Is Dream Finders Homes Stock a Buy?

Is Dream Finders Homes Stock a Buy? With many parts of the stock market taking heavy losses, some investors are looking to real estate stocks to bolster their portfolios.

 

Real estate has performed extremely well since the turn of the decade, allowing companies that build or operate properties to prosper. One such company is Dream Finders Homes (NASDAQ:DFH). 

 

Dream Finders Homes is a large builder of single-family real estate. The company builds properties ranging from entry-level to second-time move-up homes, giving it a wide variety of potential customers.

 

Dream Finders Homes operates in several large Sun Belt cities, including Dallas, Orlando, Charlotte and Jacksonville. It also does business in Denver and Washington, DC.

In Q2, Dream Finders Homes reported revenues of $791 million. This represented a remarkable gain of 118 percent over revenue from the same quarter in 2021.

 

Earnings improved by a nearly identical 119 percent, rising from $29 million in 2021 to $65 million in the most recent quarter. Per diluted share, Dream Finders Homes earned $0.60. This report beat the analyst consensus estimate by $0.08.

 

Gross margin also improved significantly over the previous year, rising from 16.5 percent to 19.7 percent. This improvement in margins is very likely tied to cooling costs for raw materials. It also reflects ongoing efforts by management to control costs.

Further positives could be found in both closing rates and the average price the company got for its homes. In Q2, the company closed on 1,649 homes, up 66 percent from the previous year. The average sale prices rose by 29 percent year-over-year to $463,447.

 

A final positive point within Dream Finders Homes’ earnings report was an increase in its cash position. Total liquidity rose 21 percent, reaching $334 million. This increase could give the company some insulation against market downturns and provide it with more capital to deploy on future development projects.

 

Dream Finders Homes competes directly or indirectly with several other home construction companies. These include M/I homes, KB Home, Tri Pointe Homes and Century Communities.

 

It should be noted, however, that not all of these construction companies operate in the same geographic areas as Dream Finders Homes.

 

The major risk for Dream Finders Homes is the possibility that the real estate market is about to cool off drastically.

 

As the Q2 earnings report demonstrates, the home builder has performed very well over the past year. That momentum, however, could grind to a halt if inflation, high prices and rising mortgage interest rates begin to suppress buying.

 

An early indication of such a trend can be found in the Q2 report itself. One of the few areas in which the company saw a contraction over 2021 was in the number of new home orders.

 

Buyers ordered 6 percent fewer homes than they had a year earlier, suggesting that demand could already be feeling the effects of macroeconomic conditions.

 

If current projections are correct, the slowdown Dream Finders Homes is currently seeing could be just the tip of the iceberg. Home sales are already 20 percent lower than they were in February, and some experts believe that mortgage originations could be cut in half by the end of 2022.

 

Such a slowdown could radically disrupt Dream Finders Homes’ winning streak and reduce both revenue and earnings.

 

A related risk is the possibility of excess inventory. With home buyers beginning to reduce their purchases, builders run the risk of having too many homes for too few buyers. This could lead to lower prices and, ultimately, lower margins.

 

Dream Finders Homes could find itself in this situation, as its controlled lot pipeline rose by 66 percent year-over-year in Q2. Investing in too many new projects could strain the company’s finances and leave it struggling to unload homes in an unfavorable market.

 

Dream Finders Homes has obviously had an excellent year, as both revenues and earnings have more than doubled. Margin improvements point to solid execution and the ability to control costs wherever possible.

 

Rising home prices have benefited the company, making it possible for it to beat analyst expectations and expand its building activities.

 

Another plus for the stock is the fact that it appears to be valued fairly. Its forward P/E currently stands at just 4.82. Its price-to-sales ratio, meanwhile, is just 0.43. Current prices likely reflect investor belief that the real estate market will cool down in the short term.

 

On the downside, though, Dream Finders Homes is subject to macroeconomic conditions over which it has no control. Just as a massive spike in demand caused the company’s meteoric success over the past year, plunging home sales would drive its revenues and earnings lower.

 

Analysts also seem to be expecting a drop in sales to weigh on the company’s stock price. Over the next 12 months, the median target price for DFH is $12, down 1.8 percent from the current price of $12.22.

 

In its Q2 commentary, management addressed these concerns by highlighting the company’s presence in high-growth metropolitan markets. While this geographic factor could certainly mitigate the effects of a slowdown, it is unlikely to insulate Dream Finders Homes from a cooling real estate market altogether.

 

Ultimately, Dream Finders Homes is likely not a buy at the moment. Despite excellent recent growth, a solid cash position and attractive pricing, the company is too exposed to the possibility of a real estate slowdown. Until the extent and nature of this slowdown is better understood, investors are likely taking too much unknown risk by buying this stock.

 

Investors who already own Dream Finders Homes, however, may want to hold their shares for the time being. The analyst estimate for earnings in Q3 is $0.66 per share, suggesting that there could still be some momentum left in the company. The home builder appears too strong to sell right now, even though buying more could be too risky.

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