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No. of Recommendations: 20
Sorry about that--I don't know why it didn't wrap.

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Although I have a hard time reconciling what I hear and what I think I know about the housing market with Mike's price data, e.g.,

http://invest.kleinnet.com/bmw1/special/HMW.html

...I think there are serious issues that won't be resolved for awhile. Here's a bedtime story about what has me really concerned:

I currently rent my house for the first time ever. In the past, although I move about every three years, I've done "OK" on buying and selling houses (I've never really lost money, although it's hard to say whether I'd have been better off renting. I do know I'd have been wise to keep some of the houses I've had in the past but didn't; and a few times I've made quite a bit of money even after only a couple of years). But right now I'm renting, and here's why--

I currently have a 5-year lease (with a military clause that allows me to get out of it when I need to move) on a really nice Nor Cal house that's "worth" $950,000. My rent?

$1650/month.

Think about that. If I were to put 10% down on this house with a 30-year fixed mortgage, my payment would be about $5800 at %7.25, and that's pre everything. That makes no sense at all.

Now, although the house I live in would be on the market (forever!) at $950K, in my Midwestern mind it's really only worth about $275,000. Well, lo and behold, that takes the payment down to about what I'm currently paying in rent! Amazing!

Now, here's a sweeping generalization for you, and it gets to the real heart of "my" approach to the BMW Method, and why I'm so interested in dividends, EPS, and the history of a company's valuation.

We can talk all we want about "intrinsic value," but in my opinion the intrinsic value of the house I live in is the rent I'm paying its owner. Period. Dot.

The same is true of a company. The intrinsic value of a company is equal to what it is willing and able to pay me as a dividend. Now, I might be amiable to suspending the receipt of a dividend today in order to get a larger dividend tomorrow, and so therefore I'm willing perhaps to accept a lower yield on a growing company than on a "stalwart" firm. And certainly, for this reason, EPS is intertwined with the overall dividend picture in that the EPS trend has to support the dividend trend or else the dividend trend going forward is in doubt (for one thing, I expect my dividend to grow and in order to do that the EPS must grow in order to fund Cap Ex). But a company's intrinsic value is what it can pay its owner--"me." Period. Dot. So back to housing.

Mike's chart for the western US shows a 6.8% average CAGR for housing prices. Just as a stock's price, dividend and EPS CAGRs are all roughly equal over time, since housing price growth rates must reflect the underlying intrinsic value of those houses, i.e., their rent, the house I live in won't really be worth what it's "worth" today until the rent supports the price.

Now, I think I have a smokin' deal on my rent. So let's say it should really be about $2200 (which is about what I'd actually be willing to pay--but don't tell my landlord). At a 6.8% CAGR, it'll take the rental market 15 years for the rent to catch up to the price. In reality, I think we'll see a combination of lower prices and, as the market flushes out, higher rents. But it the rent were to instantly jump to, say, $2500 against a sales price of $760,000 (I haven't heard anyone suggest that prices could come down this much--20%), it would still take 9 years to even out.

Is it inconceivable that housing today is roughly identical to WMT 7 years ago? I really think that it probably is. And isn't WMT a great analogy for the housing market? The company pays a dividend, it got just absolutely silly expensive, but the stock hasn't crashed hardly a lick. Why? Because everyone (except the occasional troll) knows that WMT is sound. It's a quality company, and it's just not going away. So investors are, well, "patient" probably isn't the right word--but let's just say they're not willing to give away their WMT shares anymore than my landlord is willing to give away her big Ole Nor Cal house in a really nice gated community with a lake and a golf course and all that stuff. Someday the houses around here will actually be worth what people pay for them. Same with WMT.

So what am I saying? I have no idea what's going to happen in the housing market, but I'm darn glad I'm renting. Two years ago we sold a house in San Antonio that we could easily have rented and would just have covered our payment. But I saw that houses were absurdly expensive yet great stocks were pretty cheap.

But I'm stuck on this thought: how do you reconcile the disparity between price and rent?

As for related stocks...

I've been buying on a very small position on DHI, and I'm okay with that. I think they're the most likely of the major builders to be able to capitalize on the carnage. But I sure won't bet the kids' college fund on it. This is my Texas Hold 'em money. I also hold HD, but don't believe the downside in the home MX arena is anywhere near what the builders are facing. But again, HD is hardly one of my leading positions.

John
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