Your job as an investor is to make sure that you can buy wonderful businesses at fair prices, which is what Charlie Munger (rest his soul) taught Warren Buffett to get him to pivot from accepting what he referred to as 'cigar butts.' Today, the oracle of Omaha has found a few wonderful businesses trading at more than fair prices.
Not only has Lennar (NYSE: LEN) made the list of investable stocks at Berkshire Hathaway (NYSE: BRK.A), but there are major trends in the United States economy that could make the construction sector the best investment you could ever take on in the next few years.
From a new government bill to supply and demand dynamics pushing future earnings expectations higher, this is one stock that markets love, but should you love it too? Well, some may say yes for reasons that will become clear in just a bit.
Sudden shifts
Did you catch headlines or data points showing that Blackstone (NYSE: BX) started buying up (in cash) several multi-family homes across the country? This is something that the government is looking to undo to protect you and other investors or would-be home buyers.
This new legislation, now proposed and yet to be considered or signed seeks to push hedge funds and other big Wall Street firms out of the housing market. What this means for you and others is less competition from those with deep pockets who can blow your offers on a home out of the water.
The government has pivoted, and so has the FED. During the latest FOMC meeting, FED chairman Jerome Powell suggested that 2024 could hold some rate cuts in its path, and this aligns with a bigger trend behind construction, the one that drew Buffett into the space.
But how does this benefit the homebuilders exactly? The SPDR S&P Homebuilders ETF (NYSEARCA: XHB) and its 48.4% performance year-to-date could be a starting point, just as Lennar's competitors Pulte Group (NYSE: PHM) and D.R. Horton (NYSE: DHI).
According to the Intercontinental Exchange (NYSE: ICE), most outstanding mortgages today carry an average interest rate of 3.25%, most of which originated during 2021-2022 when rates were at rock-bottom. So, put yourself in that situation as a homeowner.
This avenue becomes unattractive because selling your home would require you to take on a more expensive mortgage to replace the sold property. If you are trying to buy a house, 7.3% mortgages, and home prices at five-year highs can also make it hard to achieve.
So, what now? Well, the only way to stimulate the market is to manufacture inventory, which is fancy for builders to be building! Here is where Lennar and its peers come in.
Path to gains
According to the latest employment situation reports, two and a half thousand people were hired as residential specialty trade contractors, which means architects and other such jobs for residential construction. Now, what comes before actual construction workers on the job? Blueprints are made by these contractors.
So it does look like the industry is getting ready to get building, and markets have picked Lennar as the crowned prince in the space; here's why:
The industry is trading today for an average forward price-to-earnings ratio of 8.5x, which is the market's way of placing a value on the next twelve months of earnings. Pulte and D.R. Horton? They trade at discounts of 7% and 1% to the industry.
With a forward P/E of 9.2x, Lennar stock is giving you a premium valuation of 5.0% over the industry, which should be putting the thought of 'it must be expensive for a reason' in your head. This time, there is a reason.
Even before the FED and Congress decided to pivot in favor of future homebuyers, Lennar was already reporting expanding fundamentals, such as the ones in its last quarter. With a backlog of 21,321 homes, a pending dollar value of $9.9 billion is in the pipeline, waiting to get in the action.
New orders for homes rose by 37.0% over the year as well, building up on the future earnings momentum, and beginning to justify the premium valuation. However, there is one thing you should remember here.
These figures are all pre-FED pivots, so imagine what kind of numbers Lennar is set to report in their coming quarterly release. However, before you let your imagination run wild, keep in mind analysts see a 7.2% downside from today's prices, so maybe let the stock breathe a little.
