boFool Community member AtlantaDon recently put together a series of posts describing his analysis of homebuilding giant NVR
While Wall Street and the investing world both fete NVR for its ability to generate cash flow, Don looked at something that ought to be of more importance to shareholders than it is: How much of that cash is used for the benefit of shareholders, and how much is eaten up in what Jack Bogle of Vanguard euphemistically calls "Management Capitalism." (Tom Jacobs picked up on this tendency at NVR in last year.)
Here -- excerpted and edited for style and clarity -- are Don's takes on NVR:
You could think of NVR as having two businesses: one is their primary business of homebuilding (and mortgages), which appears to be profitable, and the other is a trading operation in NVR stock, which is unprofitable. Think of it as if Goldman Sachs
(NYSE:GS)or Merrill Lynch (NYSE:MER)was doing it. NVR consistently sells low and buys high.
In my opinion, it is simply a wealth transfer from outside shareholders to the insiders, who are sucking virtually all of the economic value out of the enterprise. Insiders have bought 1,000 shares and sold 527,000 shares in the last six months; keep in mind that these are shares that closed today at $459.55; 527,000 shares represents a fair amount of money.
If the value of a company is the free cash flow that can be taken out of it over its lifetime discounted to a present value, and the bulk of the cash flow is devoted to buying back stock that doesn't reduce the number of shares outstanding, NVR is generating very little free cash flow that will ever be available to outside shareholders. They generate hundreds of millions of dollars in cash each year, but at the end of the year it's gone (conveniently bypassing the income statement) and the cash wasn't invested in anything that will generate future cash; in some years, there may be fewer shares outstanding but when you look at the overhang from previously issued options and new options (none in 2002, but 9.4% of shares outstanding in 2001), the lower share count will not last unless the stock price collapses because they can't generate enough cash to buy all the shares back at $400+ to cover future option exercises.
And to whom do NVR executives sell a lot of those shares? They sell primarily to the company, which constantly buys back shares to jack up its EPS numbers (that don't include the cost of stock options). Basic shares outstanding at the end of 2002 versus 2001 declined by 11,444; at $450 per share, it would take $5,149,800 to buy those shares back. NVR's cash flow statement shows that it spent $362,399,000 on share repurchases during 2002. So about 98% of that cash outlay was to offset dilution from options.
To put it another way, NVR sells shares to executives -- for less than $10 in some cases -- then buys them back in the open market for over $400.
You can look at a number of technology companies -- Dell
(NASDAQ:DELL), Intel (NASDAQ:INTC), and now Cisco (NASDAQ:CSCO), which has started to buy back shares -- and see the same dynamic, though generally not to NVR's extreme.
I have nothing to add, except to say that this argument once again shows the absurdity of not expensing stock options. For more on NVR, join in the conversation on our NVR discussion board (free trial required).