Motley Fool Money - 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

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is over, the risk party just getting started. You're listening to Motley Full Money. I'm Ricky Maldi, 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 of percent to about 5 percent. 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, you've asked someone, what drives interest rates? The answer is almost always the Fed. But the Fed is in a lot of ways following interest rates. Like, 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 never 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's, 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, you know, 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, like two days ago, we were talking about, oh, it has to be 50. Otherwise, the market is going to crash. It will be point. Why isn't the debt market responding? Because the debt market is 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 is 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 Marx has talked about it in his C-change memos that these, 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, when it comes to interest rates and debt. Like, 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 Marx 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 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. And so

what they're saying here. And you're talking about, you're talking about their ability to bring either billions and billions of dollars into the market or out of the market. And so they are saying here, and I think that this is exactly right, that inflation is actually the thing that they're worried about more. And 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 in SEC Chair Gary Gensler's prepared remarks. He looked back on the history of spreads, which I didn't

realize this in the 1990s were quoted in 116th 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 a 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 are saying that, look, this is benefiting the brokers much more than it is, 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, you know, in any case, you know, 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 twelve 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, if you're 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 will 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 1 tenth of a cent per share. Thank you for picking a story with so many fractions. Point three to point one. 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. Because ultimately, in an incredibly liquid market, we don't need that, you know, we don't need an incredible amount of liquidity in the larger cap space. And in the smaller cap space, it's still going to be essentially the same thing. Are there any like sign curves or wave functions you'd like to briefly describe for our listenership after

after your discussion on fractions. I mean, I'm saying this, it's 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 a, you know, a, 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 at the, you know, at, uh, 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 means their cheddar is getting a little bit of a, 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 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 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 rubber made 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 is 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 tougher, tough, tougher 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 Marianns 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 Ann 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 days. In July of 2024, we're going to talk about the debt. Lenders were purchasing Tupperware debt for three to six cents 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, you know, 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 five cents on the dollar? Yeah, you can get, you can get quoted debt. You can even, you can even do it in a lot of cases through your brokers. Usually a full service broker can can give you a quote on the debt. Whenever you see debt that's trading what's called below par, which is a dollar, 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. If you're early in your career and looking for insight, inspiration, and honest advice,

listen to the Capital Ideas podcast hear from Capital Group professionals about leaning into the differences that make you unique, making decisions that last, and what it means to lead with purpose. The Capital Ideas podcast from Capital Group, available wherever you listen, published by Capital Client Group, Inc. We don't have enough new homes in America. My colleague Mary Long caught up with Motleyful analyst Anthony Chavone to check in on some housing stocks.

Part one runs today. Part two runs Monday. We're talking about a couple different housing stocks today, but before we dive in, let's set the table for a second. We're recording this Wednesday, September 18. 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 home builders. So the NHB surveys homebuilders by asking

several questions related to current sales, expected sales, and traffic of prospective buyers. And so the index essentially measures sentiment on a scale of 0 to 100. So zero means sentiment towards homebuilding conditions are extremely low. 50 means it's normal. And then 100 obviously means that it's great. The index has ranged anywhere from 8 to 90 of the last this century. And the index currently sits at, like you said, 41 today. So I would say homebuilder sentiment is generally neutral.

And it's good to see it moving in the right direction. And so with that kind of setup, we'll, we're going to talk about an actual home builder, a company that's playing in that space. DreamFinder's Homes is a home builder, but it's not quite like the other home builders. They employ an asset light business model, so 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 home builders 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. So 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 lots or if macro conditions weaken, they can also walk away from the deal. and all they lose is their deposits. So by using this kind of asset-light land-option contract model, DreamFunders avoids the long capital-intensive process of land development.

And 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. But, like, 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-treated homebuilders have actually shifted their business to incorporate the asset light land option model. So, with D.R. Horton, for example, which is the largest publicly traded home builder, about 75% of their land is optioned 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 home builder called NVR is that these companies do not own any land

on the balance sheet. They're all the options model, the asset light model. Whereas some of the other homebuilders typically have a combination of owned or option 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 even close to being the business that NVR is today. NVR is not only one of the best home builders out there, but it's also one of the best stocks, has been one of the best stocks

that 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. And the reasons why that is is because 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 competitor. so it has scale advantages. And their distribution and the prefabrication of parts of the home allows them to turn over inventory at an extremely high rate. So they generate high returns on capital, high returns on equity.

And then lastly, NVR's, their capital allocation has been phenomenal. Their share count is down about 70% over the past quarter century. So I'm not sure Dreamfinders will ever quite measure up to NVR. But the good news is, if you're a Dreamfighter shareholder, I don't think it has to to deliver good returns to shareholders. The market, I think, is big enough for both of them. What I think Dreamfighters 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 MVR.

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 kind of bring that down? Yeah. So they have made a couple of acquisitions of the past couple of years, and that's added to their debt load. And the debt for Dreamfinders, it's not a problem necessarily until it is a problem. If you look at the homebuilding 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 Dreamfighters 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 own about 70% of the stock. So that helps me sleep a little bit at night knowing that their interests are aligned with mine. And they know the company better than anybody. So I trust that they know the right amount of leverage that Dreamfinders can use without jeopardizing the company's financial position. CEO Patrick Zolepsky is also the founder of the company, and as you said, he owns about two-thirds of DreamFinder's home. So what's his deal? How central is he to the larger thesis here?

Yeah, well, I think he essentially is the thesis for DreamFinder's homes. He founded the company in 2008. The company built 27 homes in 2009, and they built more than 7,000 homes last year. And he's been there through it all. He's been there with, they've made acquisitions. He's been there when I went public, obviously, a couple years ago. And 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, Linar, NDR Horton. Is this a solid deal? Is this a buying opportunity for this company? What say you? Yeah, I mean, shares are up about 50% or so in the past 12 months, but like you said, it still trades at a reasonable 12 times earnings. What's interesting is Dreamfinders actually bought back a small amount of stock during the second quarter at about $26 per share. And Patrick Zalipsky, he prides himself on being a good capital allocator. So that's repurching shares, going out, making acquisitions, making organic

investments. So to me, that's a pretty good sign that DreamFinders is a good investment at 26. And it's still probably a good investment where the stock is today at 37. So 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. And thanks so much for joining us today and talking a bit about DreamFinder's 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. 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 Mulby. Thanks for listening. We'll be back tomorrow.