When Warren Buffett-led conglomerate Berkshire Hathaway(NYSE: BRK.A)(NYSE: BRK.B) recently released an updated look at its massive stock portfolio, we learned that Buffett and his team added shares of not one, but three different homebuilders. Berkshire bought D.R. Horton(NYSE: DHI), NVR (NYSE: NVR), and Lennar(NYSE: LEN), with a combined investment value of nearly $800 million.
While these are all excellent homebuilders with strong track records of growth, as well as attractive valuations, there's one homebuilder stock I've been buying in my own portfolio that I believe could perform even better for patient long-term investors. Here's a rundown of why Buffett might be so attracted to homebuilder stocks right now, and why I prefer to invest in the homebuilding industry with smaller player Dream Finders Homes(NYSE: DFH) instead.
Why homebuilders?
Let's not sugar-coat it. The real estate market in the United States is pretty bad right now. A combination of soaring home prices and mortgage rates at multi-decade highs has pushed many would-be homebuyers to the sidelines.
However, there are always some people who need homes. People still get transferred to a different part of the country for their jobs, and some people need to move to be closer to relatives or friends. And this is where homebuilders are winning.
In simple terms, existing home inventory is extremely low. Roughly half of pre-pandemic levels. Millions of homeowners have mortgages with 3% (or even lower) interest rates and don't want to give them up. So, new homes are making up a disproportionate percentage of available homes on the market. Not only that, but homebuilders have the ability to offer incentives – including promotional mortgage rates – that private sellers can't.
Why Dream Finders Homes?
There are two key factors that make Dream Finders stand out.
First, Dream Finders uses the same land-light business model that NVR uses. The short version is that unlike most homebuilders, Dream Finders and NVR don't buy any land until they're ready to start building a home on it. They don't buy large tracts of land to gradually build on. This keeps capital requirements low and allows the business to regularly generate returns on equity of 40% or more.
Second, Dream Finders is in the relatively early stages of growth and focuses on some of the fastest-growing Sun Belt housing markets in the United States. In addition to its home market of Jacksonville, Dream Finders also has a large presence in Orlando, the Carolinas, Texas, and other markets where homes are still (relatively) affordable, and job and wage growth exceeds the national average.
The company's track record has been impressive so far. Founder and CEO Patrick Zalupski started the building in the wake of the Great Recession in 2009 and has grown it to the point where it expects to close on 6,500 homes this year, despite the difficult market. And speaking of the difficult real estate market, in the second quarter, Dream Finders grew its revenue by 19% year-over-year and ended with a backlog of nearly 5,300 homes.
To be fair, we don't know for sure that Buffett and his team don't like Dream Finders. With a market cap of just $2.5 billion, it could simply be too small to attract Buffett's attention. The smallest of Buffett's three builders has a market cap that is about eight times Dream Finders' size. But if you're a long-term investor, Dream Finders is making all the right moves to evolve into one of the major players in the space in the years to come.
An attractive valuation, even after incredible stock performance
The market has certainly acknowledged Dream Finders' strong results and the better-than-expected environment for homebuilders in general. Since the beginning of 2023, Dream Finders' stock price has roughly tripled.
Even so, it looks like an attractive stock at these levels. The real estate market is bad all around – it's just better for homebuilders than for existing homes, but it's still not great. There is tremendous appetite for household formation, which could be a massive catalyst for the entry-level homes Dream Finders does so well, once inflation and economic fears normalize. Even after its tremendous performance so far this year, Dream Finders still trades for less than 13 times forward earnings. I've added to my own position at these levels, and plan to keep incrementally building it for as long as the company keeps producing strong results.
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Matthew Frankel, CFP® has positions in Berkshire Hathaway and Dream Finders Homes. The Motley Fool has positions in and recommends Berkshire Hathaway, Dream Finders Homes, Lennar, and NVR. The Motley Fool has a disclosure policy.
