The coronavirus pandemic has made homeowning more attractive, since people spend more time at home. As a result, housing prices are soaring, and that has the potential to benefit a wide range of companies.
In this segment from "The Five," recorded on Sept. 9, Fool.com contributors Jason Hall, Lou Whiteman, and Parkev Tatevosian highlight three stocks that could benefit from increasing home values.
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Jason Hall: The last topic should be pretty quick. I think it might be the most fun one we do today, too. Our fourth one here, so Ben Carlson, I'm a big fan of. I follow him on Twitter. I recommend to everybody else that you follow him on Twitter. Read his book, A Wealth of Common Sense. He recently gave, I think, an interesting analysis of housing prices, basically saying that maybe housing isn't as expensive as we think. He looked at it adjusted for inflation, combining that with low interest rates, thinking about the actual price to pay, looking at it as a portion of people's disposable income, all of those things. Maybe it's not as expensive as we think. He also pointed out that in a lot of other developed countries, housing prices have risen at a much, much faster rate than they have in the U.S. So I think that's an interesting point.
I don't want to argue that too much, because I think housing prices are crazy ridiculous. I'm embarrassed how much I was able to sell my house for here. I was disgusted at how much I had to pay to buy the new house that we're going to be buying. Instead of doing that, let's just talk about something our members will enjoy. What's the stock you really like that's tied to housing, Lou, that you think could be a big winner?
Lou Whiteman: So Redfin (RDFN 2.80%) is always my answer here, but that's always my answer, so I'll guess I'll be different. Redfin, I really believe the revolution comes from within. I like their method of going about it, where they're working within the traditional brokerage industry. That total addressable market is just salivating.
But that's boring. Why don't we talk about housing stock that really doesn't benefit so much from a housing boom, but I think is a great investment? NVR (NVR 2.17%). The sober guy at the party, the driver at the party. They don't do anything like homebuilders do. They don't leverage the way homebuilders do. They don't buy up land just so they can show pretty maps the way others do. They just plug along, generate amazing returns, buy back their stock, rinse, repeat. Plenty of room for expansion, since it's an East Coast portfolio. They came into a boom-and-bust industry, where they went bust, mind you, and learned from it. They found a way to make it predictable, boring, and steady. It's not the greatest stock in a boom time necessarily, but when inevitably it gets treated like a homebuilder when this cycle ends and it gets punished, look at it then, because it's a heck of a company.
Hall: Yeah, they're going to win through that. Also, they have a pretty good little mortgage business where they originate a lot of loans. They don't hold them, but they make a lot of money originating those loans. I think that's really good there, too. Parkev, what about you?
Parkev Tatevosian: Yeah, certainly. House prices are going up on a nominal basis, at least, if you just look at it that way. One stock that I think can do really well for investors is Home Depot (HD 0.95%). Management often says that accelerating home prices is the major contributor in what folks are willing to spend on their homes for improvement. So revenue exploded during the pandemic onset, but it's expected to slow down, clearly, but that's not the reason to own the stock.
What attracts me, again, is the healthy and expanding profit margins. From 2012 to 2021, Home Depot expanded its operating profit margin from 9.5% to 13.8%. That's while increasing revenue at a compound annual rate of 6.9%. And if you want to compare that with its main competitor, Lowe's (LOW 1.38%), their profit margin was 10.8%, so 300 basis points lower, in 2021. And over the last decade, Lowe's only averaged 8.5%.
So clearly, Home Depot is the superior performer, and they've been able to sustain that advantage over time. It's trading at a relatively fair 23 times price-to-earnings ratio, which is in the middle of its historical range, so it's not expensive at these levels, either.
Hall: Yeah, I'm going to share a quick chart here that just illustrates some of those numbers you were talking about. I think Lowe's is a pretty good business, but I think this really just emphasizes, Parkev, what you're talking about in terms of the economic performance. Again, this is a 10-year rolling period, consistently has had the superior operating margins while growing those margins. Then you look at the return that this company gets. They know where to put their money. They know where to invest capital to get the best returns. They're just very, very, very good at it.
I'm going to talk about another homebuilder here, Lou, and I want to talk about a boring homebuilder that largely does the things that you don't see NVR doing. It does take on leverage for the company, like a lot of the other companies in the industry -- has done more and more using land options to build out its portfolio, but it does buy a lot of land, too. But at the end of the day -- I've done it again. I have completely lost my chart. Let's see if I can find it. I may have closed it. It's very possible that I just completely closed it out.
Jason Hall: Yeah. I just closed it out. Here's the key with Meritage Homes (MTH 0.74%). What I like about this, this is a longtime Stock Advisor pick. This is a company that probably five or six years ago started pivoting to entry-level housing, the area that homebuilders were basically not building, from 2009 to pretty much 2017. There was just massive underbuild there, and now it makes them more than 80% of their construction. Done a wonderful job.
Under Steve Hilton, the founder who now has stepped down as CEO, retired as CEO, staying on as executive chairman, is pivoting to this model and focusing on it, and it's really paying off. The company's margins have steadily increased over the past five years and now it gets mid-20% margins. Some of the better margins in the industry. Gets great returns. Trades for single-digit price-to-earnings. I think it trades for seven or eight times earnings, which, for context now, might seem like crazy cheap compared to the market. Because of their business model, it's always going to trade at a discount to the broader market, but usually around 12 times earnings as a reasonable valuation. Trades for like eight times earnings; trades for less than six times forward earnings estimates. It's crazy cheap for a business that is this good.
Let me give you one more data point here that's huge to me. We could take every homebuilder in America. We could clone them one time and double our entire homebuilding capacity for three full years, and we would finally catch up with the needed inventory to meet demand. We're more than three years behind. It's gigantic. You know who that's good for, guys? Meritage Homes. [laughs] That's really good for great operator in this industry.