As earnings season draws to a close, I've been spending quite a bit of time looking through regulatory filings from notable investment funds. The Securities and Exchange Commission (SEC) requires large institutional investors to file a form called a 13F on a quarterly basis. This form shows what positions the fund is holding. This can be insightful, as it demonstrates what stocks notable capital allocators are buying and selling.
Analyzing the 13F of Warren Buffett's Berkshire Hathaway can be a good way to understand where the Oracle of Omaha is placing his money. While looking at Buffett's most recent 13F, I stumbled upon something interesting: Three new positions in his portfolio include homebuilding companies D.R. Horton (DHI +4.28%), Lennar (LEN +4.49%), and NVR (NVR +4.50%).
Why would Buffett take positions in homebuilders during a time of high inflation and rising interest rates? There are reasons why these three stocks may have caught Buffett's eye, and why they could be flying under the radar. Looking at historical valuation metrics may also provide some insight on why now may be a good opportunity to buy these stocks before the next bull market.
A view of the housing market
According to data from the Federal Reserve, the average rate for a 30-year fixed mortgage in the U.S. currently sits at around 7%. To put this into perspective, the U.S. has not seen mortgage rates this high since the early 2000s. With such high mortgage rates, investors may be wondering what the effect is on the broader housing market.
According to the Federal Housing Finance Agency, the price of housing in the U.S. increased 3% year over year between the second quarter of 2022 and the same period this year. Additionally, housing prices rose 1.7% between the first and second quarters of this year.
Given the increase in home prices, coupled with the highest mortgage rates in nearly two decades, investors should not be surprised that home ownership is becoming less affordable.
Image source: Getty Images.
Embrace Buffett's investing style
If you want to learn more about Buffett's investment strategy, I highly recommend reading this outline. When it comes to his philosophy, I'd like to focus on two points.
Buffett is known for not following the mainstream; instead, he spends a lot of time searching for overlooked opportunities. He also employs a long-term time horizon. In other words, Buffett didn't amass his fortune by day trading and profiting on speculative stocks. Rather, he identified undervalued stocks that the market came to appreciate over time.
Buying shares of homebuilders despite turbulent housing market dynamics is a contrarian thing to do. But sophisticated investors do not buy a stock just because everyone else is down on it. In order for contrarian investments to work out, the underlying thesis also needs to be correct.
Let's look at why these homebuilders may have appealed to Buffett by exploring some macro details around the housing market and valuation parameters for these stocks in particular.
Take a look at the valuation
D.R. Horton, Lennar, and NVR have the three largest market caps of any publicly traded homebuilders. If you go by revenue, they're three of the top four. So it makes sense that if Buffett wanted to invest in the future of the housing market, he'd start here.
When it comes to valuation, the chart below shows a five-year history of the price-to-earnings (P/E) ratios for D.R. Horton, Lennar, and NVR. As you can see, each stock is trading well off its five-year-high P/E multiple.
DHI PE Ratio data by YCharts
While no investor, including Buffett, has a crystal ball, it doesn't take too much to make an educated guess on what's going on here. In July, the federal funds rate was increased for the 11th time since March 2022. While there is still work to do to achieve the Federal Reserve's target inflation of 2%, investors should take a page out of Buffett's book and begin to think more long-term.
Eventually the Fed will taper interest rates. Another way of saying this is that rates will not go up in a linear fashion forever. It's this notion that has me thinking Buffett's homebuilder purchases were a savvy move. Home ownership should become more achievable as rates begin to fall. As the cost of borrowing gets lower, the average buyer should not be required to allocate as much of their income to a down payment or a monthly mortgage.
Should this be the case, I suspect that an influx of buyers will enter the market, thereby sparking more demand. It's this equation that could ultimately serve as a catalyst for homebuilding companies -- and we could have a bull market in housing and stocks at the same time. With D.R. Horton, Lennar, and NVR trading at reduced valuations, Buffett may have just unlocked his next profit generator.
