One way to find winning stocks is to search in areas of the market that have secular tailwinds. Put another way, find an important trend and identify the best businesses that are taking advantage of that trend. When it comes to housing in the United States, some long-term challenges will need to be addressed, and homebuilders are poised to solve the problem.
Not all homebuilders are equally positioned to be the winners in this market. However, there is one company I find particularly compelling, and it's on the top of my buy list for the coming year. Let's look at what makes Dream Finders Homes (DFH 2.06%) unique and why I think it could be one of the biggest winners in this market.
Solving the problem of a housing shortage
Due to a long period of under-building, the United States is facing a housing shortage. As you can see from the chart below, the U.S. had been slowly recovering from the crash in housing starts caused by the Great Financial Crisis. However, that pace has slowed over the last year or so as rising interest rates have cooled off the housing market.
US Housing Starts data by YCharts
According to the U.S. Government Accountability Office, this shortage is especially acute for affordable housing. This isn't a new problem, but it's being made worse by higher interest rates, which are keeping people in their homes longer. Considering this factor, new construction could be the most attractive way for potential homebuyers to find what they need.
Here's the first way in which Dream Finders Homes has an advantage. Not only has it been building and selling new homes at a rapid pace, but it also focuses on first- and second-time homes, keeping the prices within a more affordable range. Additionally, Dream Finders subsidizes mortgages through its lending business, helping first-time homes become more affordable. There is some risk to the business in doing this, but the company sees this as a growth driver.
The land-light model
Another advantage for Dream Finders is its land-light business model. Traditionally, homebuilders acquire large lots of land on which to build homes. This requires a large capital spend upfront for a development project that could take years to complete. As a result, it's typical for traditional homebuilders to have a lot of debt on their balance sheets due to the money borrowed for these land purchases.
Dream Finders takes a different approach. Rather than buying the land up front, Dream Finders purchases options to buy the land. Essentially they pay money up front, like a deposit, for the option to purchase the land at a later time. The risk here is that if the company chooses not to buy the land, it loses the deposit. However, the upside is that it doesn't have to hold large land positions on its balance sheet..
Rapid growth in popular locations
Dream Finders has focused its growth on areas of the U.S. that are seeing population increases, primarily Texas, Colorado, the mid-Atlantic, and the Southeast. This strategy appears to have paid off considering the rapid pace of the company's growth. Dream Finders has closed on more than 27,000 homes since its inception.
Data source: Dream Finders Homes.
Despite the rapid historical growth, investors should take note of the slowdown that has taken place in 2023. While that may look like a bad sign, there's some good news that goes along with it. First of all, when the company released its third-quarter 2023 results, it raised the guidance for 2023 home closings from 6,500 to 6,750. This demonstrates demand that is outpacing the company's initial expectations. Additionally, Dream Finders grew its new orders by 38% year over year and now has a backlog of 5,025 homes. Some slowing has to be expected, but the pipeline for the future remains strong.
The bottom line for investors
Dream Finders trades for 11 times trailing earnings. This isn't exactly cheap for a homebuilder, but it does put Dream Finders in the ballpark with some of its peers. That said, over the last three years, Dream Finders has grown its revenue by 227% and its net income by 254%, drastically outperforming those same peers. Taking that into consideration, the valuation looks more sensible.
An investment at this valuation isn't without risk. A recession or other shock to the economy could affect Dream Finders' performance, and send the stock price falling. For those sensitive to these potential risks, dollar-cost-averaging into this stock could make sense. Regardless, the long-term potential of this business has it at the top of my buy list for 2024.