Could This Be the Next 100x Stock?

Dream Finders Homes (DFH -1.17%) is a homebuilder that is based in Jacksonville and also has a presence in several of the hottest markets in the U.S., including Orlando, Texas, and the Carolinas. It closed on 4,874 homes in 2021 and anticipates more than 7,000 in 2022.

With the real estate market cooling off, interest rates rising, and the persistent supply chain and labor issues, homebuilders have been hit hard. Dream Finders is no exception, with its stock price about 50% below its 52-week high. But if the company can execute on its unusual business model, it could be a big win for long-term investors.

There's a lot to like about Dream Finders Homes

One of the biggest differentiating factors is that Dream Finders uses a "land-light" homebuilding model. While most other homebuilders buy large tracts of land, Dream Finders buys purchase options on lots, but doesn't actually buy them until it has a home under contract and ready to build. This frees up more of Dream Finders' capital to invest in growth and pursue other opportunities.

There are a few big reasons to like Dream Finders. First, it specializes in markets that have above-average job growth, positive net migration, and relatively affordable housing costs. The company has a backlog of nearly 7,200 homes as of the end of the second quarter, so demand is strong.

Also, the U.S. has a major housing shortage. Over the past 50 years, the annual average number of housing starts has declined while the number of households has doubled. Housing inventories are near their lowest level in 20 years. And the largest group of millennials (the 27-30 age group) will be reaching their peak homebuying age in the next several years.

Note that the 100x in the headline isn't necessarily an exaggeration. Dream Finders Homes CEO Patrick Zalupski modeled the business after fellow land-light homebuilder NVR (NVR -0.22%), which has used the asset-light model along with smart capital allocation to deliver some incredible returns. In fact, since it went public in 1993, NVR has generated a staggering 41,700% return for shareholders -- that's 417x performance in less than three decades, even after the recent downturn.

What could go wrong?

Like any stock capable of big returns, Dream Finders isn't without risk. For example, its geographic concentration makes the company dependent on the health of just a handful of real estate markets. And its outsized exposure to entry-level homes could be a long-term positive, but this part of the market is highly sensitive to recessions, pricing pressure, and other headwinds.

Debt is also a major concern. With $875 million in current debt, Dream Finders has a much higher debt-to-equity ratio than most other homebuilders, as you can see in the chart below.

Data source: YCharts.

Higher reliance on debt makes Dream Finders more susceptible to downturns, and also means that its cost of capital will increase significantly if rates rise (all $875 million is current, or short-term debt). To be sure, the willingness to take on debt has allowed Dream Finders to rapidly scale its business, but it is a major risk factor.

Is Dream Finders Homes a smart investment now?

The homebuilding space is very out-of-favor right now. All of the homebuilders on the list trade for price-to-earnings multiples of 10 or less (Dream Finders has a P/E of just six). And there are clearly some excellent long-term growth opportunities due to the overall U.S. housing shortage.

To be sure, Dream Finders is probably the riskiest homebuilder stock in the chart. But it's also the one with the most growth potential if it can keep its momentum going. If you're a patient long-term investor with a relatively high risk tolerance, Dream Finders is a stock you may want to put on your radar.