Homebuilder NVR (NVR 0.45%) has quietly built an impressive track record on Wall Street, ranking among the top performing stocks over the past 30 years.
On this clip from Motley Fool Live's Industry Focus, recorded May 20, Motley Fool analyst John Rotonti explains to Industry Focus host Nick Sciple why he thinks the stock remains an enticing buy. NVR is set up well to take advantage of the housing market's cyclical nature, and Rotonti believes that will make it one of the top performing stocks of the next five years as well.
Nick Sciple: That raises the question, John. We look at the stock today, it's about 10% off its all-time highs. We've told the story about we're in a structural undersupply in the housing market. What are you looking for over the next five years? Where do you think the company can go?
John Rotonti: I think, personally, that it can be one of the best-performing stocks in the next five years. Let me tell you why. NVR was one of the best-performing stocks in the last 30 years. I'm sure you all have seen this chart here on Twitter from Charlie Bilello. It's the best performing 30 stocks over the past 30 years. It's No. 17 on this list. In its most recent proxy, it provides this chart. On a 20-year basis, this is from the proxy, total shareholder return of 3,201% was nearly three times the total shareholder return of the next highest in the peer group and nearly eight times the 409% average of the Dow Jones U.S. Home Builder Index. By far and away, the single best player by far in another galaxy. But here's the thing, Nick, in the last year, it was last on that list. Last because the industry is selling expensive properties that they've had on their balance sheet for a while, that's the game they play. NVR, despite being, you said, 10% from its all-time high has underperformed the industry over the last year. This translates into a stock price that to me makes no sense. It's trading at a 7% free cash flow yield. What I'm doing here is I'm using numbers from new constructs. These are the most rigorous, most conservative measures of free cash flow you will find, but it's trading at a 7% free cash flow yield, Nick, which is its highest. For yields, higher the better, higher the cheaper. Here's its free cash flow yield, 6.5%. 2016, it was in the fours, then it dropped down to the threes, six, five, and five, the highest it's been in five years. P/E ratio of 14 times, Nick. The market's trading at 21 times. For these numbers, here's return on invested capital: up and to the right. Here is free cash flow margin: up and to the right. Yet, it underperformed the industry in the last year, trading at a 7% free cash flow yield. That means it only has to grow revenue or organic free cash flow, whatever you want to say, 3% to generate a 10% annualized return. Really, really cheap.
Sciple: When you lay out the track record and the free cash flow yield and all those things, it's hard to argue against it. I'm going to make you do that, John. What goes wrong in the next five years, if the story doesn't play out the way you think. What did you miss? What went wrong?
Rotonti: For the stock price, it would be an industry downturn because, like I said, they are praying, Nick, for an industry downturn because that's when they shift into high gear. That's when they use their consistent profitability and free cash flow across the cycle to be able to make acquisitions or enter new markets during a downturn. That's when they plant the seed for the next decade of growth, or they buy back cheap stock to grow earnings per share and free cash flow per share. But their stock will fall with the rest of the industry. If I'm wrong and it's not one of the best performing stocks in the next five years, it's because we have a massive housing downturn. I don't think it will happen. I think we're having an elongated cycle like I said earlier in the segment, but that would be it. The next thing I can think of, they do have large market shares in markets like D.C. and Baltimore. I hate to say it. Natural disaster, extreme weather event in one of those areas, that doesn't let them build for a while. That could be something.
The last thing I'll say is NVR is all about old school. Maintaining returns on invested cap, they're actually paid on that metric. Maintaining high returns across the cycle and growing earnings per share. They're not yet seeing the importance of green building and using more green energy building products and stuff like that. There could be more millennial focus on buying from more green builders. That could be something. Yeah, I would say industry downturn or just a shift toward buying for more green builders. Now, I think NVR could naturally make that shift and start using more green building products, but it's something I would like to see them do more of.
Nick, I just want to say one last thing about NVR. Not only is its business model unique of being asset-light, not owning the land, being vertically integrated, clustering, being market share leaders in regions, not nationally, but they don't do what other businesses do when it comes to Wall Street and communicating with the Street. So they get far less coverage, Nick. There are Wall Street analysts from the biggest investment banks that cover housing, don't cover NVR. Why? They don't hold conference calls quarterly. They don't do investor days. They don't give quarterly guidance. They don't write an annual letter to shareholders as part of their 10-K, and they only report GAAP numbers. Then this differentiated business model doesn't fit neatly into the home-building industry pattern, so it's harder to cover. They don't give guidance. They don't hold conference calls. They don't hold earnings calls. So analysts can't ask them, "Hey, can you help me fill out cell C-13 of my model." They don't talk to the Street, Nick. It's a completely different mentality. Paul Saville, the CEO since 2005, he was a CFO before that. Top three executives of the company have something like 80 years combined experience in the company. So you have a CFO running a company and just doing it by the book, by the numbers, and they do it better than anybody else. Thirty-eight percent return on invested capital in the last 12 months, industry average, 10-and-a-half percent; four times the industry average.