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This article was coproduced with Dividend Sensei.
It's been a wild year for stocks in 2022. In fact, a historic one.
It's the third worst start to the year for stocks in history, which means there are a lot of blue-chip bargains available.
I'm not just talking about wonderful companies at fair prices.
I'm talking about wonderful companies at wonderful prices.
Today I wanted to highlight a recent recommendation, for D.R. Horton (NYSE:DHI ), America's largest home builder by volume.
Let me show you the three reasons why DHI isn't just a potentially wonderful company at a wonderful price, it's potentially one of the best Buffett-style "fat pitches" on Wall Street.
One that could deliver almost 5X returns over the next five years.
“Wait for a fat pitch and then swing for the fences." - Warren Buffett
There are many ways to measure safety and quality and I factor in pretty much all of them.
The Dividend Kings' overall quality scores are based on a 248-point model that includes:
Credit default swap medium-term bankruptcy risk data
Short and long-term bankruptcy risk
Accounting and corporate fraud risk
Historical cash flow growth rates
Long-term risk-management scores from MSCI, Morningstar, FactSet, S&P, Reuters'/Refinitiv, and Just Capital
Dividend friendly corporate culture/income dependability
Long-term total returns (a Ben Graham sign of quality)
Analyst consensus long-term return potential
In fact, it includes more than 1,000 fundamental metrics including the 12 rating agencies we use to assess fundamental risk.
Credit and risk management ratings make up 41% of the DK safety and quality model
Dividend/balance sheet/risk ratings make up 82% of the DK safety and quality model
How do we know that our safety and quality model works well?
During the two worst recessions in 75 years, our safety model predicted 87% of blue-chip dividend cuts, the ultimate baptism by fire for any dividend safety model.
And then there's the confirmation that our quality ratings are very accurate.
191 Real Money DK Phoenix Recs
Positive Total Returns Over The Last 10 Years
99.5% (Greatest Investors In History 60% to 80% Over Time)
Lost Money/Went Bankrupt Over The Last 10 Years
Outperformed Market Over The Last Decade (290%)
Bankruptcies Over The Last 10 Years
100+% Total Return Over The Past 10 Years
200+% Total Return Over The Past 10 Years
300+% Total Return Over The Past 10 Years
400+% Total Return Over The Past 10 Years
500+% Total Return Over The Past 10 Years
600+% Total Return Over The Past 10 Years
700+% Total Return Over The Past 10 Years
800+% Total Return Over The Past 10 Years
900+% Total Return Over The Past 10 Years
1000+% Total Return Over The Past 10 Years
Sources: Morningstar, JPMorgan, Seeking Alpha
Basically, historical market data confirms that the DK safety and quality model is one of the most comprehensive and accurate in the world.
How does DHI score on one of the world's most comprehensive safety and quality models?
Dividend Kings Safety Score (161 Point Safety Model)
Approximate Dividend Cut Risk (Average Recession)
Approximate Dividend Cut Risk In Pandemic Level Recession
Medium-Risk (45th industry percentile risk-management consensus)
BBB Positive outlook credit rating 7.5% 30-year bankruptcy risk
2.5% OR LESS Max Risk Cap Recommendation - speculative (increased accounting fraud risk)
S&P 500/Industry Average
2.5% OR LESS Max Risk Cap Rec - speculative due to increased accounting fraud risk
25% Margin of Safety For A Potentially Good Buy
The M-score is 76% historically accurate at catching accounting fraud and 82.5% accurate at finding companies with honest accounting.
Rating agencies and accounting firms vouch for the honesty of the accounting...
But M-score indicates a 76% risk of fraud
The only reason DHI is speculative and a 2.5% or less max risk cap
I don't actually think DHI is cooking its books, but at DK we always factor in every reasonable risk into our valuation recommendations.
D.R. Horton was founded in 1978 by Donald Ray Horton in Arlington, Texas. Today it operates in 104 cities in 32 states.
“Higher Rates Likely to Cool Housing Market but Our Residential Construction Outlook Is Constructive
D.R. Horton is the largest U.S. homebuilder (by volume) with an extensive geographic footprint, wide product breadth, value focus, and financial flexibility. Management is focused on continuing to expand the business while generating sustainable returns on invested capital and positive cash flows throughout the housing cycle.
Residential construction has been a bright spot of the U.S. housing market during the pandemic, and we expect continued housing market strength over the next decade with housing starts averaging 1.6 million units annually. While affluent urban dwellers migrating to the suburbs was a key source of demand in 2020-21, we expect first-time buyers to be the main contributor to future housing demand." - Morningstar
D.R. Horton is the biggest home builder in the country by units sold and is prepared to feed the insatiable need of 150 million Millennials and Gen Zers in the next 10 to 20 years.
“Recognizing the importance of the price-conscious first-time buyer in the continued recovery, D.R. Horton launched Express Homes, its true entry-level product, in spring 2014. This bet has paid off thus far as Express Homes has outperformed initial expectations and now accounts for over 30% of homes sold. Although competing products have entered the market, we believe D.R. Horton has a first-mover advantage that will boost its growth over the coming years. With ample land supply and product offerings catering to entry-level, move-up, higher-end, and active adult homebuyers, D.R. Horton is well-positioned to capitalize on the demographic tailwinds driving the recovery." - Morningstar
The median US home price is $405K as of April 2022 and DR Horton's average selling price is expected to be $395K in 2023 as it caters to first-time home buyers.
Units sold are expected to rise from 65,388 in 2020 to 91,564 in 2023
The backlog of new homes is expected to be 22,304 in 2023
“With 33,900 homes in backlog, 59,800 homes in inventory, a robust loss supply, and strong trade and supplier relationships, we are well-positioned for consolidated revenue growth of greater than 25% this year...
Our second-quarter home sales revenues increased 22% to $7.5 billion on 19,828 homes closed, up from $6.2 billion on 19,701 homes closed in the prior year. Our average closing price for the quarter was $378,200, up 21% from the prior-year quarter...
The average sales price of net sales orders in the second quarter was $400,600, up 23% from the prior-year quarter. The cancellation rate for the second quarter was 16% compared to 15% in the prior-year quarter. " - CEO, Q1 conference call
It's boom times for home builders, despite rising mortgage rates and labor demand shortfalls.
Average prices per unit are running two years ahead of analyst forecasts, and cancellation rates are near historic lows.
“Our gross profit margin on home sales revenues in the second quarter was 28.9%, up 150 basis points sequentially from the December quarter...
On a per square foot basis, home sales revenues were up 4.8% sequentially...We expect our costs will continue to increase. However, with the strength of today's market conditions, we expect most cost pressures to be offset by price increases in the near term. We currently expect our home sales gross margin in the third quarter to be slightly better than the second quarter. " - CFO, Q1 conference call
Despite rising input costs, margins are still expanding, up a healthy 1.5% in the last year.
Margins are expected to remain strong in the next quarter as DHI has strong pricing power.
Home inventories is at record lows (470K for the entire country), because of a decade of underbuilding.
About 4 million home shortage nationwide
Approximately 5 to 10 years to work through this shortage
At March 31, our homebuilding lot position consisted of approximately 570,000 lots, of which 23% were owned and 77% were controlled through purchase contracts." - CFO, Q1 conference call
DHI has the capacity to build another 570,000 homes, representing approximately six years' worth of building capacity.
“We repurchased 3.1 million shares of common stock for $266 million during the quarter for a total of 5.8 million shares repurchased fiscal year-to-date for $544.2 million, an increase of 30% compared to the same period a year ago.
Subsequent to quarter-end, our Board authorized the repurchase of up to $1 billion of our common stock, replacing our prior authorization. The new authorization has no expiration date.
We now expect to reduce our outstanding share count by 3% during fiscal 2022. We remain committed to returning capital to our shareholders through both dividends and share repurchases on a consistent basis and to reducing our outstanding share count each fiscal year." -CFO, Q1 conference call
DHI plans to repurchase 3% of its shares this year and reduce its share count every year, as it focuses on safe and steadily growing dividends and opportunistic buybacks.
“We still expect to generate positive cash flow from our homebuilding operations this year, and we will continue to balance our cash flow utilization priorities among our core homebuilding operations, increasing our rental inventories, maintaining conservative homebuilding leverage, and strong liquidity, paying an increased dividend and consistently repurchasing shares." -CFO, Q1 conference call
DHI's priorities are on organic growth, including its relatively new rental business, growing its dividend every year, and buying back stock.
DHI is in 44 of America's 50 top housing markets and the market share leader in almost all of them.
Its average executive has 28 years of industry experience, and its regional executives have 20 years.
DHI is well positioned across the entire price spectrum, from starter homes under $300K (38% of new home sales) to luxury units for over $500K (9% of sales).
Returns on equity have doubled in recent years, rising to 34% in the last year from 17% in 2019.
Leverage, which rating agencies want to see at 40% or less debt/capital is now 17%.
Compared to pre-pandemic levels gross margins are up from 20% to 29%.
Rising input costs are passed onto consumers
DHI is leveraging its industry-leading economies of scale to control costs very effectively
DHI's inventory of new land continues to grow, approaching 600,000, nearly double what it was pre-pandemic.
DHI's growth runway is long and strong
Chance of Losing 100% Of Your Investment 1 In
(Source: S&P, Moody's)
Rating agencies estimate DHI's fundamental risk at 5.83%, a one in 17 chance of losing all your money in the next 30 years.
Net Debt/EBITDA (3.0 Or Less Safe According To Credit Rating Agencies)
By 2023 DHI is expected to have more cash than debt.
DHI's debt is expected to drift lover while cash flows soar.
Well-staggered bond maturities (all debt maturing by 2028)
100% unsecured bonds (maximum financial flexibility)
All medium-term to short-term debt
Credit default swaps are insurance policies taken out by bond investors in case a company defaults (goes bankrupt).
They serve as a real-time fundamental risk assessment from "the smart money" on Wall Street
Fundamental risk has been rising in recent months but remains consistent with BBB and BBB+ credit ratings
4.86% 30-year default risk (BBB+ credit rating)
The bond market agrees with analysts, management, and rating agencies that DHI's investment thesis is intact.
“The GF Score is a ranking system that has been found to be closely correlated to the long-term performances of stocks by backtesting from 2006 to 2021." - Gurufocus
GF Score takes five key aspects into consideration. They are:
DHI's near-perfect GF score of 92% confirms it's an industry leader in everything that matters.
Historical profitability is in the top 10% of peers and in recent years it's become even better.
Major Construction Companies More Profitable Than DHI (Out Of 108)
In the last year, DHI's profitability was in the top 10% of its peers.
DHI's margins are expected to remain stable or improve in the coming years, other than FCF margins which are naturally volatile and based on the company's growth cycle.
Return on capital = annual pre-tax profit/all the money it takes to run the business
Joel Greenblatt's gold standard proxy for quality and moatiness
Returns on capital are expected to remain stable at 2X its industry peers and almost 3X that of the S&P 500.
DHI's ROC has been stable for the last 30 years, confirming a wide and stable moat.
The same goes for the rest of its margins.
Basically, I trust DHI because:
One of the best balance sheets in the industry (and highest credit ratings)
One of the most experienced management teams in the industry
One of the highest quality and most profitable home builders in America
We're already seen how a massive housing shortage creates what analysts expect to be a 10 to 20-year boom time for home builders.
But what does that actually look like in a world of sky-rocketing mortgage rates?
Even if you ignore the pandemic boom, DHI's top and bottom lines are still growing at double digits.
Rating agencies consider 60% a safe payout ratio for homebuilders.
$17.5 billion in post-dividend retained earnings is enough to pay off its debt more than 4X over or buy back up to 69% of shares at current valuations.
% Of Shares (At Current Valuations)
Analysts expect management to keep increasing the buyback authorization and repurchase $2.4 billion worth of stock through 2023, or nearly 10% of shares at current valuations.
DHI began buying back stock in 2018, and management is guiding for 3% buybacks in 2022.
Currently at 27% cash-adjusted earnings yield
Each Share You Own Is Worth X Times More (Not Including Future Growth And Dividends)
If management buys back 3% of shares each year, then over the next 20 years, that's 45% of shares.
Analyst consensus is that DHI could buy back 59% of shares within 20 years
9.9% to 28.7% CAGR consensus range (five sources)
21.9% median growth consensus from all 22 analysts
How accurate are analyst forecasts?
Smoothing for outliers historical margins of error are 30% to the upside and 5% to the downside.
9% to 38% CAGR historical margin-of-error adjusted growth consensus range
70% statistical probability that DHI grows at 9% to 38% over time
Since the Great Recession ended, during the modern era, DHI has been growing faster than Amazon, at rates of 25% to 40% and yet trades at just 4X earnings.
And that torrid, Amazon-like growth rate is expected to continue for the foreseeable future and the company has the growth catalysts to back that up.
Since the Great Recession, tens of millions of investors have outside of bear markets and bubbles paid 12X to 13X earnings for DHI.
90% statistical probability that DHI's intrinsic value is within this range
Historical Fair Value Multiples (13- years)
Upside To Fair Value (NOT Including Dividends)
12-Month Average Fair Value Forward PE
To be extra conservative I estimate DHI is worth 7.5X earnings, and today it trades at 4.1X.
3.7X cash-adjusted earnings vs 10.9 13-year median
DHI is a screaming bargain any way you look at it.
Analyst Median 12-Month Price Target
Discount To Price Target (Not A Fair Value Estimate)
Upside To Price Target (Not Including Dividend)
Upside To Fair Value (Not Including Dividend)
12-Month Median Total Return Price (Including Dividend)
Discount To Total Price Target (Not A Fair Value Estimate)
Discount To Fair Value + 12-Month Dividend
Upside To Price Target ( Including Dividend)
Upside To Fair Value + Dividend
There's a 91% statistical chance that Morningstar's fair value estimate of 6.5 PE is absurdly low balling DHI's true worth.
And yet even Morningstar thinks DHI is a screaming bargain with a 59% upside to fair value.
Analysts expect 47% total returns in the next year alone and 84% would be fundamentally justified.
I don't care about 12-month forecasts, I care about whether or not the current margin of safety sufficient compensates investors for the risk profile.
Margin Of Safety For Medium-Risk 10/13 Speculative quality companies
Upside To Fair Value (Not Including Dividends)
For anyone comfortable with its risk profile, DHI is a potentially very strong buy, and here's why.
Right now DHI is in a 33% bear market.
DHI has been a very consistent market-beater over the last 29 years, with 11% to 23% average rolling returns.
From bear market bottoms returns as strong as 36% annually over the next 10 years
21X return over a decade
If DHI grows as analysts expect by 2024 it could deliver 228% total returns, or 64% annually.
Buffett-like returns from an anti-bubble blue-chip bargain hiding in plain sight
By 2027 if DHI grows as expected (16.5% CAGR) and returns to historical fair value, it could deliver 475% total returns or 38% annually.
12X the S&P 500 consensus
LT Consensus Total Return Potential
Long-Term Inflation And Risk-Adjusted Expected Returns
Years To Double Your Inflation & Risk-Adjusted Wealth
10 Year Inflation And Risk-Adjusted Return
Analysts expect DHI to beat most investment strategies on Wall Street in the long-term
DHI has delivered 35X inflation-adjusted returns since 1993, more than 4X better than the S&P 500.
15.6% CAGR since 1993 = 70X return vs S&P 50's 10% returns
What do analysts expect in the future?
7.5% CAGR Inflation-Adjusted S&P Consensus
Difference Between Inflation Adjusted DHI Consensus And S&P Consensus
(Source: DK Research Terminal, FactSet)
Morgan Stanley thinks housing is due for a secular mega boom for the next 10 to 20 years. During this time analysts think DHI could deliver potentially 17X inflation-adjusted returns.
Ratio Aristocrats/S&P
Ratio Inflation-Adjusted DHI Consensus And S&P Consensus
(Source: DK Research Terminal, FactSet)
And potentially beat the S&P 500 by about 6X over the next 15 years alone.
For anyone comfortable with its risk profile, DHI as one of the most reasonable and prudent hyper-growth deep value blue-chips you can buy today
45% discount vs. 5% market premium = 50% better valuation
130% higher long-term return potential than S&P 500 overtime
Nearly 5X better risk-adjusted expected return over the next five years
There are no risk-free companies and no company is right for everyone. You have to be comfortable with the fundamental risk profile.
Safety falls to 40% or less
Balance sheet collapses (highly unlikely, very little debt)
Decade long recession causes housing demand to collapse
Major disruption to traditional home building from modular construction
Growth outlook falls to less than 8.7% for four years
DHI's role in my portfolio is to deliver long-term 10+% returns with minimal fundamental risk
How long it takes for a company's investment thesis to break depends on the quality of the company.
Years For The Thesis To Break Entirely
100% Quality Companies (LOW and MA)
These are my personal rule of thumb for when to sell a stock if the investment thesis has broken.
DHI is highly unlikely to suffer such catastrophic declines in fundamentals.
“The most substantial risk the company faces is a downturn in the U.S. housing market. In general, housing downturns have resulted in industrywide declines in sales, gross margin contraction, and increased inventory impairment charges. The financial impact can be even more pronounced if there is a swift and significant drop in housing demand because homebuilders have less time to adjust to a revised demand outlook.
D.R. Horton builds speculative homes to compete with existing home sales and meet anticipated future housing demand. Although this tactic can be effective for maximizing returns in a healthy housing market, the timing of project cash flows can be uncertain, and speculative homes are ripe for impairment charges if the housing market quickly deteriorates." - Morningstar
Political/regulator risk (local zoning)
Market share risk (from major rivals like Pulte and Lennar)
Disruption risk (modular homes could threaten its current business model)
M&A execution risk (buying its rivals)
Talent retention risk (tightest job market in over 50 years)
Supply chain disruption risk: shortages of lumber, materials, and labor
How do we quantify, monitor, and track such a complex risk profile? By doing what big institutions do.
See the risk section of this video to get an in-depth view (and link to two reports) of how DK and big institutions measure long-term risk management by companies
S&P 1,000+ Metric Model
Morningstar Global Percentile (All 15,000 Rated Companies)
Just Capital Global Percentile (All 954 Rated US Companies)
Bottom 10th percentile in America
Medium-Risk, Below-Average Risk-Management, Stable Trend,
(Sources: MSCI, Morningstar, S&P, Just Capital, Reuters, FactSet)
Average Consensus LT Risk-Management Industry Percentile
S&P Global (SPGI) #1 Risk Management In The Master List
Good - Bordering On Very Good
DHI's risk-management consensus is in the bottom 13% of the world's highest quality companies and similar to that of such other companies as
Walmart (WMT) - dividend aristocrat
Atmos Energy (ATO) - dividend aristocrat
Franklin Electric (FELE) - dividend champion
Cintas (CTAS) - dividend aristocrat
Albemarle (ALB) - dividend aristocrat
The bottom line is that all companies have risks, and DHI is slightly below-average at managing theirs.
31 experts who collectively know this business better than anyone other than management
And the bond market for real-time fundamental risk assessments
“When the facts change, I change my mind. What do you do sir?" - John Maynard Keynes
There are no sacred cows at iREIT or Dividend Kings. Wherever the fundamentals lead we always follow. That's the essence of disciplined financial science, the math behind retiring rich and staying rich in retirement.
I know it seems odd to be recommending a homebuilder when mortgage rates are soaring.
But just remember five things.
DHI is priced at 3.7X cash-adjusted earnings, literally recessionary bear market lows (according to Bank of America)
it would take a 66% decline in earnings for the PE to rise to its historical fair value
positive earnings growth is expected through 2024 due to the massive shortage of homes
DHI has delivered over 15% long-term returns with mortgage rates in the double-digits
in the next recession mortgage rates are likely to fall back to 3% to 3.5% and everyone buying homes today will refinance
I can't tell you when the market is going to stop hating homebuilders, I don't have a crystal ball.
But here's what I can tell you.
76% quality medium-risk 10/13 speculative hyper-growth blue-chip
8-year dividend growth streak (no cuts since the Great Recession)
45% conservatively undervalued (potential very strong buy)
4.1X forward earnings vs 12 to 13X historical
3.7X cash-adjusted earnings vs 13-year median 10.9
BBB positive outlook credit rating =7.5% 30-year bankruptcy risk (Moody's and Fitch BBB+ 5%)
40th industry percentile risk management consensus = below-average
9% to 38% CAGR margin-of-error growth consensus range
5-year consensus total return potential: 28% to 49% CAGR
Base-case 5-year consensus return potential: 38% CAGR (12X S&P consensus)
Consensus 12-month total return forecast: 47% (6.0 PE, conservative)
Fundamentally Justified 12-Month Returns: 84% CAGR
5-Year Risk-Adjusted Expected Return: 26% CAGR (5X S&P 500)
If you're looking for the ultimate deep value blue-chip consider D.R. Horton.
If you're looking for one of the best Buffett-style "fat pitches" on Wall Street, consider D.R. Horton.
If you're looking for a blue-chip that's already trading at recessionary bear market levels, consider D.R. Horton.
If you're looking for a company that could deliver Buffett-like returns over the next five to 20 years (including potentially 6X in the next five years) then D.R. Horton is a great name to consider.
Basically, if you're looking to make your own luck on Wall Street, DHI might be just what you need in your diversified and prudently risk-managed portfolio.
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This article was written by
Brad Thomas is the CEO of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 6,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.
The WMR brands include: (1) The Intelligent REIT Investor (newsletter), (2) The Intelligent Dividend Investor (newsletter), (3) iREIT on Alpha (Seeking Alpha), and (4) The Dividend Kings (Seeking Alpha). Thomas is also the editor of The Forbes Real Estate Investor and the Property Chronicle North America.
Thomas has also been featured in Forbes Magazine, Kiplinger’s, US News & World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox. He is the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, 2017, 2018, and 2019 (based on page views) and has over 96,000 followers (on Seeking Alpha). Thomas is also the author of The Intelligent REIT Investor Guide (Wiley).
Disclosure: I/we have a beneficial long position in the shares of PHM, KBH, TOL, MDC, DHI either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Author's note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: written and distributed only to assist in research while providing a forum for second-level thinking.