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The Best Thousand-Dollar Stock You've Never Heard Of

Tuesday, May 20, 2014 - 4:15pm

When you think of stocks priced at $1,000 or more, what names come to mind?

The well-known online travel company Priceline (Nasdaq: PCLN) (which my colleague Jody Chudley recently profiled), which is currently trading near $1,150?

How about Warren Buffett's conglomerate, Berkshire Hathaway (NYSE: BRK-A)? Class A shares are going for around $190,000 apiece.

Google (Nasdaq: GOOG) recently topped $1,200 and likely would have kept going if the firm hadn't split the stock, resulting in two lower-priced share classes.

There's another great thousand-dollar stock every investor should know about, but I'll bet few have ever heard of it -- despite a nearly $1,100 price tag and the fact that the underlying company is an industry leader envied by its rivals. It would be wise to learn as much about it as possible, though, because investing in it could just about double your money during the next five years.

The company, a highly profitable homebuilder with earnings per share (EPS) of $53.90 and operations in 14 East Coast states and Washington, D.C., mainly builds single-family homes. However, townhouses and condos account for a significant portion (30%) of revenue, which is currently $4.3 billion annually.

As analysts at investment research firm Morningstar note, one aspect of NVR Inc. (NYSE: NVR) that separates it from competitors is its a far higher return on invested capital (ROIC). This statistic, calculated by dividing invested capital into net operating profits after taxes, is a key measure of proficiency in using capital to generate returns.

An ROIC of 15% is usually considered excellent -- but NVR has delivered ROICs of 50% a year, on average, for more than a decade now, versus 10% to 12% for its publicly traded peers, according to Morningstar.

NVR is an especially proficient cash generator, too. Also for more than a decade, the firm's free cash flow as a percentage of sales has averaged 9% a year, compared with less than 5% annually for its peers, according to Morningstar. What's more, free cash flow was positive in nine of the past 10 years and averaged $341 million annually during that time.

Morningstar's analysts credit NVR's emergence as a leading profit and cash machine in large part to its unique business model in which it relies almost entirely on options contracts to obtain finished lots from land developers. These options typically give NVR the right, but not the obligation, to buy land at a predetermined price and within a particular time.

In essence, they help position NVR to get much better prices on land and take possession right when the firm is ready to build homes on it. For this sort of flexibility, NVR usually pays a nonrefundable cash deposit of up to 10% of the full purchase price of the land.

There are a couple advantages to this approach. First, NVR generates higher returns by keeping invested capital lower -- in stark contrast to most homebuilders, which usually take a capital-intensive approach. That is, they pay up front for raw land, develop it themselves, and then build on it. Since NVR's business model conserves capital, the firm is often better able to endure economic downturns and usually has ample funds for more land options and stock buybacks.

Second, NVR's options are usually structured so the firm can attempt to renegotiate purchase terms or simply walk away based on changing land values and its view of each situation's profit potential at the time it's ready to build. When it walks away, all it loses is the initial deposit.

I can see some investors potentially being turned off by NVR because it's a "housing" stock, and many people want nothing to do with anything related to real estate because of the 2008 mortgage crisis.

But before you dismiss NVR, consider that the housing market is expected to keep recovering strongly in the long term: Morningstar estimates new-home sales will climb to more than 680,000 in 2016 from 454,000 in 2013. What's more, NVR's stock came through the 2008 crisis in relatively good shape, dropping 13% that year even as the overall stock market plunged 37%.

Risks to Consider: NVR's business model requires a high degree of expertise, but rivals could eventually decide to option more of their land (right now, according to Morningstar, only 10% to 30% of the typical competitor's land is optioned). If that happens, land options might become less favorable for NVR. And although it's not a major issue now and hasn't been for years, there's always the risk of an inadequate supply of developed lots for NVR to option. This could force the firm more toward the capital-intensive approach of buying and developing raw land, which would in turn hurt its returns.

Action to Take --> With its unique and especially profitable business model, NVR is well-positioned to meet projections for EPS to rise 10% a year for the coming five years. This implies roughly 90% upside for the stock to nearly $2,100 by mid-2019, assuming a price-to-earnings (P/E) ratio in the historical range of 24. With a forward P/E of 14, the stock is a very good value now.

Editor's note: This article has been updated to include attribution.

P.S. My colleague Nathan Slaughter has been telling readers of his High-Yield Investing advisory for months about the enormous opportunity in real estate right now. And thanks to stocks like the ones mentioned above, regular investors have a chance to get in on the action. To learn more about Nathan's absolute favorite picks in real estate, which help regular investors unlock an income stream previously reserved only for America's privileged elite, you can read his special report by clicking here.

Tim Begany does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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