Musings from Buffett’s Letter

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There were many good things to think about from Warren Buffett’s letter to shareholders which came out recently. In this piece, we’d like to drill down on two subjects that Buffett highlighted.

“Warren and I hated railroad stocks for decades, but the world changed and finally the country had four huge railroads of vital importance to the American economy. We were slow to recognize the change, but better late than never.”

The railroads were affected by the economy, but when it got down to four players, the behavior of the players and the position of the largest player became very favorable to Warren Buffett and Charlie Munger. The economic “importance” created strong economics for investing.

The home building industry has changed dramatically in the aftermath of the liar loans and investment mania of 2003-2006. Hundreds of thousands of houses were built into unfavorable demographics and the failure of prices in 2007-2009 poisoned the financial system. Never let a good crisis go to waste, a political strategist once said.

Out of that debacle came the biggest housing depression since the 1930s. We only built 310,000 homes in 2010 in a 300-million-person U.S. economy. As you can see below, this was a legendary low point in home building divided by population:

Source: Advisor Perspectives as of October 31, 2022.

The low point in home builds flushed the nation of small-time/Mom and Pop builders. The second thing it did was convince the largest builders, D.R. Horton (DHI) and Lennar (LEN), that NVR’s (NVR) strategy of buying lots in the late stages of development via options was superior to leveraging their own balance sheet to develop raw land. Eliminating the leverage in downcycles takes a great deal of cyclicality out of the equation.

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