My Top Homebuilder Pick

Jody Chudley, Contributing Analyst, The Oxford Club

It's a story we have been following here at Wealthy Retirement for well over a year.

The United States is facing a massive housing shortage.

When I last wrote to you, I showed you a recent study that pegs the shortage at more than 5.5 million homes.

Given that in recent years roughly 1.3 million new homes have been built annually, it is going to take a long time to dig out from under that 5.5 million home hole.

Unquestionably, this is a multiyear bullish tailwind for homebuilders.

After I pounded the table on homebuilders last spring, the sector had a furious rally - almost tripling the performance of the S&P 500.

But in recent weeks, these stocks have pulled back a bit.

This is good news.

It provides a chance to get into a multiyear growth opportunity for homebuilders at a better entry price.

Today, I'm zeroing in on one homebuilder.

This Homebuilder Stock Ticks a Lot of Boxes

Lennar Corp. (NYSE: LEN-B) is the homebuilding stock that I think is set to outperform over the next three years.

In 2021, Lennar ranks as the second-largest homebuilder in the United States in terms of revenue.

I have four big reasons I believe Lennar's shares are going to do very well.

1. Cheap Valuation

The current consensus earnings estimates for Lennar in 2021 project that the company will earn $12.84 per share.

With Lennar shares trading for $99, that means the company is currently valued at just 7.6 times current year earnings.

Against an S&P 500 that trades for more than 20 times earnings, that looks cheap.

When you factor in the growth tailwind that the homebuilding sector has behind it, 7.6 times earnings looks really cheap.

2. Excellent Balance Sheet

Following the housing bubble imploding in 2008, most of the companies in the homebuilding industry have spent the past decade focused on improving their financial positions.

Lennar is no exception, with the company's debt-to-equity ratio dropping dramatically over this time.

Lennar's Continual Balance Sheet Improvement

That means the company is heading into a boom period for homebuilders with a balance sheet that is already rock-solid.

Often, companies use cash generated in up cycles to repair their balance sheets.

Lennar doesn't need to do that, and that means the excess cash that is generated over the next several years can be returned to shareholders through increased dividends and share repurchases.

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3. A New Business Model

The majority of homebuilders in the industry tie up billions and billions of dollars in cash buying land for future development - which equates to a "land heavy" business model.

One homebuilder, NVR Inc. (NYSE: NVR), has instead used a different tactic. NVR has always avoided tying up money in huge land investments. Instead, NVR purchases land only immediately before development.

That means NVR's business model is "land light," while the rest of the homebuilders have been "land heavy."

The stock chart below tells you everything you need to know about NVR's unique business model. NVR has been one of the single best-performing stocks in the entire stock market for 30 years!

NVR Has Been an All-Time Great Investment

Understanding NVR's incredible success relates directly to Lennar because Lennar is now in the process of transitioning to a similar "land light" business model.

Avoiding having billions of dollars tied up in land is going to turbocharge the amount of free cash flow that Lennar generates going forward.

That means even more dividends (on top of the current 1.26% yield) and share repurchases.

As NVR has shown, it also means a better-performing share price.

4. Our 25% Discount

Lennar has two classes of shares: Class A shares and Class B shares.

Both classes of shares have an equal economic interest in the company and its dividends.

The Class B shares are actually the superior share class. They have supermajority voting powers and are 57.8% owned by CEO Stuart Miller.

But because the Class B shares aren't included in the S&P 500, index funds don't even have the option of owning them.

For us small investors, this is a huge opportunity.

Despite having superior voting rights, the Class B shares trade around $80, which is a 25% discount to the $99 Class A share trading price.

The institutional trading volume has driven the Class A share price higher.

With the $12.84 per share that Lennar is projected to earn this year, these Class B shares are trading at just six times earnings.

I believe that to be astoundingly cheap for a company going into a big growth cycle.

There is just so much to like about the next three years for Lennar.

I see earnings growth, its valuation multiple being revised higher, dividend increases and share repurchases.

Throw in our 25% Class B discount for owning superior shares, and I think we have the makings of a big winner.

Good investing,

Jody

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