Motley Fool Hidden Gems Investing - Gimme! Gimme! Gimme! (A Half-Point Rate Cut)

Episode Date: September 19, 2024

Markets, you got what you wanted. (00:21) Bill Mann and Ricky Mulvey discuss: - The rate cut from the Federal Reserve, and what the central bank is responding to. - New rules from the SEC that aim to make markets more efficient. - Tupperware Brands filing for bankruptcy. Then, (16:50) Mary Long and Motley Fool analyst Anthony Schiavone check in on housing stocks in the first of a two-part series. Visit our sponsor: www.landroverusa.com Companies discussed: TUP, AAPL, DFH, NVR, DHI Host: Ricky Mulvey Guests: Bill Mann, Mary Long, Anthony Schiavone Engineers: Dan Boyd, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

You've got to try breakfast at A&W. You've got to try breakfast at A&W. And what better way than with the delicious Pret Organic Coffee? Starting with just one dollar, all day, every day, now until December 31st. You've got to try breakfast at A&W. At participating A&W locations in Ontario. the Tupperware party is over. The risk party just getting started. You're listening to Motley Fool Money. I'm Ricky Mulvey joined today by Bill Mann. What was it? What was it? Willie three sticks

on the mic today. Good to see you. Glad to be here. Thanks for pulling out my nickname from when I was little. Shout out to my pal, Rob Devaney. There you go. I think we need to get more like radio nicknames going. It's going to be an initiative for 2025. I was, I thought content planning was going to be easy today. I thought we're going to have a lot of fed stuff to talk about. You're not as excited to talk about the fed, but for the first time since 2020, the federal reserve, it cut interest rates, the overnight lending rate, the baseline rate at which banks borrow from, went down by half a percent to about 5%. The cut was a little higher than some market observers had expected. What's your take? Disgusted, shocked, appalled, excited,

neutral? I'm ish. So we woke up this morning and there was a headline that said, the size of the cut was hefty. That gives Wall Street the jitters. Ricky, I ask you this, does anybody actually believe this? I don't know. I think that one of the things that has kind of gone out the window is there's this belief that the Fed drives interest rates. I mean, if you ask someone, what drives interest rates? The answer is almost always the Fed. But the Fed is in a lot of ways following interest rates. They are a responsive organization. So, I know you have never been able to borrow at the Fed funds rate, the risk-free rate. I have been able to borrow at the Fed funds rate,

the risk-free rate. Mortgage rates, which is maybe the primary way in which American consumers get their exposure to debt, have been dropping in anticipation. What does it actually matter that the Fed dropped rates 25 or 50 basis points? What does it actually mean? To me, it is a signal that the risk party might be back on. Traditionally, the Fed cuts rates, or from my brief economic memory, is an emergency measure. And now it seems to be like a little treat. Things are going well, so we're going to lower rates back down. Yeah, well, sure. But the thing that drives interest rates in general, and we know this because we've lived it over the last few years, is inflation and growth. Those are the things that drive interest rates. The Fed is

simply responding to what the inflation is and what the growth rate is. So, yeah, I mean, obviously, when you have lower rates, that means that dollars earned farther years out are worth more today. I mean, that's a very logical thing. But the fact that we are so focused on a Fed meeting in which they dropped 25 or 50, notice that the debt market's barely moved. It's the stock market that responded, and it responded in ways that people wouldn't have thought of, right? Like, the size of the rate cut was hefty. That gives Wall Street jitters. Like, come on. Two days ago, we were talking about, oh, it has to be 50. Otherwise, the market is going to crash. It will be disappointing. Why isn't the debt market responding?

Because the debt market has already anticipated it. The Fed is responding to the debt market. That's what it comes down to. When we talk about a risk party, the risk party's there, and the Fed's just showing up late, and instead of wine, they've got cheer wine. I'll give you the third thing that I think the Fed may be responding to as an undercurrent. We've talked about it a little bit. This is a theory, just a theory, but it also might be national debt at this point. If you keep interest rates really high, then the amount of money the United States spends on its national debt service becomes extraordinary, especially as we continue to take out tens of trillions of dollars in debt. And so I think there's sort of this hidden third

mandate, control inflation, labor market. And then also, you kind of can't let the debt get out of hand if you keep interest rates really high for really long. And while we've had, you know, Howard Marks has talked about it in his sea change memos that these ultra low interest rates have been abnormal and not in the historic norm. So has the level of government debt. And the Fed might be responding to that for an indefinite period of time. That very well could be. There's a great investor named David Einhorn, and he once made a jelly donut metaphor when it comes to interest rates and debt. One jelly donut gives you a blast of energy and it makes you feel really good. But the second, third, and fourth jelly donuts, which I do not recommend trying, do not

have the same effect. They have the exact opposite effect. And I think that's what Howard Marks is talking about. But I mean, ultimately, when we're talking about that, you're talking about government spending, which is also not something that the Fed has a whole lot to do with. So once again, they are being responsive to market forces that already exist. I think it is, by and large, something that the media gets really excited about, because it gives us something to cheer for. And maybe that doesn't help us pick good stocks, but it sure helps the media attract eyeballs. Bill, I know you'd rather talk about this esoteric SEC rule change in a second, but there are a couple highlights from the Fed press conference from Jerome Powell that I'm

going to hit. You can respond where we can just move on. One is that we are, quote, moving toward a more neutral stance. And then the second, I think, is a fairly interesting picture of the economy, saying, quote, the upside risks to inflation have diminished and the downside risks to employment have increased. Either one of those you want to talk about? You can take one, two, both, or pass. So, this is where I come back and I talk against what I've been speaking about before. Keep in mind that the Federal Reserve has been trying to bring about inflation from about 2012. From 2012 to 2022, they were more worried about deflation than inflation. What they're saying here, and you're talking about their ability to bring either billions and billions

of dollars into the market or out of the market. They are saying here, and I think that this is exactly right, that inflation is actually the thing that they're worried about more. I think that's real. Let's move on to this change from the SEC that you probably haven't heard about. I'm talking to the listener right now, not you, Bill, because you said we wanted to do this story this morning. The SEC has a new rule that's going to allow many popular stocks to trade in half-cent increments between the bid and the ask. Right now, stocks are priced to the penny. And SEC Chair Gary Gensler's prepared remarks, he looked back on the history of spreads, which I didn't realize this. In the 1990s, we're quoted in 1 16th of a dollar and discussing how investors benefit when

these quoted spreads are tighter. A penny is not a lot of money. Isn't that enough? What's the SEC doing this for? You know, it's a penny per share, right? So in very, very infrequently, do you buy a single share. And there are billions of shares traded each day. And so, you have a bid and an ask spread, and the brokers get to capture some of that spread. The exchanges get to capture some of that spread. What's essentially happening here is that they are saying that, look, this is benefiting the brokers much more than it is helping liquidity in the market. So, we're going to lower the increments and hopefully close down those spreads just a little bit. If you trade a lot over time, that is a little bit of a form of a tax on your overall returns, and they are trying

to lower that tax. Is it meaningful to a long-term investor who is buying some shares and holding them, hopefully, for three to five-year periods? Less so. But in any case, we have talked a lot about going to and you know obviously we're at a time now in which most brokers don't have commissions but there used to be commissions that were eight bucks and 12 bucks and they went to and they went to zero in most cases and look it's your eight bucks it's your 12 bucks it is your money that's being captured by the spread so any amount of efficiency that's added to the market i think it's a good thing even if you are buying and holding for a long period of time Another rule that was announced is we'll cap rebates that exchanges pay for less liquid stocks

to encourage trading. This kind of plays into your small cap land bill. This is going from 0.3 cents per share to one-tenth of a cent per share. Thank you for picking a story with so many fractions. 0.3 to 0.1. The exchanges are not happy about this because they like their 0.3 cent rebate. What's the impact of this here? It turns out, when you're talking about 0.3 cents or 0.1 cents, that, as you noted, is not a lot of money. But if you multiply that by billions of transactions and billions of shares traded, it does add up. So, what they're talking about here is the capacity for the market structure to make payments going back to off-exchange market makers, companies like Citadel. These are ways that we're hopefully

going to shift trading volumes and make it more efficient. Ultimately, in an incredibly liquid market, we don't need an incredible amount of liquidity in the larger cap space. In the smaller cap space, it's still going to be essentially the same thing. Are there any sine curves or wave functions you'd like to briefly describe for our listenership after your discussion on fractions. I mean, I'm saying this somewhat tongue-in-cheek, but I am genuinely curious now. I'm taking the sarcastic hat off. Why are these seemingly small changes interesting to you? Well, I mean, so the SEC chairman, Gary Gensler, actually had a proposal for much more sweeping overhaul of trading, and they wanted to end payments to off-exchange market makers. And so,

this is a little bit of an agreement between the Republican and the Democratic appointed commissioners at the SEC. And they've all voted for it. So, they are viewing this as a way to bring about a much more efficient market. And, you know, again, we're not meeting at the buttonwood tree. And you go to the trading, you go to the exchange floor in Wall Street, And it's pretty much empty. Everything is being done by computers now. And so this is a way to take away a little bit of friction from the market. And I think ultimately that's going to improve price discovery. And it's also probably why the exchanges are not terribly happy about it. It means their cheddar is getting sliced into a little bit as these rebates go away and the

spreads get tighter. That's right. They want to pretend that we're still on by the buttonwood tree, and they really, really need to make liquidity in areas where they just don't. Final story of the day, Tupperware Brands, happy trails, kind of. They're having a reorganization filing for Chapter 11 bankruptcy. Bill, until this morning, I did not know that Tupperware Brands was a publicly traded stock. I think I have some in my kitchen cabinet. There's a lot of off-brand Tupperware going around as well. How did Tupperware fall so much? It was a household brand that's been around for decades and decades. Unfortunately, Tupperware has ended up in the same place that Kleenex has, where what you probably have in your house is not Tupperware

branded plastic food containers. It's Rubbermaid or it's Glad or it's something else. Tupperware did something which I think I would agree with as being a better way to go about business on some levels where they tried to protect their sales channels, the Tupperware parties. 90% of Tupperware sales still came by it through direct sales. They only opened up an Amazon storefront in 2022, like way, way too late. So they did something that was almost the opposite of what Apple has done, where Apple routinely just takes out some of its best streams of revenue. I mean, when they brought about the iPhone, that was the end of the iPod. And that was a huge business for them. In Tupperware's case, they did not want to upend their direct sales model. And it might have

worked. I don't think COVID helped them at all, but it ended up taking the company down. They didn't change with the times fast enough. And the company right now is saying it is planning, quote, no current changes to the agreements it has struck with independent sales consultants. On the other side, you have people who own Tupperware Debt. They may have a different perspective. We'll start with the non-debt holders. Mary Ann, in the Facebook group titled, I, all capital letters, LOVE Tupperware Gateway Rockers Party Sales, said, quote, in spite of the news that is being flooded over the airwaves, we are still going strong. Tupperware, we are Tupper Tough, Tupper Strong. Bill, how are you balancing these perspectives?

I think we're defining down the word tough and strong just a little bit by adding tougher to them. I think that Marianne is probably closer to right than we might think, because ultimately, when companies go bankrupt, it's not because they're unprofitable. Generally speaking, they go bankrupt because they don't have enough cash to service their debt. So, the Mariannes of the world are going to remain very, very important to these debt holders in terms of maximizing the amount of cash they're going to receive for the debts that they hold. So, yeah, I think that Marianne is probably closer to right. She is part of the solution, not the problem. But I would suspect for Mary and that she's going to be competed with

in a lot of different ways in the future. Your email inbox is about to look a little different in a couple of days. In July of 2024, we're going to talk about the debt. Lenders were purchasing Tupperware debt for $0.03 to $0.06 on the dollar. According to the bankruptcy value, they essentially bought most of the company's $800 million worth of debt for $15 to $30 million. We talked about the debt side for a little bit, but how can regular investors, how should they check in on the debt with the companies that they own to see if there's trouble coming before the debt starts selling for $0.05 on the dollar.

Yeah, you can get quoted debt. You can even do it, in a lot of cases, through your brokers. Usually, a full-service broker can give you a quote on the debt. Whenever you see debt that's trading what's called below par, which is $1, it is essentially broadcasting that the debt holders or the debt market believes that the company is impaired in some ways. Now, three to six cents, those are, I guess you would almost call them undertaker investors. Those are investors who are assuming that the equity is worthless and that they are going to be able to benefit by just simply recovering more than three cents on the face value of the debt. I was going to make a joke. We'll call it the end of a cigar. Bill

Mann, thanks for being here. Appreciate your time and your insight. Thanks, Ricky. You've got to try breakfast at A&W You've got to try breakfast at A&W And what better way than with a delicious Pret Organic Coffee Starting at just $1 all day, every day, now until December 31st You've got to try breakfast at A&W At participating A&W locations in Ontario We don't have enough new homes in America. My colleague, Mary Long, caught up with Motley

Fool analyst, Anthony Chavone, to check in on some housing stocks. Part one runs today, part two runs Monday. We're talking about a couple of different housing stocks today, but before we dive in, let's set the table for a second. We're recording this Wednesday, September 18th. We got an update to the U.S. Housing Market Index yesterday. For those that don't follow housing numbers super closely, what does the Housing Market Index measure? Yeah, the Housing Market Index, it's an index designed by the National Association of Home Builders in collaboration with Wells Fargo. And the purpose of the index is to gauge the sentiment of single-family homebuilders. The NAHB surveys homebuilders by asking several

questions related to current sales, expected sales, and traffic of prospective buyers. The index essentially measures sentiment on a scale of 0 to 100. 0 means sentiment towards homebuilding conditions are extremely low. 50 means it's normal. 100 obviously means that it's great. The index has ranged anywhere from $8 to $90 over the last century. The index currently sits at, like you said, $41 today. I would say homebuilder sentiment is generally neutral. It's good to see it moving in the right direction. With that kind of setup, we're going to talk about an actual homebuilder, a company that's playing in that space. DreamFinders Homes is a homebuilder, but it's not quite like the other homebuilders. They employ an asset-light business

model. They build homes, but they don't own any land and instead use only options contracts. How does that work exactly? Yeah. Like you said, most homebuilders typically acquire land, they put it on their balance sheet, and then develop that land before actually constructing the single-family house itself. Instead of owning and developing the land, DreamFinders typically negotiates with land developers to have the option to purchase a finished lot. How it works is, DreamFinders will pay an upfront deposit, generally around 10% to 20% of the total agreed-upon purchase price. They pay that to the land developer to develop the land. Then, DreamFinders has the right to either purchase the lot, or if macro

conditions weaken, they can also walk away from the deal, and all they lose is their deposits. By using this asset-light land option contract model, DreamFinders avoids the long capital intensive process of land development. They also mitigate risk because if the economy takes downturn, they can simply walk away from the deal without having all this land and the associated leverage that comes with it sitting on their balance sheet. That setup has worked pretty well for the company. Their stock is up over 70% since 2020. Hearing you explain this asset-light model and seeing how well it's worked for DreamFinders, why don't other homebuilders use the same strategy? Well, when you think about traditional

homebuilding, it's essentially two businesses, right? You have land development, which is a subpar capital-intensive business. And then you have homebuilding, which is a much better higher-margin business. And today, actually, a lot of the publicly-traded homebuilders have shifted their business to incorporate the asset-light land option model. So, with D.R. Horton, for example, which is the largest publicly traded homebuilder, about 75% of their land is option today. 10 years ago, that number was less than 30%. So, the land option model is much more prevalent today.

But I think what's interesting about DreamFinders and another publicly traded homebuilder called NVR is that these companies do not own any land on their balance sheet. They're all the options model, the asset-light model. whereas some of the other home builders typically have a combination of owned or optioned land. So I'm glad you mentioned NVR because in looking at DreamFinders, I came across a lot of comparisons to NVR. You mentioned that they both employ this asset-light model, so there's a similarity between the two. What is DreamFinders doing better than NVR, or what could DreamFinders learn from NVR? Well, I think DreamFinders has the potential to be a great company, but

I don't think it's even close to being the business that NVR is today. NVR is not only one of the best homebuilders out there, but it's also one of the best stocks, has been one of the best stocks to own this century. If you invested $10,000 in the NVR at the beginning of this century, you're sitting on more than $2 million today. The reasons why that is, is because NVR NVR pioneered this asset-light land option model. It's also one of the largest homebuilders, so they can procure labor and materials better than its competitors, so it has scale advantages. Their distribution and the prefabrication of parts of the home allows them to turn over inventory at an extremely high rate. They generate high returns on capital, high returns on equity.

Lastly, NVR's capital allocation has been phenomenal. Their share count is down about 70% over the past quarter century. I'm not sure DreamFinders will ever quite measure up to NVR. But the good news is, if you're a DreamFinder shareholder, I don't think it has to deliver good returns to shareholders. The market, I think, is big enough for both of them. What I think DreamFinders can improve upon is scale, which I think will come over time. But I would like to see them focus a little bit more on reducing their leverage. They have a lot more leverage than NVR. So, kind of reducing that leverage so that they can be aggressive during market downturns instead of protecting their business during market downturns.

The debt alone for DreamFinders is not necessarily a concern in and of itself, but it's when you compare it to its competitors where that debt kind of becomes maybe more of a worry. It has a debt-to-equity ratio that's about four times that of DR Horton and NVR. what would you like to see DreamFinders do to bring that down? Yeah. They have made a couple of acquisitions over the past couple of years, and that's added to their debt load. The debt for DreamFinders, it's not a problem, necessarily, until it is a problem. If you look at the home building market today, we have a massive shortage of homes. The economy is doing good for the most part. People are employed, and large home builders

are doing pretty well. But this is still a cyclical industry. So, I think if DreamFinders can focus on lowering their leverage, maybe not being so aggressive on the acquisition front, as long as the returns aren't there, and maybe repaying some of their debt, I think that could be better for the company in the long run. But what's interesting is, they actually have a lot of insider ownership, too. Their CEO owns about 65% of the stock. I think insiders in total at about 70% of the stock. That helps me sleep a little bit at night knowing that their interests are aligned with mine. They know the company better than anybody. I trust that they know the right amount of leverage that DreamFinders can use without jeopardizing the company's

financial position. CEO Patrick Zalepsky is also the founder of the company. As you said, he owns about two-thirds of DreamFinders' home. What's his deal? How central is he to the larger thesis here? Yeah. Well, I think he essentially is the thesis for DreamFinders Homes. He founded the company in 2008. The company built 27 homes in 2009, and they built more than 7,000 homes last year. He's been there through it all. He's been there when they've made acquisitions. He's been there when they went public, obviously, a couple of years ago. With this asset-light model that DreamFinders has, they generate a lot of cash in the business, and that cash has to be allocated appropriately. And he's the one who's doing that. So, he's super important to the

thesis. The company's only been public for a few years, like I said, but so far, he's done a good job. And he's only in his 40s. So, there's a good chance that he's going to be with the company for decades to come. DreamFinders is currently trading at less than 12 times forward earnings. That seems pretty compelling, especially when you line it up against competitors, fellow builders NBR, Lenar, and DR Horton. Is this a solid deal? Is this a buying opportunity for this company? What say you? Yeah. Shares are up about 50% or so in the past 12 months. But like you said, it still trades at a reasonable 12X earnings. What's interesting is, DreamFinders actually bought back a small amount of stock during the second quarter

at about $26 per share. Patrick Zalipsky prides himself on being a good capital allocator. That's repurchasing shares, going out and making acquisitions, making organic investments. To me, that's a pretty good sign that DreamFinders is a good investment at $26. It's still probably a good investment where the stock is today at $37. Even if we just look at that share repurchase they made last quarter, so far, it's been a pretty good capital allocation move with the stock now around $37. Ant, thanks so much for joining us today and talking a bit about DreamFinders Homes. Really appreciate having you on the show. Thanks for having me.

As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.