In 2019, I gutted my bathroom in preparation of a remodel. But after completing the demolition, I made a last-minute change to my remodel plan. I needed a particular flooring product fast and tried sourcing it at local home-improvement retailers in vain. I then stumbled upon a Floor & Decor (FND 1.89%) about one hour away from my home and found exactly what I needed.
Investing great Peter Lynch advocated for buying what you know. And as I drove home from Floor & Decor that day, I wondered if it was publicly traded. Shortly thereafter, I discovered it was, researched the business, and purchased shares.
Floor & Decor has been a great investment for me so far. But after what the company just did, I might double down. Here's why.
Why Floor & Decor stock has beaten the market
Floor & Decor went public in 2017 and has since outperformed the market average by a wide margin.
There's a lot that goes into an investment thesis. But three things that I look for in retail businesses like Floor & Decor are unit growth (opening new locations), growth in same-store sales (comps), and profitability. Floor & Decor has all three, and that's what attracted me to it as an investment.
Here are the numbers since it went public.
| 2017 | 2018 | 2019 | 2020 | 2021 | |
|---|---|---|---|---|---|
| Unit growth | 20% | 20% | 20% | 10% | 20% |
| Comps growth | 16.6% | 9.2% | 4% | 5.5% | 27.6% |
| Net income growth | 139% | 13% | 30% | 29% | 45% |
Source: Annual SEC filings. Chart by author.
By opening new stores this fast, Floor & Decor has grown its revenue at a rapid pace. Comps growth helps increase revenue, too, but it also helps the company gain operating leverage because there are fixed costs at the store level. Lastly, retail businesses that struggle with profitability early tend to keep struggling as they scale, in my opinion. Fortunately, that's not a concern here.
These three components to the Floor & Decor thesis remain mostly intact in 2022. In the first half of the year, the company opened 14 net new warehouse stores, and comps were up 11.7%. Net income was down 3.7% to $152.8 million. But this is still solidly profitable amid a difficult inflationary environment. Therefore this minor dip isn't a major concern presently.
Why Floor & Decor could be a golden opportunity
I purchased shares of Floor & Decor in December 2019 and October 2020. Warren Buffett's Berkshire Hathaway revealed its stake in November 2021, and I was excited by this vote of confidence from the investing great. In aggregate, my stake is up 56% in value as of this writing and the largest position in my retirement portfolio. But I'm seriously considering adding even more shares here, not because of Mr. Buffett, but because of the company's long-term potential.
Backtracking slightly, another reason I watch comps with retail businesses is it signals to me whether a company should expand. If sales at existing locations go up and up, then logically there's demand for the company's large selection of flooring products and there will be demand in every new city it expands to with its stores. And on that note, Floor & Decor is on pace for its 14th consecutive year of comps growth this year.
After last year's 27.6% gain, I assumed Floor & Decor's streak would end in 2022. However, it's on pace for double-digit comps growth again this year. And this has strengthened my belief that the company has staying power and will be able to meet its long-term growth target of 500 locations, compared to just 174 at the end of the second quarter. This is why I'm considering doubling down now.
For the record, I fully intend to hold until Floor & Decor reaches this 500-location goal. Management says this should take eight to 10 more years. Therefore, my intent is to hold at least through 2030.
This is important because there are near-term challenges to overcome. Inflation is raising costs, which is hurting profits, as already noted. And the housing market might be slowing, which historically leads to underperformance for home-improvement retailers like Floor & Decor.
It could underperform in the near term. But I expect Floor & Decor's business to adjust for the impact of inflation. And I don't expect the housing market to cool off forever. Consider that in 2020, Freddie Mac estimated there was a shortage of 3.8 million homes in the U.S. That's enough to keep builders building for a long time and keep home-improvement retailers' prospects booming.
Given average sales volume per location today, Floor & Decor could be generating over $10 billion in annual revenue at scale. And given historical profit margins, the company could be earning somewhere in the ballpark of $600 million to $800 million per year. That's a lot of ammunition for rewarding shareholders with share repurchases and a possible dividend, which I fully expect it to do at scale considering other home-improvement retailers pay dividends.
Selling tile and laminate flooring might not be the flashiest business. But few companies can match Floor & Decor's execution to date. And it gives me great confidence to tie a significant piece of my financial future to this company.
