We all know how hot the U.S. housing market is right now. There are only an estimated three months of housing supply and a home shortage of 5.2 million across the country. This is good news for anyone in the business of building homes, otherwise known as the homebuilders. Coupled with soaring housing prices, there is a huge economic tailwind for the housing industry that could continue over the next decade. 

The simplest way to go along with this trend is to own a large homebuilder like Lennar Corporation (NYSE:LEN). Does this housing trend make Lennar stock a buy?

Two people building a house.

Image source: Getty Images.

One of the nation's oldest homebuilders

With a history tracing back to 1954, Lennar is one of the nation's longest-running homebuilders. It has acquired many different businesses over the years, including a mortgage financing unit and many homebuilding competitors. Most recently, in 2018, it completed a large merger with CalAtlantic Homes for $5.7 billion. The combined company is the largest homebuilder in the United States. It also has delved into different businesses, including title insurance, multi-family properties, and rental complexes. Lastly, it has a portfolio of housing-related investments, like a stake in Opendoor Technologies

With the rise in home prices and quick reduction in supply over the last 18 months, Lennar's business has received a large boost. In the second quarter, which ended this May, Lennar's revenue was $6.4 billion, up 22% year-over-year, driven by a 14% increase in homes delivered and a 6% increase in average selling price to $414,000. 

Because of its scale, rising home prices, and technology improvements, Lennar has greatly improved its gross margin over the past year. In Q2, gross margin was 26.1%, up from 21.6% a year ago. What's more, Lennar has been able to reduce its operating expenses as a percentage of revenue from 8.3% last year to 7.6% this year. All of this adds up to homebuilding net margin rising to 18.5%, which shows the strong operating leverage in this business. These margin improvements should remain in place if Lennar is able to grow its revenue in line with the overall demand from potential and existing homeowners. 

A spin-off is coming

Over 90% of Lennar's revenue comes from homebuilding, but its mortgage origination business is a large portion of its profit because of its high margins. In the second quarter, Lennar's financial services segment contributed $121 million in operating earnings, and in 2020 the segment did $480 million in operating earnings. With a market cap of $30 billion, this financial services segment is a huge contributor to Lennar's business value.

Outside of residential home building and mortgage origination (which falls under financial services), management believes there is value hidden in Lennar's amalgamation of businesses and investments. To try and realize this value, it is planning on spinning off all of these non-core operations. The new entity will have an asset base of $5 billion to $6 billion. The remaining Lennar Corporation will focus solely on homebuilding and financial services, which is what management believes it does best. No more details have been released, but any investor or potential investor should be watching to see what is going to be included in this spin-off.

It doesn't come without risks

Lennar Corporation did around $2.5 billion in earnings last year and is on pace to do much more this year. Compared to its market cap of $30 billion, that gives it a fairly low price-to-earnings ratio (P/E) of 8.9 based on the last 12 months of earnings, and an estimated forward P/E of 7.1 based on the next 12 months.

With demand for housing so high, investors might think this makes Lennar a slam-dunk investment opportunity. However, a lot of economic variables can affect Lennar's growth and profitability. These include supply costs (like lumber) and interest rates. If the Federal Reserve raises interest rates in a significant manner, that will flow through to mortgages, making it more expensive to own a home. This would likely affect the demand for Lennar's products.

Over the last five years, Lennar's P/E was only above 20 for a short period of time and has historically hovered around 10. While it is now below those levels, investors shouldn't expect much multiple expansion when owning shares of this stock.

LEN PE Ratio Chart

LEN PE Ratio data by YCharts

So is it a buy?

Taking all these factors into consideration, Lennar Corporation looks like a solid bet for conservative investors with a long-term time horizon. The company has lasted for decades, is riding a strong industry tailwind, and trades at a very cheap earnings multiple. Don't expect this to be a 100 bagger, but this combination of factors makes Lennar a sensible bet vs. other US homebuilders at the moment. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.