The CFA Research Challenge: Predictions, Predictions!
Kareem Powell
AuthorEarlier this year, I did this "competition thing" with a few MBA friends, where we tried to analyze and price a randomly selected company. We did pretty well and came in second placed place! But I thought it would still be fun to ask, three months later… how has our analysis held up?
Our January 30th recommendation for PennyMac Financial Services (PFSI) was a Moderate Buy with a one-year target price of $113.55 — a 12.18% upside to its December 31, 2024 price of $102.25. Interestingly enough, PFSI reached its 2025 year-high of $114.82 the day of our recommendation — however dropping back to $104.38 the day after, following the release of its 2024 earnings report. PFSI's price has remained fairly stable since then until Thursday, April 3rd's Liberation Day — when most U.S. stock prices fell. The following week, PFSI dropped to its 2025 year-low of $89.28. However, since then, the stock crawled its way back to $99.28, as of yesterday, Tuesday, May 13.
Now this large drop in price we had mostly anticipated, although to a lesser extent — as you will see from our experience competing at this year's Los Angeles CFA Research Challenge.
What's The Challenge About?
Before we jump in, what was the CFA Research Challenge about? From the challenge's website:
"The CFA Research Challenge provides students with in-depth exposure to the U.S. stock market. Challenge participants work as equity analysts to value a company’s stock creating a 21-page report and 50+ slide presentation, and then defending their recommendation to a panel of CFA Charterholders."
For the 2024–2025 competition, we analyzed the residential mortgage finance company, PennyMac Financial Services (PFSI). PFSI was founded shortly after the 2008 financial crisis, in which over 10 million people ended up losing their homes. Leading up to the crisis, in an effort to juice their earnings, banks provided mortgage loans irrespective of people's credit history. When interest rates increased and monthly payments went up, many people couldn't afford their payments, causing a massive wave of defaults.
After this balloon of mortgage loans popped, PFSI then swooped in to stop the bleeding. By purchasing some of these failed mortgage loans and providing affordable repayment plans, some homeowners were able to not foreclose. In addition to affordable loan servicing, PFSI also provided mortgage loans, and created its subsidiary PennyMac Mortgage Trust (PMT) to invest in real-estate financial assets.
Where Did We Start?
We began with familiarizing ourselves with the company’s operations by reading through previous Form 10Ks and 10Qs — combined 100+ page documents with information on company financials, services, risks, etc.
We then looked at PFSI's three major lines of businesses (LOBs) — loan production, loan servicing, and investment management — noting early on the effects on earnings of internal and external events. For example, in the declining FED rate environments of 2022 to 2024, PFSI originated significantly more mortgage loans than in previous years — as resulting deflation meant that people had "more income" to spend on things such as homes.
With loan origination being the company’s largest source of income, PFSI saw record growth of 81% over these two years! From $56.66 in December 2022 to $102.35 in December 2024.
While on the opposite end, servicing and investment management performed better during periods of rising interest rates due to higher mortgage payments and interest payments respectively.
This example of the complex effects of external events on PFSI's earnings highlights the difficulties we faced in our analysis. However, we seemed to have pulled it off nonetheless! Why was this the case? Well, mainly one thing:
Our Valuation Reflected Economic Reality — Not Our Hopes Or Dreams
When creating our valuation, and modeling the effects of internal and external events, we ensured that our models reflected current realities and not what we wanted or hoped would happen. Given the record-breaking market performance of 2024 and the resulting low interest rate environment, it wouldn’t have been difficult to assume that the same be the case for 2025 — which is exactly what we thought, at first.
However, discussing with my mentor the reasoning behind our valuation led me to realize that my thought process was driven by optimistic beliefs. Thinking about the 2025 market, it just did not line up that budgetary cuts, tariffs, and de-regulation would contribute to a continued low inflation environment. Higher inflation would eventually result in higher rates of interest which would then lead to a lower demand for mortgages. As if it became difficult for people to afford basic goods such as eggs, mortgages would no longer be as attractive as before.
But despite our methodical, well-thought out approach, we seemed to have just missed out on the coveted first place. Why was this the case?
Well, simply put. We considered almost every major possibility, missing out on a few important market developments; one of which included: the possible privatization of Freddie Mac and Fannie Mae.
Why Would This Have Been Significant?
Fannie Mae and Freddie Mac were two of the largest publicly traded mortgage companies that provided mortgage guarantees that reduced the risk of loans, leading up to the 2008 financial crisis. But in 2008, with massive mortgage loan defaults, both companies had to be bailed out by the U.S. government for an amount close to $200 billion. They were then placed under government control — otherwise referred to as conservatorship — which meant that the government would collect their revenues, until their debt was paid off.
There have recently been calls to return both companies to the public, as both companies seemed to have repaid their debt in full. So, what would have been the relevance in our analysis of the mortgage industry? Well, without continued government guarantees, there would be a higher risk of defaults which would inevitably lead to higher mortgage rates — thus decreasing the demand for mortgages.
Additionally, since PFSI purchases its loans from Freddie Mac, privatization would also mean higher costs of purchasing, as it can be reasonably argued that a non-government company would inevitably charge more to maximize earnings for its shareholders.
The Takeaway?
We placed second in the CFA Research Challenge because we nailed the real-world drivers behind PFSI’s stock price. But if we had gone one step further, leaving no stone untouched, we just might’ve taken first!
