Motley Fool Hidden Gems Investing - "This is the most important company on planet Earth."

Episode Date: January 13, 2022

Taiwan Semiconductor posted record profits in the 4th quarter, but that's not why John Rotonti believes the company is so important. He analyzes their commitment to invest more than $40 billion this year to increase their manufacturing capacity, as well as the latest news from homebuilders KB Home and Lennar. Plus, Deidre Woollard and Matt Argersinger discuss Sun Belt migration, remote work, and other big trends in real estate, along with some investment opportunities to consider. Stocks: KBH, LEN, TSM, AAPL, QCOM, VNQ, MAA, META, ROKU, ARE Host: Chris Hill Guests: John Rotonti, Deidre Woolard, Matt Argersinger Producer: Ricky Mulvey Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

Chris Hill. Today on Motley Fool Money, from housing to office space, we'll take a look at real estate trends and investing opportunities to go along with them. All that and more coming up right now. I'm Chris Hill, joined by Motley Fool Senior Analyst, John Rotondi. Thanks for being here. John Rotondi. Thanks for having me on the show, Chris. We've also got an update on semiconductors, but let's start with a big day in the housing industry. Shares of homebuilder KB Home up more than 12% this morning after fourth quarter profits came in solidly higher than expected. Revenue was a little light, but KB Home says that 2022

is going to be a good year. When you consider how much we've all been talking about supply chain issues, John. This kind of guidance out of KB Home, I understand why the stock is up. I consider this a beat-and-raise quarter. Like you said, revenue was a little light, but they crushed earnings and then they raised their guidance. They're expecting guidance of midpoint 30% sales growth, 30% revenue growth for 2022. They've also increased their guidance for return on equity, which is a measure of profitability. In 2021, they did 20%. They're expecting to do 26%. So, a 600 basis point improvement year over year. That's just incredible. And I think it shows the pricing power that homebuilders have right now given

the supply-demand imbalance. If we go back to microeconomics 101, almost the first day of class, you learn about how supply and demand affects price. And right now, Freddie Mac estimates we're 4 million homes short in the U.S., because we underbuilt coming out of the global financial crisis. And so, you know, I've seen estimates that we're anywhere from 4 million to actually 6 million homes short, at the same time that we're seeing a surge in demand, because millennials are now at that prime home-buying age. That on top of the fact that COVID and the pandemic has changed living patterns, and now people want to move outside of the cities. Some people want to move outside of the cities to more suburban rural areas where they have more

room and more space to work from home, play from home, exercise from home in a socially distanced way. And so, the combination of massive shortage of supply and surging demand is giving home builders pricing power. And so, we're seeing an increase in ASPs, average selling prices. And yeah, that's the story with KB Homes. And hopefully, this is a read-through for the rest of the industry that the other home builders will have a good quarter as well. We'll get to the other home builders in a second. For a brief moment there, when they were talking about their guidance, I had this crazy idea that it meant good things for people looking to buy homes. Because much like the used car market and therefore the new

car market, the home buying market has just been on fire. Anecdotally, I think we all know people out there who have tried to buy a new home, a bigger home, and have gotten priced out very quickly or ended up paying more than they probably would have in normal times. But to your point on the deficit in homes, it really does seem like, when you're talking about nationwide, four to six million homes short, are we going to see the housing market on fire like this for years to come, or does it start to cool off at some point? So, there's two views to this. I do think that we're going to see an extended upcycle, Chris, an extended upcycle, because inventory is so low, because supply is so low. But if you look

at where KB Homes is trading, it's trading at a price-to-earnings ratio of 6. That suggests that the market thinks we could be at peak earnings. So, it's an interesting enigma with the homebuilders right now. I'm of the view that we're going to see an extended upcycle for all the reasons we just discussed, the supply-demand imbalance. But the market seems to think that we are approaching a peak and that earnings could start trailing off. Because a PE of 6, that's the only explanation I can think of. Let's move to a homebuilder that is nearly 10 times the size of KB Home, and that's Lenar. no earnings report out of Lennar, but they're increasing their annual dividend by 50%.

How good are they at capital allocation? Because I can't imagine you make a move. We've seen plenty of times where the news is someone is increasing their dividend by a penny, a couple of percentage points. You got to be confident you're going to make this stick if you're going up 50% for for an annual dividend, right? This is a signal that the management team has a lot of confidence in the company's ability to generate strong and stable cash flows across the cycle so that they can sustain this dividend. No management team wants to have to reduce, suspend, or cut a dividend because that's going to crush the stock. I mean, no management team wants that. And so, yes, this is a signal that they think they're going to have really strong,

robust cash flows going forward. It is a 50% increase. It's an increase I love to see because this is a company that I actually admire a lot, Lennar. But to put it into perspective, their dividend payout ratio is very low. So, they had a lot of room to increase. Before this announcement, I think their dividend payout ratio was well less than 15%. So, meaning they're paying out less than 15% of their earnings, of their net income, as a dividend. This increase will take Lennar's dividend yield, which is different than the payout ratio. The payout ratio is the percentage of earnings that they pay out as a dividend. The yield is the dividend divided by the stock price. This will take their dividend yield from about 1% to about

1.4%. So, it is a nice boost in the dividend yield, but that dividend payout ratio is still very low. And so, actually, that indicates they have room to improve this dividend much further over time. You mentioned, I think you used the word admire with respect to Lenar. We talked previously about KB Home. D.R. Horton is a major homebuilder. What is it about Lenar and the way they run their business that makes you like them, more so than the others? If I had to put one thing on Lennar that I like more than the others, they have a division which is called LenX, or LennarX, which is basically a venture capital division, where they invest in different home-related technologies, one of which is Opendoor, the

leading iBuying company in the world. Now that Zillow has closed its iBuying business, we're left with Opendoor and Redfin. They own a minority stake, but a substantial stake in Opendoor, and then a variety of other venture-like investments as well. I like the industry as a whole because they're moving from an asset-heavy, land-heavy business model where they would own and develop the land, which required a lot of debt, to one that is much more land-light. They're owning and developing less land and focusing more on returns on invested capital and returns on equity. We saw that in KB's guidance where they're increasing their return on equity from 2021 levels by 600 basis points.

Before we move on to semiconductors, I need you to cure me of something. You referenced Zillow. When I hear the phrase iBuying, unfortunately, I think of Zillow and the debacle of Zillow. Zillow attempting to roll up their iBuying program and then cutting it back and then suspending it. It was breathtaking the speed with which they launched and shut down their iBuying program. I feel like iBuying is one of those things, my default thought should not be Zillow and its debacle was iBuying. How should investors think about iBuying either on the consumer side or just as something to watch within this industry? I don't know. I was bullish on the potential for iBuying to really transform

the home buying and selling experience from the consumer standpoint until the Zillow debacle. Now, I'm much less bullish on iBuying. One thing I'll say about Opendoor is they are a pure play iBuying company. Zillow started as something else. Zillow started as a basically advertising-driven search engine for homes. Then they tried to shift into iBuying. Maybe Opendoor will have a better go at it because that's all they do. And maybe they're just better at it. Maybe they're better managed when it comes to that, better organized when it comes to that. The thing I like about Lennar and owning a stake, which I don't have a stake in Lennar personally, but the thing I like about investing through Lennar is you get some exposure to iBuying

through their investment in Opendoor, but you're paying once again like a PE of seven or eight or something like that. Chris Hill Taiwan Semiconductor posted record profits in the fourth quarter. They also offered upbeat guidance and said they plan to spend up to $44 billion this year to increase their manufacturing capacity. For those unfamiliar with Taiwan Semiconductor, their supplier for Apple, Qualcomm, and others of that size and ilk shares up more than 5% this morning. Is it the record profits, the guidance, the commitment to investing the money, or is it some combination of all three that's pushing this stock higher? It's all three. Taiwan Semiconductor,

and I don't like to speak in superlatives, is probably the most important company on planet Earth. Wow, really? Yeah. Every electronic device in the world has something from Taiwan Semiconductor in it. They manufacture over 50% of all the world's contracted semiconductors, but they manufacture 90% of the most advanced technological chips. 90%. They're a really, really important company, especially as we get more and more digital and electronics start pushing into more and more of our daily lives. The other thing I'll say is, $44 billion in capex is probably, I'd have to check this, the most capital-intensive business on Earth. I'm not aware of another

company spending $44 billion in property plan equipment in one year. There may be a few, but I could count them on my hand, so there's not a lot. What that signifies, Chris, what that signals, $44 billion in CapEx, is that's the demand that they see for their products. They need to build this capacity in order to satisfy demand. Along with that increase in CapEx guidance for 2022, they also increased their long-term revenue guidance from 10% to 15% up to 15% to 20%. demand. That's a substantial jump. You see how important a company is when they need to invest $40-plus billion a year in capital to satisfy demand. This is a demand story. It's incredible. The world is short semiconductors, and Taiwan Semiconductor is trying to take

share and fill that demand. This seems like one of those bits of data that whether you're bullish or bearish on semiconductors and the global supply chain, you got something to work with here. Because on the bullish side, you look at them raising guidance, you speak of the demand. On the bearish side, they're investing this money, it's not going to increase capacity in the next 12 months. This is a long play and I think that for a company of this size, you want to see this type of investment. But this isn't going to dramatically move the needle on semiconductor production in 2022, is it? No, you're exactly right. Some of this CapEx is going to go towards

building next-gen chips, which they aren't even selling yet. These three nanometers and these two nanometers chips, right now, the size of the chips they're selling are in the seven nanometers and five nanometers space. A lot of this is, like you said, far out. It takes over a year and between $10 billion and $20 billion to build one of these fabs, one of these fabrication facilities. It's extremely capital-intensive. By the way, currently, Taiwan Semiconductor only has one competitor for the world's most leading-edge chips, and that's Samsung. They will soon have Intel as well. Intel says they're going to get into this space. But right now, it's a duopoly, and Taiwan Semiconductor is far and away the leader. They have 90% market

share of the world's most advanced chips. Last thing and then I'll let you go. Taiwan Semiconductor, I feel like they are akin to Nvidia in the sense that both companies are worth more than $600 billion each, but they're not nearly as well-known to consumers and even investors as other companies of that size. When you think about consumer names like Facebook, I'm sorry, meta-platforms that we're supposed to call it now. But these are enormous companies. From a stock perspective, it's had a tremendous run. Do you look at Taiwan Semiconductor as a stock people should look at right now, or is this one of those times where it's like, I don't want to say you have to have a strong stomach, but it's a little frothy right now maybe?

No, sure. If you have a long enough time horizon, which I'll define as at least five years, you're willing to hold the stock for five years, yes, I think now is a good time to look at Taiwan Semiconductor. 30 seconds, I'll just say, you mentioned NVIDIA. Taiwan Semiconductor is a platform that they allow their customers to acquire much more value than Taiwan Semiconductor keeps for itself. For example, Jenschen Wang, the CEO of NVIDIA, has a quote. There's basically air and Taiwan Semiconductor. That's how important NVIDIA sees Taiwan Semiconductor to its own business. It was a platform before Amazon Web Services was a platform. This is why I love talking to John Rattati. Thanks for being here.

Thank you, Chris. I hope I can come back soon. After an historic year for real estate investing, what can investors expect in 2022? Among other things, a sea change in commercial real estate. Deidre Woollard has more. Thanks, Chris. I'm Deidre Woollard, and I'm here with lead real estate analyst, Matt Argersinger. Matt, 2021 was a pretty strong year for real estate in the stock market, huh? It certainly was, Deidre. I mean, if you look at the Vanguard Real Estate ETF, which is a benchmark that we follow when we're looking at real estate investments, it was up over 40%. It was its best year ever, and that index has been around for about 16 years. If you

look at the National Association of REITs, which is another index, it had its second best year on record of 41%. Extraordinary year for real estate and REITs in 2021. REITs a great track record. For those listening who might not be familiar with REITs, Real Estate Investment Trusts, if you factor in 2021, they've returned on average 13.5% per year since 1972, so almost 50 years' worth of data. That outperforms the S&P 500. It was a great year for real estate in 2021, but really, real estate investing has been doing well for investors for decades. REITs were bouncing back from a pretty hard 2020 and some of the impact of COVID-19. Yeah, it's fair to point that out. I think

2020 was a difficult year for real estate. It was one of those sectors that was more acutely affected than other industries, just because if you think about retail, real estate, hotels, hospitality, office is one that's still suffering from the effects of the pandemic. So 2020 was a very, very difficult year. REITs were down in the high single digits on average that year. So I expected, I think, as you did, that 2021 was going to be better, and it certainly was. I don't think we thought it was going to be this good or historically good as it was, though. Exactly. Well, let's talk about some of those trends that we're most interested in. The first one, I feel like, is one that's both pandemic-driven, but also was already in process

for years before that, and that's Sunbelt migration. People moving to Texas, Florida. Redfin came out with their hottest neighborhoods recently. I think most of them were in Florida. A lot of really interesting activity happening in the Sunbelt right now. Yeah, that's right. I mean, as you said, this was happening before the pandemic. We saw all kinds of trends, population. If you look at U-Haul data, which is a cool data set that you and I look at now and then, it was all heading down toward the Sunbelt markets, the southeast, the southwest, away

from the coasts. And what the pandemic did is it really just accelerated that trend. Suddenly, you had a lot of workers who were used to living in sort of the big coastal gateway markets. your San Francisco's, Los Angeles's, your New York's, your Boston's. All of a sudden, they had a lot more flexibility with their job and they can work remotely wherever they thought would be best for them. That meant looking for, in a lot of cases, cheaper places in the South Southwest or in the inner parts of the country, or just places that they'd have a

better life. They prefer to live and still be a productive employee. Those trends really took off with the pandemic, they have not ceased, and we continue to see this big population swell down to those other markets. What you're also seeing in a lot of those places is there's just not enough houses. There are not enough houses at all in the country to meet the demand out there, but especially in those markets, those hot demand markets. You mentioned Florida and Texas. If you look at places like Austin, Texas, Houston, Dallas, Fort Worth, or if you go to Florida and you look at Miami or Tampa, there's just so much demand for housing. There's not a lot of it. there's a demand for apartments, so you're seeing home prices go up, you're seeing apartment rent

surge. Unfortunately, development is just not going to be able to meet that kind of demand. You're going to see, I think, again, rising home prices, rising rents, especially in those markets. So, cheaper rents, hopefully bigger apartments, warm weather. If investors were looking to bet on some of those trends, what's one idea they could take a look at? Well, I think one idea that comes to mind is Mid-America Apartment Communities, tickers MAA. It's the biggest owner-operator of apartments in the country, actually, but they have so much exposure, about 90% of their assets are in the, quote, Sunbelt region. That's where they've been focused for decades now. As the largest apartment owner

and operator in those markets, I think they've been a huge beneficiary of this demand. Their occupancy rates are at record. Rents in a lot of their markets are up double digits, if not even 20% more in a lot of places. I think that's going to continue. Mid-American apartment communities, it's had a nice run as a stock, but I could see more upside as this trend plays out. Now, our last trend I feel like is pretty much COVID-driven, and that's the impact of remote work on the office real estate sector. A lot of companies were planning to have people come back in January, that's been pushed back. Some companies have just given up on announcing deadlines of return at all. Yet at the same time, I've seen a flurry of big office leases from

companies like Meta, Roku, in markets like New York and Los Angeles. What's going on here? It is the most confusing part of the real estate market for a lot of reasons. As you pointed out, teacher, we know what the pandemic has done with the work from home and hybrid work schedules and what that means for office occupancy, which is so low right now. Yet, a lot of these technology companies out there and life science companies out there are leasing office space at record paces. And maybe that's not surprising. But I think if we step back and look at the office market, I really do think that we've passed peak office, so to speak. I mean, no matter where you look, what surveys you read or which economists you read, the prevailing thought is that companies

are going to lease less office space today and in the future than they did prior to the pandemic. It's a real major sea change for the industry. I don't think we understand the full implications of this, but the real short-term implication is that we have too much office square footage in this country. A lot of it needs to be transitioned to probably apartments, as you're seeing in certain cities, or maybe even to hospitality, or maybe that office just gets converted to co-working spaces. It's not necessarily a dedicated corporate office or corporate headquarters anymore. It's a place where employees come to collaborate on maybe not an off-routine basis. That's the state of office right now. Now, there are parts of the office market that I think can

do well. Technology, R&D, life science, medical offices. We're actually in a position after the pandemic to actually need more of that office. There are parts of the office market that I think think are going to work. Again, co-working is probably going to do well, medical office, flex spaces. But the traditional office building, I think, is going to probably become a thing of the past, believe it or not. Well, you can't do your medical research at home, and that's one of the reasons that you and I are both excited about life sciences and the growth in that sector. I know that you and I both have a favorite in this category. Let's talk about it. Sure. Well, my favorite has always been

for a long time, and that's Alexandria Real Estate Equities, ticker ARE. It's the leading real estate REIT for life sciences and technology. They really cater to, if you think about companies like Moderna or Pfizer, who led the vaccine front, or companies like Facebook that are doing all kinds of innovations, I'm sorry, Meta, I keep calling it Facebook, Google. These are the companies that really lease from Alexandria Real Estate. We see that demand has not fallen off. Alexandria Real Estate's occupancy has never been higher. It had no problem collecting rents throughout the entire crisis, which is such a departure from other office REITs, which did suffer. I love it. It's got a founder-led management team. They've

been outperforming the market for decades now at this point. Even though the stock has had a really nice run, it's a little bit expensive, maybe from just some valuation points of view, but it's one that I like very much. It's really taking advantage of this trend towards life science office. Absolutely. Yeah, they had a recent big deal with Moderna in Cambridge, Massachusetts. They're really focused in all of the markets where life science is booming. That's right. You mentioned Moderna there. I think it's a 500,000 square foot new headquarters building in Cambridge, and it's going to be owned and operated by Alexandria Real Estate. Love it. Well, always a pleasure to

talk real estate with you. Thanks, Matt. Thanks, Deidre. for today, but coming up tomorrow, earnings season officially kicks off with financials. Jason Moser and Maria Gallagher will be here to break it all down. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow. Thank you.