The coronavirus pandemic has made property more attractive as people spend more time at home. As a result, house prices are skyrocketing, which could benefit a wide range of businesses.
In this segment of “The Five”, recorded on September 9, Fool.com contributors Jason Hall, Lou Whiteman and Parkev Tatevosian highlight three stocks that could benefit from rising home values.
Jason Hall: The last topic should be pretty quick. I think this is maybe the most fun we have today too. Our fourth here, so Ben Carlson, I’m a huge fan of. I follow him on Twitter. I recommend everyone else to follow him on Twitter. Read his book, A wealth of common sense. He recently gave, I think, an interesting analysis of house prices, basically saying that housing may not be as expensive as we think it is. He looked at it adjusted for inflation, combining that with low interest rates, thinking about the real price to be paid, seeing it as part of people’s disposable income, all of those things. It might not be as expensive as you think. He also pointed out that in many other developed countries, house prices have increased at a much, much faster rate than in the United States. So I think that’s an interesting point.
I don’t want to discuss it too much, because I think the house prices are completely ridiculous. I am embarrassed at how much I have been able to sell my house here. I was disgusted with how much I had to pay to buy the new house that we are going to buy. Instead of doing that, let’s just talk about something our members will enjoy. What stock do you really like that is housing related, Lou, and do you think it could be a big winner?
Lou Whiteman: So Red tuna (NASDAQ: RDFN) is still my answer here, but it’s still my answer, so I guess I’ll be different. Redfin, I truly believe that the revolution comes from within. I like the way they work, where they work in the traditional brokerage industry. This total addressable market is only salivating.
But it’s boring. Why aren’t we talking about a housing stock that isn’t really benefiting from a real estate boom, but I think it’s a great investment? NVR (NYSE: NVR). The sober guy at the party, the driver at the party. They don’t do anything like the home builders. They don’t take advantage of the way home builders do. They don’t buy land just to show nice maps like other people do. They plug in, generate incredible returns, buy back their stock, rinse, start over. Lots of room for expansion, since this is an east coast portfolio. They got into a booming industry where they went bankrupt, mind you, and learned from it. They found a way to make it predictable, boring, and stable. It’s not necessarily the best stock in a boom time, but when it inevitably gets treated like a homebuilder when that cycle ends and he gets punished, then watch him because it’s one hell of a business. .
Room: Yes, they will win because of it. Also, they have a pretty good small mortgage business where they take out a lot of loans. They don’t own them, but they make a lot of money from these loans. I think it’s really good there too. Parkev, how about you?
Parkev Tatevosian: Yeah, sure. Home prices are going up on a nominal basis, at least if you look at it that way. One stock that I think can do very well for investors is Home deposit (NYSE: HD). Management often says that accelerating home prices are the biggest factor in how much people are willing to spend on home improvements. So income exploded during the onset of the pandemic, but that should clearly slow down, but that’s not the reason to own the stock.
What attracts me, again, are the healthy and expanding profit margins. From 2012 to 2021, Home Depot increased its operating profit margin from 9.5% to 13.8%. That’s all while increasing income at a compound annual rate of 6.9%. And if you want to compare that with its main competitor, Lowe’s (NYSE: LOW), their profit margin was 10.8%, or 300 basis points lower, in 2021. And over the past decade, Lowe’s has only averaged 8.5%.
So it’s clear Home Depot is the top performer, and they’ve been able to maintain that edge over time. It trades at a relatively fair price-to-earnings ratio of 23 times, which is in the middle of its historical range, so it’s not expensive at those levels either.
Room: Yes, I’m going to share a quick graph here that just illustrates some of those numbers you were talking about. I think Lowe’s is a very good company, but I think that just underscores, Parkev, what you talk about in terms of economic performance. Again, this is a rolling 10 year period, which has always had higher operating margins while increasing those margins. Then you look at the return that business is getting. They know where to put their money. They know where to invest the capital to get the best returns. They’re just very, very, very good at it.
I’m going to talk about another home builder here, Lou, and I’m talking about a boring home builder who does a lot of the things you don’t see NVR doing. It exerts a leverage effect on the company, like many other companies in the sector. She is increasingly using land options to develop her portfolio, but she is also buying a lot of land. But at the end of the day – I did it again. I completely lost my card. Let’s see if I can find it. I may have closed it. It is very possible that I closed it completely.
Jason Hall: Yes. I just closed it. Here is the key with Meritage Houses (NYSE: MTH). What I love about it is a long time Equity advisor to take. This is a company that probably five or six years ago began to move towards entry-level housing, the area that home builders hardly built, from 2009 to to roughly 2017.% of their construction. Did a wonderful job.
Under Steve Hilton, the founder who has now resigned as CEO, retired as CEO, remaining as executive chairman, is pivoting to that model and focusing on it, and it really pays off. The company’s margins have grown steadily over the past five years and it is now achieving 20% margins. Some of the best margins in the industry. Gets great feedback. Trade for a single-digit price / earnings ratio. I think it is trading for seven or eight times earnings, which for the context now may seem unbelievably cheap compared to the market. Due to their business model, it will always trade at a discount to the broad market, but usually around 12 times the earnings as a reasonable valuation. Trading for about eight times profit; is trading for less than six times forward earnings estimates. It’s really cheap for such a good company.
Let me give you another data point here which is huge for me. We could take all the home builders in America. We could clone them once and double our house-building capacity for three full years, and we would finally catch up on the inventory needed to keep up with demand. We are over three years late. It is gigantic. Do you know who it’s good for, guys? Houses of Merit. [laughs] It’s really good for the big operator in this industry.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.