B E H I N D T H E N U M B E R S : Costco Wholesale Corp.

Perpetual Growth Machine

While Costco shares aren’t cheap, value investor Nicholas Sleep shares some fascinating insights
about the company and makes an excellent case for its long-term prospects.

Value investors have long been ny’s cost – with no exceptions. This The real power of Costco’s strategy –
intrigued by Costco Wholesale Corp. It pricing discipline – even Wal-Mart’s and the source of its competitive advan-
has a fabulous long-term record of mark-ups are around 20% – engenders tage, according to Sleep – is how the
steady growth, it’s old-school in its man- outstanding customer loyalty. As the benefits of growth are reinvested in the
agement and compensation practices, company has raised its annual member- relationship with the consumer. As
Berkshire Hathaway’s Charlie Munger is ship fee over time, to $45, membership Costco opens new stores, supplier and
on the board – plus, any bargain hunter renewal rates have barely budged from other scale cost savings are passed back
loves to shop there. Not so many value an enviable 86%. to customers through even more compet-
investors own the stock, however, in part
because it has extremely low margins –
INVESTMENT SNAPHOT
less than 2% after tax – and the stock
rarely looks cheap, trading today at 24x Costco Wholesale Corp. Financials (TTM):
trailing earnings per share. (Nasdaq: COST) Revenue $49.16 billion
So we didn’t expect anything particu- Operating Profit Margin 2.91%
larly new when we sat down to read the Business: Membership warehouse retailer Net Profit Margin 1.86%
discussion of Costco in the annual letter offering members low prices on limited
selection of branded and private-label prod- Valuation Metrics:
of Nicholas Sleep of London's Marathon (Current Price vs. TTM)
ucts across multiple product categories.
Asset Management. But Sleep’s fresh COST S&P 500
Primary operations in U.S. and Canada.
insights, arguments and analysis – P/E 23.9 23.1
“Mungeresque” in tone and content – Share Information P/CF 15.8 13.9
(@2/18/05):
persuaded us that Costco’s intrinsic value Largest Institutional Owners:
is probably quite a bit higher than we’d Price 45.80
Company % Owned
thought. We followed up with him to 52-Week Range 35.05 - 50.46 (@ 9/30/04)
Dividend Yield 0.9%
learn more on why he believes, even if it’s Davis Selected Advisers 7.9%
Market Cap $21.64 billion Barclays Bank Plc 3.6%
not a 50-cent dollar, Costco is an out-
standing long-term investment. Short Interest: State Street Corp 2.7%
(@1/10/05) Capital Guardian Trust 2.3%
Customer really is king Shares Short/Float 2.47% Vanguard Group 2.2%

Retailers love to boast that the “cus- COST PRICE HISTORY

tomer is king,” but none live it like 55 55
Costco. It starts with how the company
negotiates with suppliers. As Sleep notes: 50 50
“Costco’s key to negotiating terms is 45 45
that the number of items in a store
40 40
(SKUs) is fixed at around 4,000, with
those suppliers that provide the best 35 35
value proposition to the consumer win-
30 30
ning space on the shop floor. Contrast
this to normal industry practice, where 25 25
2003 2004 2005
the supermarket assumes the role of
landlord, auctions space to the highest
bidder and pockets the rents (“slotting THE BOTTOM LINE
fees” in industry parlance). Many Costco’s “perpetual machine” of growth is capable of keeping company revenue and
supermarkets make their money from cash flow growing 13% annually, says Nicholas Sleep of London’s Marathon Asset
buying from the supplier. Costco makes Management. If the market price reflected even a 10% growth expectation, he says,
COST would trade at $62, a 35% premium to the current market price.
money from selling to the consumer.”
Costco fixes its retail prices at a Sources: Company reports, other publicly available information
maximum of only 14% over the compa-

February 22, 2005 www.valueinvestorinsight.com Value Investor Insight 16

 B E H I N D T H E N U M B E R S : Costco Wholesale Corp.

itive prices. Customers then respond to that’s just Wall Street’s obsession with with Price Club in 1993, Costco
the better prices, driving incremental short-term outcomes. The firm could thought 31 stores were too many for
revenue at both new and old stores. As earn Wal-Mart margins by taking pric- the market, but today there are 36.
Sleep writes: ing up a little and the stock would then Likewise, in Seattle and Alaska, the
“In the office we have a white board trade at 11x earnings, but would it be a penetration of membership cards is an
on which we’ve listed the very few better business as a result? We think astonishing 65% of households, but in
investment models that work and that not, because it might allow the competi- most markets it is below 10%.”
we can understand. Costco is the best tion to catch up.” All told, Sleep estimates that Costco
example we can find of one of them: Contributing to margin pressure in can conservatively increase revenue and
scale efficiencies shared with customers. recent years has also been a rise in free cash flow by 13% per year into the
We often ask companies what they SG&A costs as a percentage of rev- foreseeable future – 4% from the
increasing asset turns of newer stores as
they mature, 4% from same-store
PRIVILEGES OF MEMBERSHIP
growth at already-mature stores, and
Costco’s membership-only model helps foster a 5% from new stores.
unique relationship with its customers. People shop “This is an early life-cycle company
there because it’s Costco, not because it stocks whose competitive moat gets deeper as
Pepsi or Pampers. As Costco has raised its basic the company gets bigger and the con-
annual membership fee over time, to $45 currrently,
sumer is consistently cut-in on the bene-
membership renewal rates have barely budged from
an enviable 86%. fits of the company’s growth,” Sleep
says, terming this cycle a “perpetual
machine” of growth.
would do with windfall profits, and enues, fueled in large part by spending The market, which currently prices
almost no one replies ‘give it back to on a new warehousing and distribution Costco shares at around $46, is not so
customers’. How would that go down system and rising employee wages and generous in its growth expectation.
with Wall Street? That is why competing benefits. A sign of trouble? No, Sleep calculates that if Costco shares
with Costco is so hard to do. The firm is explains Sleep: “We clearly differentiate were priced to reflect just 10% annual
not interested in today’s static assess- between ‘good’ and ‘bad’ SG&A spend- growth, the stock would trade at $62
ment of performance. It is managing the ing,” he says. “In both of these cases, today. Even at that price he wouldn’t
business to raise the probability of long- Costco is investing in areas critical to its sell, he says, given his expectation for
term success.” growth.” With the new warehousing even faster growth.
By sharing the cost savings of growth, system in place, efficiency gains will What could go wrong? Wal-Mart,
Costco earns revenues per square foot – start showing up in the financials this with Sam’s Club, could mount a sus-
around $830 – that are the envy of the year. And the slightly higher wage base tained direct attack to undercut Costco’s
industry. Wal-Mart’s Sam’s Club checks in helps Costco retain its employees twice prices. Sleep considers that unlikely, as
at around $500 per square foot, while BJ’s as long as competitors do, which Sleep Costco has shown itself more than capa-
Wholesale Club is about $400. Even more sees as positively impacting customer ble of competing head-to-head with the
importantly, Sleep estimates that mature service and contributing to its very high discounting giant. The departure of
Costco stores – open at least five years – customer retention. CEO James Sinegal, 68, the architect of
generate revenue of over $1,000 per Costco’s unique and disciplined culture,
square foot. Still an early life-cycle company could also be a blow. Sleep points out
Even with annual sales of nearly $50 that Sinegal shows no sign of slowing
Margin trouble? billion, Sleep makes a compelling case down, and that Costco’s experienced
Costco’s pricing discipline, by defini- for Costco as a growth company, board can be counted on to appoint a
tion, keeps margins low – at 1.9%, they through geographic expansion, worthy successor.
are roughly half those of Wal-Mart increased market penetration, and the We’ll leave to Marathon’s Nicholas
(3.6%) and Target (4.1%). Sleep argues virtuous cycle of growth in maturing- Sleep the final word on Costco: “The con-
that Wall Street’s focus on margins is store asset turns as scale efficiencies sensus has it that Costco is a low-margin
short sighted: result in even lower prices. retailer with an expensive stock and a cost
“True, the company has low margins, “One-third of the store base remains problem. That is certainly one description.
but that’s the point. The firm is defer- in California, and almost half on the But in our judgment it is a cost-disciplined,
ring profits today in order to extend the West Coast. Management always con- intellectually honest, high-product-integri-
life of the franchise. Of course Wall fesses to underestimating saturation. In ty, perpetual motion machine trading at a
Street would love profits today, but Los Angeles, for example, after merging discount to value.” VII

February 22, 2005 www.valueinvestorinsight.com Value Investor Insight 17

O’Reilly and the Retail Auto Parts Business
by John Huber | Mar 1, 2017 | Investment Journal | 5 comments

This post is just an outline on why I like the business, and why it’s on our watchlist. Here are some things to like
about O’Reilly:

High returns on capital
Durable, recession­proof business
Steady and predictable free cash flow
Big lead in commercial (“DIFM”) business
Distribution network that is positioned for growth
Long growth runway

The After­Market Auto Parts Business

The retail auto parts business is a pretty good business, and in my opinion probably one of the best businesses in all
of retail. The top players in the industry have shown a surprising amount of resiliency against the threat of online
retail (although this threat is growing).

O’Reilly sells auto parts to people who want to fix their own cars as well as to mechanics who fix cars for their
customers. The “DIY” segment represents about 58% of the business, with the commercial business (the so­called
“do­it­for­me”, or “DIFM”) making up the other 42%.

O’Reilly is one of the top players in a consolidating industry. There are around 35,000 auto parts stores in the US.
The top three players control roughly 15,000 of those stores, but the tenth largest chain has fewer than 100 locations,
and the bottom half of the industry is extremely fragmented (mostly mom and pops and very small family­owned
chains):

Given the attractive returns on capital that can be earned by buying out Mom and Pop, rebranding the store, and
increasing sales with a much more efficient distribution model, it’s almost certain that the industry will continue to
consolidate. Unlike many businesses that “rollup” various competitors in their business, O’Reilly and its competitors
have generally used its sizable free cash flow to finance growth.

Let’s review some of the reasons why I like O’Reilly’s business:
High Returns on Capital

O’Reilly had about $1.7 billion of capital invested in the business ten years ago. Currently, there is about $3 billion
invested (I’m defining capital as the net working capital plus net fixed assets). During this decade, operating income
grew from $300 million to $1.7 billion. So this incremental capital investment of $1.3 billion has led to $1.4 billion in
incremental pretax earning power, a pretty remarkable return on capital. Part of this has been fueled by removing
working capital from the business through better payables terms, but the unit economics of this business are
outstanding, with very solid cash on cash returns for each new store that is opened. These high returns on
incremental capital investments in the form of new stores combined with a long­growth runway creates a nice
compounding effect over time.

Durable Business

The auto parts retailers are very defensible businesses that have proven to do quite well during economic downturns.
Fixing your car is a must, and whether you do it or your mechanic does, the overall economy is not a deciding factor.
You need your car, and you likely need it back in a day or two. Also, economic downturns can actually be somewhat
of a boon for these companies as many people postpone buying a new car during recessions, which means that the
average age of cars as a whole increases, and as cars age, they break. O’Reilly benefits from a population of cars
older than five years old (typically the age when the dealer warranties expire). This cohort of vehicles often increases
during recessions, which benefits the auto parts business. O’Reilly and others did very well during the last recession,
when new car sales plummeted from 17 million to 10 million per year at the nadir.

Free Cash Flow

The business produces a lot of operating cash flow. Some of this has been used to finance the company’s growth
plans. O’Reilly’s growth capital expenditures could be divided into three main categories, acquiring smaller
competitors, increasing its store footprint by opening new locations, and building out its distribution network.

The company produces enough cash flow to finance all of its growth needs, and historically has used its excess cash
flow to buy back stock. One of the advantages O’Reilly has over its competitors is that it has spent the past decade
or so investing in the distribution network, and so going forward the company should produce excess free cash flow,
which means accelerating buybacks.

Commercial Business

O’Reilly gets 42% of its sales from commercial business, and this business has been growing over time at a slightly
faster pace than its retail business. There are a few reasons to like the commercial business, but one I’ll mention
here is that it’s more insulated from ecommerce competition. The mechanic makes money by moving cars through
his bays at as fast a rate as possible. Speed is absolute crucial to his business. The more cars he moves through his
bays, the more money he makes. So the mechanic is less worried about the absolute cheapest price for the part, and
much more concerned with how quickly he can get the part to put in the car. He largely passes the cost of the part on
to the customer anyhow.

O’Reilly’s distribution network ensures that they can get the part to the mechanic in a very short period—often in just
a few hours—and this is usually the deciding factor for where the mechanic decides to source his parts. Also, there is
a stickiness factor to this business from a service perspective. The mechanic is very busy, and doesn’t have a lot of
extra time to do price comparisons. He also doesn’t have a real desire to switch his relationship with his sales rep.
Most mechanics have their parts guy on speed dial and have a system for ordering parts that makes this part of the
mechanic’s business as easy as possible. The effort it would take to switch this setup would likely cause an
unwanted headache, and at least temporarily, would interrupt business.

I also think more and more people are getting their cars worked on by a professional rather than trying to fix it
themselves. The dealers get a lot of this business, but with the average age of a car on the road over 11 years old
now (and well­past any new­car warranty periods), the mechanics will still get a big piece of this pie.

Distribution Network

The company’s distribution centers (DC’s) are large warehouses that deliver parts to smaller “hub” stores and also
the main retail stores. O’Reilly’s DC network is much more established than its competitors, with 26 DC’s and nearly
300 mini­hubs (locations that are larger than traditional stores with around 44,000 SKU’s but act as a mini­warehouse
for other nearby locations). O’Reilly has spent the better part of the last decade building out this distribution network,
which looks like a wise decision, as competitors like Autozone spent their cash flow buying back stock (note: this has
worked out very well for AZO shareholders, and it wasn’t a poor use of capital, but it has created a situation where
AZO is now forced to play “catchup”, as O’Reilly has by far the best distribution network in the business with much
greater capacity and much better positioning for store growth).

Growth Runway

As mentioned above, the auto parts retail business is very fragmented. Just like big box home improvement stores
slowly but steadily consolidated a fragmented collection of individual hardware stores over the past few decades, a
similar dynamic exists in auto parts retail shops. Owning a small auto parts store is a fairly capital intensive business.
If you are a small shop owner, you lack the buying power to garner attractive terms from your suppliers, and so you
have to tie up a lot of working capital in your store’s inventory. Financing your inventory with your own cash (or debt)
makes your business much more capital intensive. It lowers your store’s return on capital, but more importantly from
the shop owner’s perspective, it means more of your cash has to effectively remain tied up on the store shelves.

Charlie Munger once lamented this dynamic when he owned a heavy machinery dealership that sold Caterpillar­type
equipment. He commented how every year they’d sell enough equipment to make a profit, but all of profit ended up
sitting out in the yard, tied up in the next year’s inventory.

Large players like O’Reilly achieve attractive terms from their suppliers (in the form of longer “days payables”) which
means that big players like O’Reilly and Autozone are now to the point where their inventory is completely financed
by its payables. This dramatically increases the company’s capital efficiency because it removes billions of dollars’
worth of capital requirements for O’Reilly. The company’s $2.9 billion in accounts payables more than offsets its $2.8
billion in inventory, which frees up cash to be used to invest in new stores, make acquisitions, or return cash to
shareholders through buybacks.

As O’Reilly has grown, it has steadily extracted better and better terms from its suppliers:

As O’Reilly’s scale and buying power has increased, payables as a percentage of inventory have steadily climbed
over the past decade, and its cash conversion cycle (the amount of time (in days) it takes for the company to turn its
investment in inventory into cash flow) has plummeted. A decade ago, O’Reilly had a cash outlay, let’s say, of $100
or so for an alternator to put on its shelf for sale. In 2007 it took 145 days between the time O’Reilly shelled out this
$100 and the time it got back its cash for the sale of this alternator. A decade later at the end of 2016, this period of
days—thanks to better and better terms from suppliers—had shrunk from 145 to 4.

O’Reilly gets its suppliers to finance (in the form of longer payables periods) what smaller retailers have to pay cash
for.

There are also another few key points that make the business more attractive for larger players with better
economies of scale:

1. Sizable Store­Level Inventory Investments

O’Reilly has around $575,000 worth of inventory in each store, spread across 23,000 SKU’s. Mom and Pop certainly
have a much narrower selection and likely a smaller total value of inventory in their stores, but auto parts retail is a
business that requires a fair amount of stock on the shelves in order to adequately service the customer. Cars are
complicated machines with many thousands of parts—all of which can break and will need replacement.

The distribution network of O’Reilly means that they can stock a very limited number of each SKU in each store
(since the company can quickly replace each item sold with a quick shipment from one of its many “hubs” or
warehouses). Smaller competitors need to carry a “deeper bench” (more than one or two of each SKU), given their
more limited inventory management system. This means smaller competitors have a more difficult time matching the
breadth of O’Reilly at the store level (since more shelf space has to be tied up with redundant SKU’s at the smaller
stores).
2. Slow Inventory Turns

Not only do the smaller competitors have to put up a sizable amount of capital to stock their shelves, but the auto
parts retail business has a very low “turnover” rate. This means that on average, each part sits on the shelf for a
relatively long time before someone comes in and buys it. It takes about 8 months for O’Reilly to turnover its
inventory. This is likely even slower at smaller competitors.

Low turnover is not in and of itself a bad thing, but it is in one of the two main variables that impact profitability. As
DuPont taught us back in the 1920’s, return on assets (ROA) equals the product of two factors: asset turnover and
profit margins. Some profitable businesses have large profit margins to offset low turnover (jewelry, high­end brands,
etc…); others like grocery stores or big box superstores like Walmart and Costco have very low margins but very
high turnover.

But in the absence of decent inventory turns, profit margins must pick up the slack. And given that smaller
competitors have both lower buying power (leading to lower gross margins) and smaller scale (leading to higher
operating expenses as a percentage of sales, since fixed costs are spread across fewer locations), margins are
much lower at smaller competitors.

3. Sales per Square Foot

This business generates a relatively modest amount of sales per square foot relative to many other retailers. It’s not
at the absolute low end, but definitely somewhere near the bottom quartile.
O’Reilly generates around $260 per square foot, which again, is likely much greater than many of its smaller mom &
pop competitors. Again, this is another way that economies of scale benefit the larger players. O’Reilly can achieve
close to 20% operating margins because of higher gross margins, but also because it can spread the fixed portion of
its operating expenses across many different locations.

So sizable working capital requirements combined with low turnover and challenging margins for small stores are
reasons why bigger is better in the auto parts retail business. Life is harder for the smaller competitors and there are
real benefits for the larger businesses to acquire the smaller businesses. I think both of these factors will lead to a
steadily consolidating industry over time.

Risk

Amazon is the biggest risk to the DIY segment of the business.

I don’t see this as nearly as big of a risk in the commercial segment, where breadth of products on hand and the
speed at which that product can reach the mechanic are much more of a driving factor for the mechanic than price.

But since DIY is still a majority (58%) of O’Reilly’s business, this is not an insignificant risk for them. I think for most
people fixing their own car, the price is probably the biggest factor (followed closely by speed and selection). I’ve
done a number of price comparisons, and it seems that while Amazon isn’t always the lowest price, they are lowest
the vast majority of the time. As they get faster and faster at delivery, and as their auto parts selection continues to
expand, I think they are going to be a real factor in this industry.

On the other hand, on yesterday’s conference call the AZO CEO argued that there are a few differentiating factors
between his business and Amazon (and since O’Reilly has the same basic model, it’s applicable here also). Here is
why AZO’s CEO thinks his company can go head to head against Amazon’s lower prices:

Immediacy—people want their car fixed now. They don’t want to wait a couple days for a part.
Advice in store—the employees are knowledgeable, and can help you figure out what part you need.
Core return—consumers can bring in their alternator core, for example, in exchange for a new alternator at a
slightly discounted cost (that also has a refurbished core). There is apparently a sizable reverse supply chain in
the after­market auto parts business.

I would agree that the service component of this business is valuable. Not everyone knows exactly what they need,
and the employees in the stores are always very knowledgeable from my experience. I do think this is a factor that
helps O’Reilly.

I am much more skeptical about the first point. I’m not sure that immediacy is as much of an Amazon deterrent as the
AZO CEO believes. There are certainly some people who will drive over to the store to pick up a part that day, but
with Amazon getting faster and faster delivery, this supposed advantage gets slimmer and slimmer for the auto parts
retailers. If I can order my alternator today on Amazon and get it tomorrow, or even the day after tomorrow, and I can
save $20, I’m likely going to do that.

Valuation

I started this post saying that I just wanted to mention some reasons why I like the business. Unfortunately, while I
think ORLY is a very good business, I don’t think the stock is “punch­card cheap” at the moment. The company will
produce around $1 billion of free cash flow this year, and it will add another 200 or so stores to its footprint. The
bottom line is growing at a healthy double digit pace when factoring in the steady buybacks, which are almost certain
to continue. Shares outstanding have dropped from 142 million in 2010 (after the digestion of its last major
acquisition) to 97 million today, and the company is retiring shares at a very fast pace.

This creates a nice tailwind, but at 25 times free cash flow, I think the stock is pricing in all of the good things I
mention, and possibly not giving any of the risks (Amazon) any real possibility. I don’t think Amazon is an existential
risk for O’Reilly, but I do think they’ll be a major competitor in this space. I think O’Reilly is a very good business, but
I’d rather pay a lower price for the cash flow it produces, especially since there is a chance that competition might
make it harder for the company to expand as quickly as it would like going forward.
Description
NVR is a homebuilder. Their operating model, which is unique (and which is 
described later), allows them to assume the least risk in the industry and  
produce returns that are the largest.   
 
 
Homebuilders are generally dismissed because they're cyclical and 
 
interest­rate sensitive (really, though, which industry isn't?) and
 
downturns inevitably leave homebuilders holding large inventories of unsold 
properties ­­ the unlevered builders then suffer large inventory writedowns  
while the levered builders go into bankruptcy. However, NVR's model will   
 
prevent it from suffering the same fate and, indeed, NVR will prosper in a 
downturn at the expense of the weaker builders.   
 
 
Two of the most important facets to its operating model are: 
 
 
(1) NVR acquires control of land inventory through options contracts. These contracts give
NVR the right to buy finished lots from developers. NVR secures a supply of land for its
homebuilding operations through the use of these options whereas other homebuilders purchase
land outright and engage in land development. By avoiding that speculative practice of land 
purchase/development, and instead using options, NVR is able to control   
large blocks of land (years' worth) in its markets while employing less  
 
capital to do so. The lower capital requirements of this method translate 
into lower inventory risk and greater returns on capital.   
 
 
(2) NVR pre­sells nearly all of its homes. Other homebuilders typically 
participate in some speculative construction. NVR does not. Before NVR   
begins construction, an order must be placed and a deposit made. This   
practice reduces risk and working capital requirements, which further  
enhance returns on capital.   
 
 
In addition to NVR's superior model, consider the following: 
 
 
­­ Low valuation: NVR trades at a P/E of 8.6x trailing (7.1x 2001E EPS) and a TEV / EBITDA of
4.7x (trailing). TEV / (EBITDA ­ Capex) is 4.8x 
 
(trailing). TEV / FCF is 7.8x (trailing). I am defining FCF as Net income plus D&A minus
Capex. 
 
 
­­ Backlog: NVR has a backlog of 5,765 ordered homes. These homes 
 
represent $1.49 billion of revenue. To put this into perspective, this is 
nearly three fiscal quarters of revenue. In addition, the homes in backlog  
carry higher gross margins than the ones in the historical results. All of  
this should translate into higher EPS. (Management says 2001 EPS should be  
just under $20 per share. In the short history that the company has  
 
provided guidance (previously they refused to) they have consistently been 
ridiculously conservative. Their 1Q results and the backlog indicate to me  
that the $20 EPS estimate continues to be the case).   
 
 
­­ High ROIC: The low capex nature of its business ($301 mil LTM 
 
homebuilding EBITDA versus consolidated LTM Capex of $5 mil) and the low 
working capital requirements of its model allow NVR to produce superior   
 
returns on invested capital: 45.3% in 2000, and 5­year average ROIC of 25%. Bonus fact: In
2000, NVR sold $325 mil more homes than it did in 1999, yet inventory (the bulk of a
homebuilder's working capital requirement) increased only $11 million. 
 
 
­­ Intelligent allocation of excess capital: High returns on capital and 
excess cash flows are only useful if you have a management that is smart  
 
about deploying it. In NVR's case, management has chosen thus far to deploy that capital to
buy back its own stock. Between 12/31/93 and 12/31/00 the company reacquired 13.5 mil shares.
In the first quarter of 2001, NVR purchased another 0.85 mil shares For perspective, there
are only 8.1 mil primary shares out today (I'm using primary shares to illustrate this but I
use diluted shares for enterprise value calculations). 
 
 
­­ Homes a basic necessity: People will always need homes to live in. The 
process of building a home has not changed materially in decades. Neither  
 
of these statements is likely to change in the next year, the next 5 years, 
or even the next 20 years. There is minimal technological or obsolescence   
risk.   
 
 
­­ Dominant in its markets: NVR competes in 18 geographic markets. It is 
 
the #1 player in 10 of them. As for the remaining 8, it is usually #2 or #3 (always at least
in the top 5). The rest are markets that NVR has just 
recently entered and will dominate with time.   
 
 
­­ Tax factors: The industry has indirectly enjoyed the benefits of a 
government subsidy in the form of tax deductible mortgage interest.  
 
Additionally, in the last few years, homebuyers no longer have to pay tax on the first $500k
of capital gains on a home. This lowers the effective 
 
purchase price of a home for a consumer, increases the relative 
 
attractiveness of a home as an investment, and adds a little boost to demand for NVR's
product. 
 
 
NVR's profits and market dominance are all the more amazing when you 
 
remember that the results have been achieved without land development. NVR 
has margins better than its competitors despite the fact that other  
 
homebuilders benefit from the gross margin boost of speculative development 
in an inflationary environment.  

Catalyst
The small number of shares outstanding occasionally creates large downward 
gaps. NVR's recent 25% drop is one such opportunity.   
 
 
Also, share repurchases will continue to drive the stock. It's hard to 
 
overemphasize the magnitude of the repurchases or the wonderful track record 
of buybacks:   
 
 
12/31/95: 15.21 (millions of shares outstanding) 
12/31/96: 13.57   
12/31/97: 11.09   
12/31/98: 10.39  
12/31/99: 9.17   
12/31/00: 8.86  
04/18/01: 8.14