Client Update, June 2026: Valuation Risk and Opportunity

“The essence of investment management is the management of risks, not the management of returns.”

Value Investor Benjamin Graham (The Intelligent Investor, 1949)

Over the last several months, I have written extensively and broadly about the uncertainty inherent in today’s market. Between tariffs, inflation, interest rates, geopolitics, fiscal policy, and more, there is no shortage of big-picture macro considerations for investors to consider.

This month, however, I want to narrow the spotlight squarely back onto the portfolio.

Specifically, in last month's letter, I mentioned that I would explain why I have been avoiding some of the market's frothier areas while continuing to add to high-quality companies trading well below their historical averages.

Right now, on the micro level, I see strong parallels to the late 1990s and the dot-com bubble, along with all the risks associated with any bubble. Most notably, we are continuing to face an increasingly concentrated market where a relatively small number of companies and themes are driving a disproportionate share of investor enthusiasm and market returns. In short, a bubble.

Pictured: The History of Stock Market Bubble Concentration (x)

Within tech, that means AI and the infrastructure supporting it, from semiconductors to data storage. Outside of public markets, it can also be seen in examples like SpaceX, whose trillion-dollar (!) targeted IPO valuation price is evidence of a market that has grown very stretched from a valuation standpoint.

Importantly, this is not a criticism of technology or innovation per se. We continue to own businesses such as Google (NSQ: GOOGL) and Amazon (NSQ: AMZN) because they remain exceptional companies with durable competitive advantages.

In other words, my concern is not with the quality of these businesses. Instead, the biggest challenge right now is valuation risk. We can’t make money if we don’t buy at prices lower than inherent value. In fact, there is no easier way to lose money permanently than making bad judgments relative to valuation risk.

So, my job in this environment is to identify and, on a portfolio level, take advantage of companies that remain strong but are being systematically neglected and therefore undervalued. For that reason, I’ve been steering the portfolio in directions that offer structural advantages, strong moats, and attractive long-term prospects but which are, right now, out of favor and trading at or near multi-year lows.

Portfolio Updates

Lennar, Floor & Décor, Trex: When long-term opportunities hide under short-term headwinds

Few industries have felt the impact of higher interest rates more directly than housing, and the entire housing market has largely fallen out of favor as a result.

Mortgage rates have risen rapidly from the historically low levels that prevailed during the pandemic era, which in turn has created a challenging environment for homebuyers and housing-related businesses alike. Higher borrowing costs have discouraged transactions, pressured affordability, and caused many homeowners to remain in their current homes longer than they otherwise would have.

However, housing now presents a nice set-up with a multi-year time horizon.

People still need places to live, and new households will continue to form, but the United States remains structurally undersupplied when it comes to housing. This situation favors larger builders who, better capitalized than smaller ones, can help “buy down” interest rates on mortgages and thus take greater market share, even while moving to an asset-light model that improves balance sheet risk.

Lennar Corp. (NYQ: LEN)

Consider homebuilder Lennar. Last year, Lennar completed a spin-off of a new entity, Millrose Properties (NYS: MRP). Millrose serves as a “land bank” entity for Lennar. It acquires and develops land before making it available to Lennar through option agreements. So, rather than tying up large amounts of capital owning land outright, Lennar can now control future development opportunities with substantially less balance sheet risk (contributing to a balance sheet that currently carries a debt-to-capital ratio of just 15.7%) and improved Return on Equity (ROE) over time.

It also means Lennar is better positioned to play offense when most of the industry is playing defense. For example, Lennar can use its in-house financing operation to help buy down mortgage rates for qualified buyers. If a customer qualifies for a mortgage at 7%, Lennar may effectively subsidize that rate (i.e., lower it) to make a new home purchase more affordable even in a high-rate environment. This program will likely level off as rates steady or decline.

Plus, Lennar is just well-structured and run. Its management team has remained aggressively shareholder oriented. The company has used its strong balance sheet and cash position to buy back stock at highly attractive prices, including authorizing a $5 billion share repurchase program in 2024, now largely complete.

However, due mostly to the pressured environment in which it is operating, Lennar is trading at a discounted valuation near a 52-week low and not far off from a 5-year-low. With Lennar, we are trying to position ourselves in a strong situation that’s low-risk based on current valuation and, importantly, operating in a “meat-and-potatoes” industry facing little to no threat from technologies like AI.

Two other companies in the same basket, Floor & Decor and Trex Company, represent different expressions of the same broader theme.

Floor & Décor (NYQ: FND)

Floor & Decor continues to benefit from structural advantages that have little to do with the current interest-rate environment. Stabilizing interest rates will certainly help FND, but it has significant long-term structural levers in place to enable it to manage volatile and/or high-interest rate market situations regardless. For one thing, its direct sourcing model allows it to purchase products directly from manufacturers rather than relying on traditional intermediaries, helping support margins even during difficult periods.

At the same time, management continues to expand the store base. The company currently operates more than 275 locations and expects to open more than 20 additional stores this year. Floor & Decor does not need a perfect environment to continue growing. It can afford to wait out challenging markets because housing products eventually need replacement (e.g., floors wear out, plumbing needs replacing, etc.). Over time, that creates a natural recovery mechanism within the business. Yet, like Lennar, FND is trading just above a 5-year low.

Trex (NYQ: TREX)

Trex offers a similarly compelling setup. While a cyclical recovery in housing and/or a stabilizing rate environment would help, the long-term story for Trex is growth on composite decking. Composite is more expensive up front than pressure treated wood, but reduced maintenance costs make composite cheaper over the asset’s life. Currently, composite accounts for somewhere between 25% and 40% of total decking sales in the U.S., but this percentage has been growing by about 1% each year for the past decade ($80M in marginal sales). This creates plentiful opportunity for market share take over time, and Trex already controls half the market.

In other words, there are multiple ways for Trex to win. If housing activity eventually normalizes, Trex benefits. If the long-term transition from wood to composite materials continues, Trex benefits. Ideally, both occur simultaneously.

But, as with other housing-related businesses, Trex has been caught in the market's broader concerns about housing and interest rates. The result has been an undue devaluation.

The Housing Basket

Ultimately, each of these positions represent precisely the type of situation I find most attractive.

They are trading at or near multi-year lows, but these are strong and well-positioned businesses poised to be re-rated significantly higher as the market cycle turns. We’re not the only ones who think there’s opportunity in the housing sector, either. Berkshire Hathaway, for example, is buying Taylor Morrison (another homebuilder) for $8.5 billion.

Ultimately, these positions all represent classic cases of out-of-favor businesses. When they shift, either due to cyclical recovery or investors looking for a more reliable meat-and-potatoes alternative to overheating segments like AI, their valuations will re-rate higher. With them in the portfolio, we will be positioned to realize the rewards of that shift.

Zoetis: When Great Businesses Fall Out of Favor

Zoetis (NYQ: ZTS) represents another example of the type of opportunity I find particularly compelling today.

This company is the clear leader in animal health, with a portfolio of more than 300 products spanning multiple species and a dominant position in companion animal care. Roughly 70% of revenue comes from cats and dogs, which places the business squarely in the middle of a long-term trend that continues to reshape the industry: the increasing “humanization” of pets.

In other words, for many households, pets are no longer viewed simply as animals. They are family members. (That is certainly the case in my own household, with our beloved Buster). As a result, spending on pet health often behaves more like a staple expense than a discretionary one. Owners may postpone other purchases, but they are far less likely to delay care for a beloved pet.

Pictured: Buster Surowiec

That dynamic has helped make Zoetis one of the highest-quality businesses in its industry. The company has historically generated exceptional returns on equity (67.75%) and invested capital (24.99%) while maintaining leading market share across many of its core categories.

Yet despite those strengths, the stock has fallen dramatically.

Part of that decline is understandable. During COVID, pet ownership surged as millions of people spent more time at home. Investors recognized the trend and poured capital into anything connected to it. Zoetis became one of the market's favorite stories and eventually traded at unsustainable valuations.

That enthusiasm has now reversed. Over the last several years, concerns surrounding patent expirations, product safety debates, and slowing growth have weighed heavily on investor sentiment.

Some of those concerns deserve attention. No business is immune from competitive pressures, and Zoetis is no exception.

What interests me, however, is the gap between those concerns and the quality of the underlying business. The company remains the industry's market-share leader, as veterinarians continue to rely heavily on its products. Management continues to invest in next-generation therapies while expanding into diagnostics and genomics. At the same time, management has remained aggressive during periods of price weakness, repurchasing over $9B of stock since 2021, including $606M in the most recent quarter alone.

In short, the market has overcorrected from ZTS’s pandemic era highs. Sentiment has become far too bearish toward a company that has spent decades establishing itself as the industry's leader. At today's valuation, the market is pricing Zoetis as an average business when the underlying economics suggest something far better.

A Quick Note on Stock Buybacks

Readers may have noticed that I frequently mention share repurchases when discussing portfolio companies. It comes up often enough that I should probably clarify precisely what I am and am not saying with these references.

A stock buyback is neither inherently good nor inherently bad. Like any capital allocation decision, its value depends entirely on how it is executed.

Companies can destroy shareholder value by repurchasing stock at inflated prices, taking on excessive debt to fund buybacks, or investing capital into businesses that are already in structural decline. Those situations are not attractive.

The setups I prefer look very different. I want to see financially strong businesses buying back stock when the market is undervaluing their shares. In those circumstances, management is effectively reinvesting in a business they already understand better than anyone else. When done thoughtfully and at the right price, buybacks can be one of the highest-return uses of shareholder capital available. That’s the type of stock buyback decision I look for.

Both Lennar and Zoetis illustrate the type of behavior I like to see. In each case, management has used periods of stock price weakness as an opportunity to become more aggressive rather than less aggressive. That willingness to act counter-cyclically when justified often separates exceptional capital allocators from average ones.

Research Update: Rivian

You may have also noticed that Rivian (NSQ: RIVN) is a frequent topic of discussion in these letters; this year, mentions of Rivian have outpaced even portfolio mainstays like Google and Amazon. That’s partially because Rivian has grown as an important holding in the portfolio, but even more so because it’s simply one of the most interesting and dynamic businesses that we own.

Much of that comes down to the sheer quality of Rivian’s leadership. Last month it was revealed that, to date, CEO RJ Scaringe has raised more than $12B across three startups. He’s managed this feat in part because he’s genuinely a talented leader and in part because Rivian is more than just a car company. Their software business, their joint ventures with partners like Volkswagen, and their work in robotics all showcase how Rivian is gaining a foothold in multiple spaces that interconnect and all of which will gain in importance over the next few years. If you can raise $12B across multiple ventures, you’re doing something right.

It’s not just Scaringe who’s clearly a smart, forward-looking leader at Rivian, either. Rivian’s Chief Software Officer Wassym Bensaid participated in a fascinating Reddit “Ask Me Anything” thread last month. One of the most striking elements of Bensaid’s answers is just how aggressively Rivian is focused on improving almost every aspect of their service and product offerings. Scaringe has reinforced that message in insightful interviews with Top Gear Magazine and Inc. Magazine about the future of Rivian (and its upcoming R2 model), the EV market, and the path forward for self-driving technologies.

On My Desk This Month

Lastly, this month I have found myself returning to a conversation between Scott Galloway and author Morgan Housel, in which they discuss the ways in which debt is increasingly replacing the traditional American dream for younger generations.

Whether you agree with every conclusion or not, I found the discussion thought-provoking because it forces us to consider how dramatically the financial landscape has changed over the last several decades. This follows a point I made in last month’s letter about how young college graduates are doing “the right thing” (getting a college education) and still facing an uncertain future.

Many younger Americans are entering their prime earning years carrying levels of financial burden that would have been difficult to imagine for previous generations. Housing affordability remains challenging. Student debt continues to weigh on household balance sheets. The cost of many essentials has increased far faster than incomes.

Viewed through that lens, some of the behavioral shifts we observe among younger generations become easier to understand.

I’ll also note Morgan Housel is a notable author in his own right. His works, like Same as Ever and Everyone Believes It; Most Will be Wrong, are well worth a read themselves.

Closing Thoughts

In periods when markets become increasingly concentrated and valuation discipline falls out of favor, restraint can feel uncomfortable, leading to a sort of investor-specific FOMO (fear of missing out). That’s partially how and why bubbles get built up, and valuation risk grows.

The interesting thing, though, is that these periods almost always create genuinely attractive opportunities. They’re just not the opportunities that everyone else is chasing.

Regardless of how today's uncertainties ultimately resolve, I remain focused on the same objective that has guided our approach from the beginning: identifying high-quality businesses, purchasing them at attractive valuations, and allowing time and disciplined capital allocation to do the heavy lifting.

As always, thank you for your trust and the opportunity to navigate this environment on your behalf.

With warm regards,

Glenn