Berkshire Hathaway's (BRK.A -0.50%) (BRK.B -0.45%) chairman and chief executive officer, Warren Buffett, has seen numerous recessions, wars, and global pandemics over his investing career spanning more than eight decades. His lifetime of investing experience and success is why it's savvy to consider being a fellow shareholder of wonderful businesses alongside the Oracle of Omaha.
Among the smaller holdings in Berkshire Hathaway's portfolio is a 4.5% stake worth nearly $500 million in the specialized home improvement retailer Floor & Decor (FND 3.27%). Let's dig deeper into why this underrated retailer could be worthy of a place in your portfolio.
A specialty market in the massive home improvement industry
When investors think of home improvement retailers, big-box retailers such as Lowe's (LOW 0.51%) and Home Depot (HD 0.72%) are typically the first to come to mind. This is arguably because they serve every market in the home improvement industry.
Floor & Decor probably doesn't come to most people's minds ahead of these two companies because its niche is hard-surface flooring. But the retailer isn't a run-of-the mill, niche business: With more than 4,000 products in its warehouse-themed stores, Floor & Decor has everything you could possibly imagine for flooring and more that you can't find at any other store.
FND Gross Profit Margin data by YCharts
Floor & Decor's well-established relationships with manufacturers and quarries also allow it to source tile, wood, and stone floors directly from these vendors. This leads to lower costs compared to its competitors, which translates into lower prices for customers and superior gross margins for the company. Floor & Decor's gross margin was most recently just under 40%, which was well above Lowe's and Home Depot.
And with just 191 warehouse stores in 36 U.S. states, the company anticipates that it will enter many more markets in the coming years. This is why Floor & Decor has a long-term objective to open 500 stores. Analysts believe that the quickly increasing store count will power 19.4% annual earnings growth over the next five years. For context, this is nearly triple the 6.7% annual earnings growth rate that is expected from the home improvement retail industry for that period.
The company's financial health is nearly flawless
Investors need not worry about whether Floor & Decor has the capital to fund its growth ambitions. That is because the company's balance sheet is quite robust.
Analysts expect the company's net debt position to be nearly $95 million. Stacked against the $660 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) that is projected for 2023, this is a net debt to EBITDA ratio of just a tad more than 0.1. Simply put, Floor & Decor's debt load is almost nonexistent compared to Home Depot's expected net debt to EBITDA ratio of 1.5 for 2023.
Tremendous compounders don't come cheap in the traditional sense
After a sizable share price decline in 2022, the market has cozied up to Floor & Decor in 2023. The stock has rocketed upward by 42% so far this year.
This has pushed Floor & Decor's forward price-to-earnings (P/E) ratio up to 33.8. While that is much higher than the home improvement retail industry average forward P/E ratio of 18, the company's vastly better growth potential and outsized total returns in recent years justify this valuation in my opinion.
