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Portfolio Recovery Associates (PRAA) is essentially in the business of buying discharged receivables, bad debt, for much less than its face value, then attempting to collect on that debt. Right now, in the teeth of the housing bubble collapse and the recession, bad debt is cheap: people who can't pay their mortgage don't pay their credit card bills either. Lumpy purchasing and collections make this a hard business to understand based on superficial EPS numbers, and I think the herd on Wall Street is underestimating its value, though the 10-K's, 10-Q's are straightforward and informative, and management seems honest and forthright in conference calls.

PRAA management has a long history of good discipline in purchasing receivables, and they have recently (Spring 2007) leveraged up the business with a substantial line of credit (as much as I love debt-free businesses, there are some cases where it makes sense). Their debt to equity ration remains below 1, and ROE is around 18%. In 2007, PRAA bought roughly twice the dollar value of discharged receivables as in any previous year. If the portfolios of discharged debt they're buying now perform as well as they have historically, PRAA stands to make 300-400% on them over a period of years, before expenses, generating a non-linear increase in revenues.

The business is, to a certain degree, kept intentionally opaque in order to keep competitors in the dark, though management breaks out the earnings in a variety of helpful ways in 10-Q's and conference calls (e.g., average collections per hour at a given facility and returns realized on debt bought during different purchase periods). Interestingly, collections have remained strong in Q1 and Q2 despite the macroeconomic climate in the U.S. and despite the hiring of new, and currently less productive, employees. There is a seasonal pattern to collections, with slightly lower collections in Q3 and Q4--which sometimes leads to an unwarranted selloff in the stock.

Several things to keep an eye on include operating expenses and employee retention (more experienced collectors make the company more money and are more highly compensated, but cold calling people who've defaulted on their loans is a thankless job). But these are relatively minor issues. PRAA should continue to perform well, and if over the next few years they are able to collect on the receivables they've purchased at anything approaching historical rates, the stock price rise along with earnings.