East Coast homebuilder NVR (NYSE:NVR) has long stood out from the crowd. It uses a different strategy compared to most other homebuilders. As a result, it takes less risk, and is more resistant to economic shocks. NVR stock even held up well during the financial crisis, when most other housing stocks were blown away.
Unfortunately, many traders couldn’t really do much with NVR stock due to its absurdly high share price, which currently clocks in at $2,800 each.
But there’s good news on that front. The popular brokerage firm Robinhood is rolling out fractional share trading on its app. Early access is underway, and all clients will get the ability to trade fractional shares within months. This capability will allow folks to trade as little as one-millionth of a share, all in real-time and commission-free.
As a result, a formerly prohibitively expensive stock like NVR will be in play. If you don’t have $2,800 on hand for a single share, you’ll be able to buy whatever dollar amount of NVR that you want.
It isn’t just Robinhood either. Fidelity is rolling out a similar service. Also, Charles Schwab (NASDAQ:SCHW) has said that it will be bringing similar capabilities to its platform as well. So if you want to buy smaller chunks of high-priced stocks like Alphabet (NASDAQ:GOOGL), Amazon (NASDAQ:AMZN) and NVR, that should soon be possible across many brokerages.
NVR Stock Is Worth It
Homebuilding is generally not a great business. Economics are fairly poor, and you can lose more in a bust than you make in the whole up-cycle. However, like with Nucor (NYSE:NUE) in steel and Southwest (NYSE:LUV) in airlines, it’s possible to create a different or niche business model that works even as the industry itself tends to be a poor one.
What’s NVR’s secret sauce? The firm uses options on land instead of buying it outright.
Most homebuilders buy large swaths of land with the intention of developing it in the future. This gives them huge upside in booming markets, as they can buy cheap, and then develop at ever-increasing prices as the market soars.
In a bust, however, they get stuck with land that is generating no return on capital. If the homebuilder has significant debts or short-term liabilities, they can end up insolvent, as their main asset — the raw land — is not particularly useful for anything until the economy improves.
NVR, by contrast, pays landowners a deposit of up to 10% of the value of a lot and then has the right to buy the lot at a set price for a certain amount of time. If NVR doesn’t want the land anymore, they lose their deposit, giving the landowner a significant payoff. And if conditions remain favorable, NVR exercises the lot option and proceeds toward building a home there.
In this way, NVR smooths out its returns. Admittedly, it loses upside during speculative booms. But during downturns, it can simply let its lot options expire, taking a fixed and manageable loss rather than getting stuck with thousands of acres of overvalued land and no liquidity to deal with a crisis.
NVR’s Geographic Edge
NVR comes in as one of the top five homebuilders in the U.S., generally ranking around the fourth-largest or so in any given year. While you might assume that it would be a huge company based on its size, the homebuilding market is highly fragmented. Despite being the fourth-largest builder in the country, it’s primarily focused on the East Coast. It gets more than a third of its revenues from the Washington D.C., and Baltimore markets alone.
Thus, the market isn’t saturated. In theory, NVR can continue to grow nicely for many years as it expands to more markets where it can obtain the same benefits that have made it so successful on the East Coast.
Also, notably, since NVR pays no dividend, it tends to have plenty of cash left over. It’s bought back a third of its outstanding stock over the past decade. That will cause earnings to soar even if they struggle to find good expansion markets.
What About the Virus?
NVR has a great history and a superior business model compared to other homebuilders. Yet shares are down more than 25% from their recent peak, and they hit 50% down briefly in March.
So while sentiment has improved significantly since March, NVR stock is still at a meaningful discount to pre-virus levels. For that to change, we have to answer the question: “How long will the housing market stay affected by the virus?”
Unfortunately, there’s still a ton of uncertainty there. On the one hand, record-low interest rates could cause buyers to swarm back into the market. Mortgages are dirt cheap right now. People may rush out of quarantine determined to buy a spacious house immediately so they don’t get cooped up in a small apartment again.
But the unemployment rate has already surged to 15% and seems likely to continue rising. Low interest rates won’t matter as much if a large chunk of people lose their income and no longer qualify for mortgages.
NVR Stock Verdict
With the coronavirus, we have an unprecedented situation. There’s simply no historical event that resembles what we have now. Will the economy start right back up and save the fall homebuying season? Or will the housing market be a bust into 2021?
If you’re optimistic on housing, NVR could be a buy here. At first glance, NVR seems really cheap. It’s trading at 13x trailing earnings, which is a large discount to where it has been in recent years.
Throw in its history of double-digit compounded earnings growth, and it seems like you have a bargain. But earnings may not get back to 2019 levels for quite awhile. The economy was strong last year, and is unlikely to regain that vigor anytime soon.
That said, NVR has a clever business model that makes it stand out versus its rivals. You can make a good argument for it being the best-in-breed homebuilder. With fractional share trading rolling out on many platforms in later 2020, NVR stock is one to keep on your radar. If shares slide back toward the March lows, it’d definitely be a worthwhile pick at that point.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.