Author Topic: NVR - NVR Inc.  (Read 8806 times)

KJP

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Re: NVR - NVR Inc.
« Reply #20 on: March 17, 2020, 10:48:59 AM »
Is there liquidity in this name?

I ask because the underlying business fundamentals shouldn't be hurt by the virus? I would think buying a new house is nothing like buying an existing house in terms of social distancing. Also, NVR gets paid before they build.

Even if construction stops for awhile, it would just be pushing cash flows down the road. It wouldn't hurt them? Or am I thinking about this wrong?

NVR has a very robust business model. I would agree that itís a slow down and not a long term problem.

However I recommend closet evaluating their earnings and the amount of stock the company issues to calculate their real earnings. I donít believe the reported numbers are right.

What adjustments would you make to GAAP financials to account for the relatively large equity-based component of NVR's compensation structure?

Sure, good question. I will "show my work" on this one and hopefully you guys find it useful.

NVR is actually quite an easy company to do this for, because their financials are simple and their capital allocation policy even simpler (use all cash flow to buy stock - every year going way back). Over the past ten years they have reduced their shares roughly from 6 million to 3.66 million outstanding, which is nice to see. About 5% reduction per year.

However, using their filings, you can see they actually repurchased on the open market 4.3 million shares. Shockingly, that means they issued almost 2 million shares to the employees on a starting base of 6 million.

The average buyback price was about $1,235/share. Net of cash inflows from exercise, they spent just over $4 billion for the decade buying stock. What does this mean to me?

It means to me that of the $4.1 billion of reported repurchases (almost an exact match to $4 billion of net income 2010-2019), only about $2.9 billion worked for the benefit of shareholders ($1,235 buyback price x 2.35 million shares actually reduced).

So their true "owner earnings" were 70% of what was reported. Again: 100% of earnings went to buybacks, and only 70% of buybacks stuck to shareholders' ribs. It is quite literally cash out the door -- if NVR didn't issue all that stock, they could have spent $2.9 billion on buybacks and sent the other $1.2 billion to shareholders, and have the same number of shares out today.

I know this will feel crazy high for some of you, but it is the truth. They only expensed about $45 million per year through the income statement.  That is clearly not correct.

You can do whatever you like with this to adjust going forward, but I would not just dilute the shares 8%, because NVR will be issuing a lot more over the coming decade. This is simply how they run the business.

They certainly have a great business model and also create value with repurchases.

That is one way to look at it.  NVR's GAAP stock-comp numbers on the income statement are required to be ex-ante estimates of cost and I believe use Black-Scholes .  You've looked at it from an ex post perspective, which includes the actual stock price movement (and accompanying buyback prices).  Until a few weeks ago, the last ten years had seen the stock go from ~$700/share to ~$4000/share.  I believe that would handily beat a Black-Scholes estimate, thus leading to exactly the ex post result you calculate, i.e., GAAP stock comp numbers underestimate the true cost/dilution of the equity comp.

The broader point implied by your analysis is also correct:  The greater the percentage of compensation that comes from stock comp (rather than cash), the greater the percentage of potential upside current shareholders are giving up.  The flip side, of course, is that the more equity comp you use, the less current cash costs you have, which can be a very good thing in certain circumstances.  In addition, if you have a price collapse, I think you'll find that prior GAAP years might ultimately overstate actual ex post equity comp costs (rather than understate them) as previously issued options either expire worthless or at prices below the Black-Scholes estimate.
« Last Edit: March 17, 2020, 10:54:19 AM by KJP »


coc

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Re: NVR - NVR Inc.
« Reply #21 on: March 17, 2020, 11:44:33 AM »

Sure, good question. I will "show my work" on this one and hopefully you guys find it useful.

NVR is actually quite an easy company to do this for, because their financials are simple and their capital allocation policy even simpler (use all cash flow to buy stock - every year going way back). Over the past ten years they have reduced their shares roughly from 6 million to 3.66 million outstanding, which is nice to see. About 5% reduction per year.

However, using their filings, you can see they actually repurchased on the open market 4.3 million shares. Shockingly, that means they issued almost 2 million shares to the employees on a starting base of 6 million.

The average buyback price was about $1,235/share. Net of cash inflows from exercise, they spent just over $4 billion for the decade buying stock. What does this mean to me?

It means to me that of the $4.1 billion of reported repurchases (almost an exact match to $4 billion of net income 2010-2019), only about $2.9 billion worked for the benefit of shareholders ($1,235 buyback price x 2.35 million shares actually reduced).

So their true "owner earnings" were 70% of what was reported. Again: 100% of earnings went to buybacks, and only 70% of buybacks stuck to shareholders' ribs. It is quite literally cash out the door -- if NVR didn't issue all that stock, they could have spent $2.9 billion on buybacks and sent the other $1.2 billion to shareholders, and have the same number of shares out today.

I know this will feel crazy high for some of you, but it is the truth. They only expensed about $45 million per year through the income statement.  That is clearly not correct.

You can do whatever you like with this to adjust going forward, but I would not just dilute the shares 8%, because NVR will be issuing a lot more over the coming decade. This is simply how they run the business.

They certainly have a great business model and also create value with repurchases.

That is one way to look at it.  NVR's GAAP stock-comp numbers on the income statement are required to be ex-ante estimates of cost and I believe use Black-Scholes .  You've looked at it from an ex post perspective, which includes the actual stock price movement (and accompanying buyback prices).  Until a few weeks ago, the last ten years had seen the stock go from ~$700/share to ~$4000/share.  I believe that would handily beat a Black-Scholes estimate, thus leading to exactly the ex post result you calculate, i.e., GAAP stock comp numbers underestimate the true cost/dilution of the equity comp.

The broader point implied by your analysis is also correct:  The greater the percentage of compensation that comes from stock comp (rather than cash), the greater the percentage of potential upside current shareholders are giving up.  The flip side, of course, is that the more equity comp you use, the less current cash costs you have, which can be a very good thing in certain circumstances.  In addition, if you have a price collapse, I think you'll find that prior GAAP years might ultimately overstate actual ex post equity comp costs (rather than understate them) as previously issued options either expire worthless or at prices below the Black-Scholes estimate.

(Sorry, wrote another message accidentally deleted - below is what I recall!)

We agree and disagree. You are of course right that my analysis is backward looking.

However there's a big real world offset which is that if the stock price is weak and the options expire out of the money, more options are issued, at a lower price. I believe the system is set up to get money in employees' pockets, plain and simple. If options keep expiring out of the money, employees will demand compensation in another form -- that's just my experience.

So if NVR had a weak stock in that period, I believe a huge number of shares would have made it out there anyways.

One could argue I'm understating the magnitude of the problem, because if they were buying shares below intrinsic value, they were equally issuing them to employees below intrinsic value.

Given that we're talking 1.95 million shares or thereabouts, this is the difference between NVR's $880 million of earnings giving current shareholders $238/sh or $550/sh. The stock would be worth more than twice as much!

KJP

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Re: NVR - NVR Inc.
« Reply #22 on: March 17, 2020, 12:07:33 PM »

However there's a big real world offset which is that if the stock price is weak and the options expire out of the money, more options are issued, at a lower price. I believe the system is set up to get money in employees' pockets, plain and simple. If options keep expiring out of the money, employees will demand compensation in another form -- that's just my experience.

So if NVR had a weak stock in that period, I believe a huge number of shares would have made it out there anyways.


As I noted earlier in this thread, NVR issues a large number of options in four-year cycles, and then fewer options in other years.  Did management and the comp committee deviate from that cycle during the housing bust or otherwise issue "extra" options at low prices to make up for expiring worthless (or low value) options?  The stock also suffered a long, prolonged decline during the housing bust, going from ~875 in mid-2005 to the low 300's in 2009 and stayed under 850 until 2012.   Were any options recut during that period or did the employees and management take the hit?  More broadly, we have a relatively recent example of a substantial, prolonged stock decline.  What "real world" actions would you point to during that period to support your beliefs about NVR's equity compensation program?  I'm not saying you're wrong; I just don't recall such actions. 

You're plainly correct that the higher the stock price goes the more expensive prior options grants look.  But don't you want the share price to rise? 

Kaegi2011

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Re: NVR - NVR Inc.
« Reply #23 on: March 17, 2020, 12:34:08 PM »
Have been an admirer of the business for a long time, finally pulled the trigger on some today. 

Appreciate the folks highlighting the issue w/r/t the exec comp piece.  All are good points.  Thank you.

coc

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Re: NVR - NVR Inc.
« Reply #24 on: March 17, 2020, 12:47:54 PM »

However there's a big real world offset which is that if the stock price is weak and the options expire out of the money, more options are issued, at a lower price. I believe the system is set up to get money in employees' pockets, plain and simple. If options keep expiring out of the money, employees will demand compensation in another form -- that's just my experience.

So if NVR had a weak stock in that period, I believe a huge number of shares would have made it out there anyways.


As I noted earlier in this thread, NVR issues a large number of options in four-year cycles, and then fewer options in other years.  Did management and the comp committee deviate from that cycle during the housing bust or otherwise issue "extra" options at low prices to make up for expiring worthless (or low value) options?  The stock also suffered a long, prolonged decline during the housing bust, going from ~875 in mid-2005 to the low 300's in 2009 and stayed under 850 until 2012.   Were any options recut during that period or did the employees and management take the hit?  More broadly, we have a relatively recent example of a substantial, prolonged stock decline.  What "real world" actions would you point to during that period to support your beliefs about NVR's equity compensation program?  I'm not saying you're wrong; I just don't recall such actions. 

You're plainly correct that the higher the stock price goes the more expensive prior options grants look.  But don't you want the share price to rise? 

They issued 387,000 options in 2005 at $743, and then 290,000 three years later in 2008, at $515. That's my point -- they issue them regularly, and at whatever price the stock is at the time -- the stock decline means one or two years of options are forfeited, but not the new ones, which are even more valuable than the expired ones (because the price is down). The options from 2008 forward have pretty much all been in the money, as you know.

But look, the only way to actually know the value of an option is indeed in hindsight. NVR is a valuable, growing company -- it's just a lot less valuable if they issue 5% of the company in options every year. We agree that a successful company will end up having very valuable stock options -- that's exactly my point. I don't believe Black Scholes captures that at all.

As an example, in 2014 they issued a huge package (almost 700k shares, or 17-18% of the company) of 5-year options at $1,095/share. Black Scholes said they were worth $236 - a breakeven of $1,331. I don't agree with that. The company earned $200 per share in 2019 on the 2014 share count.

Here's my question: Would you rather NVR issue 150k options this year at $2,250 or pay the employees $90 million cash? Because that's about the B-S value. I sure as hell would prefer they used cash.

KJP

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Re: NVR - NVR Inc.
« Reply #25 on: March 17, 2020, 01:08:29 PM »

However there's a big real world offset which is that if the stock price is weak and the options expire out of the money, more options are issued, at a lower price. I believe the system is set up to get money in employees' pockets, plain and simple. If options keep expiring out of the money, employees will demand compensation in another form -- that's just my experience.

So if NVR had a weak stock in that period, I believe a huge number of shares would have made it out there anyways.


As I noted earlier in this thread, NVR issues a large number of options in four-year cycles, and then fewer options in other years.  Did management and the comp committee deviate from that cycle during the housing bust or otherwise issue "extra" options at low prices to make up for expiring worthless (or low value) options?  The stock also suffered a long, prolonged decline during the housing bust, going from ~875 in mid-2005 to the low 300's in 2009 and stayed under 850 until 2012.   Were any options recut during that period or did the employees and management take the hit?  More broadly, we have a relatively recent example of a substantial, prolonged stock decline.  What "real world" actions would you point to during that period to support your beliefs about NVR's equity compensation program?  I'm not saying you're wrong; I just don't recall such actions. 

You're plainly correct that the higher the stock price goes the more expensive prior options grants look.  But don't you want the share price to rise? 

They issued 387,000 options in 2005 at $743, and then 290,000 three years later in 2008, at $515. That's my point -- they issue them regularly, and at whatever price the stock is at the time -- the stock decline means one or two years of options are forfeited, but not the new ones, which are even more valuable than the expired ones (because the price is down). The options from 2008 forward have pretty much all been in the money, as you know.

But look, the only way to actually know the value of an option is indeed in hindsight. NVR is a valuable, growing company -- it's just a lot less valuable if they issue 5% of the company in options every year. We agree that a successful company will end up having very valuable stock options -- that's exactly my point. I don't believe Black Scholes captures that at all.

As an example, in 2014 they issued a huge package (almost 700k shares, or 17-18% of the company) of 5-year options at $1,095/share. Black Scholes said they were worth $236 - a breakeven of $1,331. I don't agree with that. The company earned $200 per share in 2019 on the 2014 share count.

Here's my question: Would you rather NVR issue 150k options this year at $2,250 or pay the employees $90 million cash? Because that's about the B-S value. I sure as hell would prefer they used cash.

Based on your response, I think we agree on their past practices:  Every four years they issue big grants at whatever the price is, and alot fewer shares in other years.  They don't recut old out of the money options or deviate from the four-year cycle to game the system.

There seems to be an inconsistency in your reasoning.  On the one hand, you assert that employees demand the "excess" comp from the stock option program and would get more comp if the options didn't turn out to be as valuable as initially thought.  But on the other hand, you posit a world in which the company could get the exact same operational performance if it used only cash comp at the Black-Scholes value, which you believe vastly underestimates the amount of comp employees actually receive (and by one half of your hypothesis, would extract one way or the other). 

To answer your question, if I could get it, I would prefer your hypothetical world in which the company's operational performance was exactly the same, but all comp was paid in cash.  But that's a hypothetical world.  Here's what's happened in the real world (I pulled this quickly off yahoo, so it should be split-adjusted, but might contain errors):

From January 3, 1994 - March 17, 2020:
Lennar:  $11.06/share - $34.79:  ~2x return in 26 years
Toll Brothers:  $$4.25/share - $15.75/share:  ~3x return in 26 years
NVR:  $9.63/share - $2,275/share:  ~230x return in 26 years

Are the very size of the equity comp grants a factor driving the company's culture and (out)performance?  I don't know, but why mess with what's worked?

EDIT:  By the way, I don't intend to be flippant or sarcastic with my responses.  You're right to think hard about and examine closely an equity comp program that's as large as NVR's.  I believe many managements use them to rip off shareholders.  But NVR's equity comp program appears to have actually fit the purpose of them, i.e., aligning management with the long-term interest of shareholders.  (I'm going from memory, but I believe NVR issues relatively long-term options, which may help in this regard.)
« Last Edit: March 17, 2020, 01:25:20 PM by KJP »

coc

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Re: NVR - NVR Inc.
« Reply #26 on: March 17, 2020, 01:31:37 PM »

However there's a big real world offset which is that if the stock price is weak and the options expire out of the money, more options are issued, at a lower price. I believe the system is set up to get money in employees' pockets, plain and simple. If options keep expiring out of the money, employees will demand compensation in another form -- that's just my experience.

So if NVR had a weak stock in that period, I believe a huge number of shares would have made it out there anyways.


As I noted earlier in this thread, NVR issues a large number of options in four-year cycles, and then fewer options in other years.  Did management and the comp committee deviate from that cycle during the housing bust or otherwise issue "extra" options at low prices to make up for expiring worthless (or low value) options?  The stock also suffered a long, prolonged decline during the housing bust, going from ~875 in mid-2005 to the low 300's in 2009 and stayed under 850 until 2012.   Were any options recut during that period or did the employees and management take the hit?  More broadly, we have a relatively recent example of a substantial, prolonged stock decline.  What "real world" actions would you point to during that period to support your beliefs about NVR's equity compensation program?  I'm not saying you're wrong; I just don't recall such actions. 

You're plainly correct that the higher the stock price goes the more expensive prior options grants look.  But don't you want the share price to rise? 

They issued 387,000 options in 2005 at $743, and then 290,000 three years later in 2008, at $515. That's my point -- they issue them regularly, and at whatever price the stock is at the time -- the stock decline means one or two years of options are forfeited, but not the new ones, which are even more valuable than the expired ones (because the price is down). The options from 2008 forward have pretty much all been in the money, as you know.

But look, the only way to actually know the value of an option is indeed in hindsight. NVR is a valuable, growing company -- it's just a lot less valuable if they issue 5% of the company in options every year. We agree that a successful company will end up having very valuable stock options -- that's exactly my point. I don't believe Black Scholes captures that at all.

As an example, in 2014 they issued a huge package (almost 700k shares, or 17-18% of the company) of 5-year options at $1,095/share. Black Scholes said they were worth $236 - a breakeven of $1,331. I don't agree with that. The company earned $200 per share in 2019 on the 2014 share count.

Here's my question: Would you rather NVR issue 150k options this year at $2,250 or pay the employees $90 million cash? Because that's about the B-S value. I sure as hell would prefer they used cash.

Based on your response, I think we agree on their past practices:  Every four years they issue big grants at whatever the price is, and alot fewer shares in other years.  They don't recut old out of the money options or deviate from the four-year cycle to game the system.

There seems to be an inconsistency in your reasoning.  On the one hand, you assert that employees demand the "excess" comp from the stock option program and would get more comp if the options didn't turn out to be as valuable as initially thought.  But on the other hand, you posit a world in which the company could get the exact same operational performance if it used only cash comp at the Black-Scholes value, which you believe vastly underestimates the amount of comp employees actually receive (and by one half of your hypothesis, would extract one way or the other). 

To answer your question, if I could get it, I would prefer your hypothetical world in which the company's operational performance was exactly the same, but all comp was paid in cash.  But that's a hypothetical world.  Here's what's happened in the real world (I pulled this quickly off yahoo, so it should be split-adjusted, but might contain errors):

From January 3, 1994 - March 17, 2020:
Lennar:  $11.06/share - $34.79:  ~2x return in 26 years
Toll Brothers:  $$4.25/share - $15.75/share:  ~3x return in 26 years
NVR:  $9.63/share - $2,275/share:  ~230x return in 26 years

Are the very size of the equity comp grants a factor driving the company's culture and (out)performance?  I don't know, but why mess with what's worked?

EDIT:  By the way, I don't intend to be flippant or sarcastic with my responses.  You're right to think hard and examine closely an equity comp program that's as large as NVR's.  I believe many managements use them to rip off shareholders.  But NVR's equity comp program appears to have actually fit the purpose of them, i.e., aligning management with the long-term interest of shareholders.  (I'm going from memory, but I believe NVR issues relatively long-term options, which may help in this regard.)

Fair point. On this, we disagree. If NVR had issued 1/2 or 1/3 as many options, would they have performed just as well? I think the answer is clearly yes. Tons of companies issue tons of options without achieving success -- if it was that easy, everyone in Silicon Valley would have it made. I think this is a spurious correlation.

However even if I'm wrong, my core point is not that the employees would alternatively demand some exact $$ amount in cash were it not for options - it's that NVR is a heavy, heavy issuer no matter what is going on with the stock price, and that they give away much of their value creation. And finally, that the amount given away is simply not reflected in the Black Scholes estimates. They're too low. (Buffett has commented similarly in the past, if I recall.)

You say you'd rather they give cash -- it's because you intuitively feel that the shares they are issuing are worth a lot more than the cash.

In the end, my argument is not necessarily that NVR should change (although I certainly wish they were less generous), but that their earnings are overstated. Last year alone, they spent a net $424 million on repurchases and their share count went up! All of that money went to the employees.

KJP

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Re: NVR - NVR Inc.
« Reply #27 on: March 17, 2020, 01:48:36 PM »

However even if I'm wrong, my core point is not that the employees would alternatively demand some exact $$ amount in cash were it not for options - it's that NVR is a heavy, heavy issuer no matter what is going on with the stock price, and that they give away much of their value creation. 


I take it you would prefer to give cash when the company is trading at 10x earnings and options when the company is trading at 25x earnings.  But do you think that's fair way to deal with employees?  Or is the fairer approach to do what NVR actually does -- issue the options at whatever the price is, so sometimes employees appear to get a bargain and sometimes they don't?

And finally, that the amount given away is simply not reflected in the Black Scholes estimates. They're too low. (Buffett has commented similarly in the past, if I recall.)

Yes, B/S may misprice LEAPs, particularly if a company has a lasting competitive advantage.  But I note that the ex post calculation only looks particularly expensive if shareholders also do well. 


You say you'd rather they give cash -- it's because you intuitively feel that the shares they are issuing are worth a lot more than the cash.


No, what I said was I'd rather give cash if I could get the same performance.  I don't think the performance would be the same.  Instead, I'd think you'd have performance closer to Toll Brothers and Lennar.  Alternatively, if I'd get the same performance, I'd like to give cash at 10x earnings and options at 25x, which you also seem to prefer.  But again, I don't think performance would be the same; I think you'd just alienate employees. 

At the end of the day, some people (perhaps fairly) think "2 and 20" is robbery, no matter what the performance is.  Others look only at their net gains.  The long-term returns for NVR shareholders have been great, even after management's cut.  But perhaps the future will be different.
« Last Edit: March 17, 2020, 01:54:55 PM by KJP »

coc

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Re: NVR - NVR Inc.
« Reply #28 on: March 17, 2020, 06:01:20 PM »
Weíll have to agree to disagree on this. I donít think NVR should issue options sometimes and cash sometimes as you imply. I think they should issue many fewer options and pay cash. But if youíre happy with it I canít tell you otherwise - thatís your prerogative.

I do not however hear a counter argument on the main and original point which is that their earnings are overstated if BS is undervaluing the options. I (believe) we agree on that - and think anyone evaluating NVR ought to account for it. It isnít just a hindsight observation - and it is a real uncounted cost, even if you are correct that it improves productivity.
« Last Edit: March 17, 2020, 06:02:55 PM by coc »

KJP

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Re: NVR - NVR Inc.
« Reply #29 on: March 17, 2020, 06:21:34 PM »

I do not however hear a counter argument on the main and original point which is that their earnings are overstated if BS is undervaluing the options. I (believe) we agree on that - and think anyone evaluating NVR ought to account for it. It isnít just a hindsight observation - and it is a real uncounted cost, even if you are correct that it improves productivity.

I don't agree with the statement above, but there's no sense rehashing what I've already said.  Thanks for the discussion.  It's good to hear contrary opinions, and I hope others found our dialogue useful.