums are more related to risk (prime or sub-prime) rather than bulk or traditional.

The way that private MI works is that the MI will insure the top 25% to 35% of the risk and the lender takes the rest. Some lenders are asking this to increase to the top 40% with little or no increase in premium & MGIC is saying no.

Example: House purchased for $150,000. PMI insurance purchased for 30%. Purchaser defaults. House sold for $140,000 then PMI pays the difference minus capital repayments already made. However if there was a severe downturn and house sold for $100,000 then PMI pays maximum 30% of $150,000 or $45,000 minus capital repayments. As the capital is repayed bt the purchaser (borrower) the PMI's liability is reduced.

You will note that MGIC expects the bulk business to increase to 25% of their business in 2003 from 21% in 2002.

I suspect that increases in sub-prime lending which commands a much higher premium is the main reason for the apparent problems at MGIC. As the insurance is written sales & earnings increase but as the "book" ages so the expected loan losses increase. The margins are still there but it it is a difference in timing between the inflow of funds and the cost of doing that business. This is a relatively new market for MGIC and as the book matures I would expect the loan loss provisions to stabilize.

One problem that I see is that the PMI industry only books the loan loss provisions once the account is deliquent (that is more than I month in arrears) even though they say that they expected higher loan losses once the sub-prime book matured. I do not see this as a long term problem once this is recognized however it is likely to provide some volatilty in earnings and consequently share price particularly in the short term.

If you have worked on some figures/research on MGIC please post your ideas as I and others are always interested

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