Could D.R. Horton Deliver 10–15% Annual Returns?

Key Concepts

• Dr. Horton (DHI): A major US home builder, the largest by volume.
• Moneyball Wreck: A rating system for companies, scoring them on a 1-10 scale across various categories.
• Cyclical Industry: An industry whose performance is tied to the overall economic cycle.
• Land Inventory: Undeveloped land owned by a builder, intended for future development.
• NVR: Another large home builder, considered the "gold standard" with a differentiated business model.
• Executive Chairman: David Ald, who replaced founder Don Horton.
• CEO: Paul Romanowski.
• 38 Bagger / 53 Bagger: Refers to a stock price increase of 38 times or 53 times, including dividends, since the late 1990s.
• Trailing Earnings: Earnings per share over the past 12 months.
• Forward Expected Earnings: Earnings per share projected for the upcoming fiscal year.
• PE Ratio (Price-to-Earnings Ratio): A valuation metric comparing a company's stock price to its earnings per share.
• Value Trap: An investment that appears cheap based on valuation metrics but continues to underperform.
• Under Supplied: A market where the demand for housing exceeds the available supply.
• Resale Market: The market for existing homes being sold by current owners.
• Rental Market: The market for properties being leased out.
• Cadence Design Systems: The next company to be discussed on the Moneyball Wreck segment.

Company Strength: Dr. Horton (DHI)

• Rating: Both Jason Hall and Rick Manares gave Dr. Horton a 7 out of 10.
• Key Points:
  • Dr. Horton is the largest home builder in the US by volume, closing on nearly 85,000 new homes in the past year.
  • The company operates in 37 states.
  • Revenue streams include selling homes, providing financing, rentals, and residential lot development.
• Supporting Evidence/Details:
  • The "7" rating is given on a curve due to the inherently difficult and cyclical nature of the home building industry, which requires significant capital and involves holding land inventory for extended periods.
  • Compared to other large builders, with the exception of NVR (considered the gold standard due to its differentiated business model), Dr. Horton is considered one of the best among the top five.
• Perspective: The industry is tough, making a 7 a high score.

Management: Dr. Horton (DHI)

• Jason's Rating: 8 out of 10
• Rick's Rating: 7 out of 10
• Key Points:
  • Dr. Horton has a strong executive leadership team, evidenced by its sustained growth as the largest residential real estate developer by volume for over 40 years.
  • A past forecast of moving 90,000 to 92,000 homes in fiscal 2025 was not met, with actual closings falling short of 85,000.
• Supporting Evidence/Details:
  • Rick attributes the missed forecast partly to macro issues beyond management's control, but also notes that operating in 37 states means exposure to struggling markets.
  • David Ald, the Executive Chairman (who replaced founder Don Horton in May 2024), has been with the company since the late 1980s and was Don Horton's long-time associate.
  • Paul Romanowski, the CEO, has been with the company since the late 1990s.
  • Both Ald and Romanowski have experience navigating real estate and interest rate cycles.
  • Since the late 1990s, when both Ald and Romanowski were at the company, the stock price has increased 38 times, and with dividends, it's a 53-bagger.
  • The company has continued to outperform the market in recent years, with management deserving credit.
• Perspective: While acknowledging macro challenges, the long tenure and proven track record of the leadership team, especially in driving significant shareholder returns, are highlighted.

Financials: Dr. Horton (DHI)

• Jason's Rating: 7 out of 10
• Rick's Rating: 6 out of 10
• Key Points:
  • Dr. Horton demonstrates an ability to perform well during favorable market conditions and protect shareholders during downturns.
  • A concern for Dr. Horton and other home developers is the current stall in the resale of second-hand homes, attributed to higher mortgage rates. This situation is expected to change as the resale market recovers.
• Supporting Evidence/Details:
  • Rick's lower score reflects his concern about the current market environment and the potential impact on future performance. He rates the company's past performance as a 7 or 8 but projects a 4 or 5 for the next few years, averaging to a 6.
  • Jason's 7 is given with a curve, acknowledging the industry's cyclicality.
  • Compared to peers, Dr. Horton is at the higher end, though some operators may have better operating margins and cash flows.
  • Debt has increased, but this is offset by strong balance sheet assets, which is crucial for navigating cyclical pressures.
• Perspective: The company's financial resilience is strong, especially considering the industry's inherent volatility. However, current market conditions, particularly the stalled resale market, present a headwind.

Valuation and Future Outlook: Dr. Horton (DHI)

• Jason's Safety Score: 7 out of 10
• Jason's Expected Annualized Returns (Next 5 Years): Lower end of 10% to 15%
• Rick's Expected Return (Next 5 Years): 0% to 5%
• Rick's Safety Score: 6 out of 10
• Key Points:
  • Dr. Horton is considered relatively safe for its business type.
  • The company is expected to generate moderate annualized returns over the next five years.
  • Current valuation is around 12.5 times trailing and forward earnings.
  • Analysts anticipate flat earnings growth for the current year.
  • The housing market is generally under-supplied in areas with population and economic growth.
  • A rebound in the resale market is anticipated, which could create a larger glut of homes.
  • Dr. Horton is expected to be a survivor in a potential home builder shakeout.
• Supporting Evidence/Details:
  • Jason notes that the current PE multiple is at the lower end of its 10-year range. However, he cautions that the cyclical nature of the industry leads to a wide range of potential outcomes.
  • Future returns will be significantly influenced by the housing cycle and investor sentiment in five years.
  • For higher returns, Dr. Horton needs to execute well in opportunistic markets and reduce exposure in less promising ones.
  • Rick is more conservative, citing that most real estate developers trade at PE ratios in the low teens. He warns of a potential value trap.
  • Analysts project declining profitability in the new fiscal year, with business picking up a year from now.
  • Rick believes a larger share of a shrinking pie will still leave investors wanting more.
• Perspective: While Dr. Horton is a strong player in an under-supplied market, current economic conditions and the potential for increased competition from a recovering resale market temper expectations for significant near-term gains. The company's ability to navigate these challenges and focus on high-growth markets will be crucial.

Overall Score and Conclusion

• Overall Score: Dr. Horton received an average score of 6.6 out of 10.
• Key Takeaways:
  • Dr. Horton is a dominant force in the US home building industry, characterized by its scale and long-standing management expertise.
  • The company's financial health is robust, particularly its ability to manage debt and navigate the cyclical nature of its business.
  • While the long-term outlook for housing demand remains positive due to under-supply in growth areas, near-term challenges exist, including higher interest rates impacting the resale market and potential shifts in profitability.
  • The company's valuation is reasonable, but the cyclicality of the industry introduces a wide range of potential future outcomes.
  • Dr. Horton is well-positioned to weather industry downturns and emerge as a survivor.
• Next Up: Cadence Design Systems.