Companies that make home equity loans or loans to borrowers with substandard credit are among the hottest - and most misunderstood - on Wall Street, analysts say.
"It is a growth story without a doubt," said Jennifer S. Scutti, senior financial services analyst in equities research at Prudential Securities, New York.
"I think there is good business to be done in this sector, and it should show some good, top-down growth," said Merrill H. Ross, an equities analyst at Wheat First Butcher Singer, Richmond, Va.
The stocks of the five major financial services companies that specialize in substandard and home equity lending have climbed an average of 25% since Jan. 1. The Dow Jones industrial average has risen about 4% during the same time.
The strong performances of these companies' stocks reflects the boom time the industry is entering.
"I think it is a growing market," said Selman Akyol, research analyst at Pauli & Co., St. Louis, referring to the group as a whole. "It is kind of nice because they are not as interest rate sensitive as banks are."
Analysts say some investors have the misconception that such lenders are exposed to interest rate risk.
But Mr. Akyol said so-called hard lenders - those that cater to borrowers with flawed credit - and home equity lenders are not making mortgages to those who have the ability to shop around or wait for rates to fall. These borrowers need loans, and they can't be choosy about interest rates since they are not "A" borrowers.
Among the most successful companies has been Aames Financial Corp. In the last year, the Los Angeles company has expanded significantly beyond California. And its unit that buys loans wholesale from mortgage brokers has skyrocketed, according to analysts.
Prudential's Ms. Scutti, for one, suggests that investors buy Aames stock.
The shares have climbed 52% in value since Jan. 1. They are now trading at about $12.125.
Jonathan P. Braatz, vice president of Fahnestock & Co., New York, said Aames should continue to show strong earnings. Its stock price should hit $16 within the year, he said.
Money Store Inc., Sacramento, Calif., outperformed analysts' predictions of fourth-quarter earnings, and the stock's price has jumped 26.4% since then, to about $22.75 a share.
The stock of Beneficial Corp., Wilmington, Del., has jumped 9% in value since Jan. 3 - despite a downgrading by Prudential Securities because of a debt filing.
And Advanta Corp.'s stock has surged, too. Both the Horsham, Pa., financial services company's stock classes have risen more than 25% in value.
Even United Companies Financial, Baton Rouge, La., has seen its stock price rise. (The lender had been stung by losses unrelated to its core home equity and substandard credit lending.) The reason: solid industry growth.
"If they would focus on their core operation . . . this should be a stock that sells in the 40's," said Ms. Ross of Wheat First Butcher Singer. The stock sells now for about $31.75, up 17% since Jan. 1.
