I frequently use Bloomberg’s data banks to run screens. I screen for companies that are selling at low price-to-earnings (PE) ratios, low prices to revenues, low price-to-book values, or low prices relative to other relevant metrics. Usually, the screens produce a number of stocks that merit additional analyses, but almost always the additional analyses conclude that there are valid reasons for the apparent undervaluations. During my career, I probably have run thousands of screens, but only a tiny fraction of 1 percent have resulted in a successful investment idea. Using screens to find investment ideas is like searching for a single pin in a field of haystacks.

In mid-1994, while screening for companies selling at large discounts to their book values, I came across the name U.S. Home, a builder of single-family homes. My early read showed that the company had entered Chapter 11 bankruptcy in 1991 and had emerged from Chapter 11 in 1993 as a profitable company with an average-quality balance sheet for a homebuilder. The company had a book value of about $27 per share and was earning about $2.50 per share. The shares were selling at about $17, or at only about 0.63 times book and 6.8 times earnings. Very low multiples of book and earnings are adrenaline flows for value investors. I eagerly decided to investigate further.

I noticed that the law firm of Kaye Scholer had represented U.S. Home in its bankruptcy proceedings. I knew the managing partner of Kaye Scholer and gave him a call. It was a lucky call. The managing partner was very familiar with U.S. Home and its management. In Kaye Scholer’s opinion, U.S. Home had entered bankruptcy because of a weak housing market in Texas in the mid-1980s, followed by a general recession in the housing market in 1990. The company had been overexposed to the Texas housing market at a time when a sudden sharp decline in the price of crude oil led to a weak demand for new homes in oil-centric areas of Texas. Within a few months, demand turned so soft that U.S. Home was forced to close 36 of the 70 subdivisions it was operating in the Houston area. The soft market in the mid-1980s weakened the company’s financial strength—and then the housing recession in 1990 served as a knockout punch. Importantly, according to my friend at Kaye Scholer, U.S. Home’s financial problems had been created by external problems and, except for its finances, the company had been well managed, efficient, and highly regarded.

I immediately developed the thesis that U.S. Home’s shares were undeservedly depressed because of the stigma of the bankruptcy. I reasoned that, with time, the stigma would diminish and the shares would appreciate. I then started to learn more about the company and its industry.

U.S. Home was formed in 1959 upon the merger of several small homebuilders. The company grew organically and by acquisition and, by the mid-1980s, had revenues in excess of $1 billion. The company seemed to enjoy a good reputation for producing quality homes, and it seemed to be growing. Its net debt was somewhat high, but the debt was backed by inventories of raw land, developed lots, and homes under construction. There was nothing wrong with the company, but there was nothing to write home about it.

Homebuilding seemed to be an industry of average quality and average growth potential. The business works as follows. Homebuilders normally purchase large tracts of undeveloped land. They then seek permits from local authorities to subdivide and develop the land. Development includes the construction of roads and the laying of water, sewage, natural gas, and electrical lines. Then, homebuilders normally build a few model homes and open the subdivision for business. While the models and some other houses in a subdivision are built before they are sold, most homes are not built until a sales contract is received and a deposit is paid. After a house is completed, a certificate of occupancy is received, and title then passes to the purchaser.

Historically, most single-family homes were built by local builders. Eventually, some of the local builders became larger, expanded geographically, and became publicly owned. The larger publicly owned companies enjoy efficiencies of scale and, importantly, access to the capital markets. The access generally gives the public companies an advantage when borrowing to finance the purchase of raw land, the development of lots, and the construction of homes.

I studied U.S. Home’s financial statements, constructed an earnings model, and concluded that the company could earn $3 to $4 per share by 1996 or 1997. Initially, I valued the company at about 12 times earnings, and therefore believed that the shares would be worth $36 to $48 two or three years down the road. However, I noticed that other builders typically sold for somewhat less than 12 times earnings. For some reason, the homebuilding industry was not highly regarded on Wall Street. In fact, the industry earned the pejorative nickname “stick builders.” Therefore, I toned down my expectations. However, even if U.S. Home’s shares were worth only 10 times earnings, they appeared to be an attractive investment opportunity given that they were selling at only $17 at the time. So, I started buying the shares.

It turned out that U.S. Home was a frustrating holding. The company itself did fine, much better than I expected. Between 1994 and 1999, the company’s revenues increased by 91 percent, and its earnings more than doubled from $2.50 per share to $5.30 per share. Given these results, the shares should have been an out-of-the-park home run. But they were not. The shares continued to sell at 6 to 7 times earnings. Management tried to promote interest in the shares. Bob Strudler, the company’s chairman, told U.S Home’s story to anyone who would listen. On March 5, 1997, the company held a full-day meeting for securities analysts. I thought Bob Strudler did an excellent job explaining the company’s strategies, strengths, and growth potentials, but to no avail. In June, the shares sold at a lower price than they had sold at in early March.

In 1998 and 1999, I spoke to Bob Strudler frequently. Usually when I speak to an executive of a company, my questions are honed in on the fundamentals of the company—on new products, competition, strategies, and finances. But my conversations with Bob were centered on why his stock sold at 6 to 7 times earnings and at a material discount to its book value. We both were perplexed. U.S. Home was a well-managed, successful company. Almost no decent company sold at 6 to 7 times earnings and at a discount to book value. U.S. Home was a value investor’s dream. I recommended the stock to a number of other money managers. The shares continued to sell at 6 to 7 times earnings. I was more than frustrated.

Finally, in early 2000, somebody else recognized that U.S Home was selling at a bargain price. The somebody was another homebuilder, Lennar Corporation. Lennar acquired (really “stole”) U.S. Home for $34¾, or for only 6.6 times earnings. Usually, when a company bids to acquire one of our holdings, we have cause to celebrate. Champagne corks pop. But I had no cause to celebrate receiving 6.6 times earnings for U.S. Home’s shares. We had owned the shares for about six years and had about doubled our money. That works out to an average annual return of about 12 percent. Since our goal is to achieve average annual returns of 15 to 20 percent (and hopefully closer to 20 percent than 15 percent), the investment was not successful.

However, there is a bright side to the story. Ownership of U.S. Homes’ shares led us to one of the most profitable investment ideas in our history—to a home run. The home run is the subject of the next chapter.