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Camden Property Trust (NYSE:CPT) is trading erratically with what seems to be a singular focus on instantaneous growth rate. This has caused it to be overvalued when growth was rapid and undervalued presently now that growth has stalled. In both cases, the market was extrapolating the present growth rate as if it were a standard S curve.
In this article we will discuss a few academic concepts as a deeper understanding of how they work reveals the mispricing in Camden:
- S curve
- First derivative of earnings
- Second derivative of earnings
So let us begin with the concepts themselves and then move on to how they apply to the Camden situation.
S curve
There is a well documented tendency for growth to follow an S curve like the one below.
2MC
Earnings growth starts out slow then accelerates rapidly until the pace of growth eventually tapers off at which point earnings tend to plateau.
The S curve is most often seen in the start-up space but can also be relevant to product launches or new segments of existing companies. There are natural aspects of economics which result in companies following the S curve despite having no intent to do so.
I like to think of the S curve as having three key sections labeled below.
2MC
For the sake of illustration let’s say there is a new product that scores really well in initial tests. Despite being a strong product, growth takes a while to kick in because customers don’t yet know about the product.
The company utilizes various advertising channels which slowly build customer awareness. Eventually it hits what is called the “tipping point” which in this case would be a critical mass of customer awareness and sales accelerate. The sales feed upon themselves with word of mouth and FOMO continuing the rapid pace of earnings growth.
Eventually, the product reaches a point of saturation. It is now already owned by the portion of the total addressable market that it is capable of achieving. This point of saturation is also referred to as maturity. At that point there is little room left to grow and earnings tend to plateau or even decline a bit if the product is of a nature where fatigue sets in (something trendy versus practical).
Earnings derivatives as a means of diagnosing a company’s stage within the S curve
Growth, in the business sense of the word, refers to earnings increasing. In the mathematical sense, growth is roughly speaking the first derivative of earnings. It measures the rate of change in earnings.
Acceleration or deceleration can be thought of as the second derivative of earnings. It is the rate of change in the rate of change of earnings.
As a company progresses along the S curve, its earnings derivatives will often look as follows.
2nd Market Capital
Market participants often look at the second derivative as a means of diagnosing what stage of the S curve a company or product is in.
Early in the S curve, the second derivative is strongly positive and then late in the curve it turns negative.
Thus, the market sees it as follows:
- Slow but accelerating growth is perceived as the early part of the curve
- Rapid stable growth is perceived as being in the middle part of the S curve
- Decelerating earnings growth is considered a sign of heading toward the plateau
The relevance of this discussion is that the earnings multiple at which a company should trade depends on what part of the S curve it is in.
A company in the early stages should trade at a very high multiple as it has lots of rapid growth ahead. Conversely, a company in the late stages should trade at a low multiple because its earnings are about to stagnate.
The market is usually fairly good at trading companies at multiples appropriate to this concept. Mispricing is introduced when it gets the diagnosis wrong.
Many start-ups trade at astronomical multiples in anticipation of hitting that nice part of the S curve, but if the growth fails to materialize then it is just grossly overvalued.
Similarly, later stage growth companies will trade down to low multiples in anticipation of the plateau, but sometimes they can just keep growing.
The key lesson here is that the S curve is just a tendency. Certain aspects of product or segment launch TEND to result in S shaped growth, but it is not a certainty.
The market has a bad habit of overutilizing the S curve model. It will misappropriate the S curve to the trading price of companies that get a sudden burst of growth even if it really doesn’t apply.
That is precisely what happened with Camden.
Camden trading price following S curve logic
The COVID pandemic interrupted development of apartments by destroying supply chains and making financing difficult to obtain. This resulted in undersupply of apartments in 2021 and early 2022.
Occupancy soared into the high 90s and landlords, particularly those in the sunbelt like Camden, suddenly had the power to raise rents dramatically. Camden began raising rental rates by 20% which was higher than ever before seen in modern apartment history.
This sudden acceleration in growth represented a strongly positive second derivative of earnings which set off the alarm bells of the market:
“That looks like the early stages of the S curve”
In classic fashion, the market traded Camden up to an egregious multiple that would require a full S curve to justify.
From January 2021 to January 2022, CPT’s multiple increased from 19X to 33X.
S&P Global Market Intelligence
Camden has been able to sustain the higher rental rates and the stronger earnings that came with it.
However, the pace of earnings growth was of course not sustainable. The surge in growth inspired quite a bit of development of new multifamily properties. As the growth was strongest in the sunbelt, development starts were most concentrated in the sunbelt.
Those developments started to complete and lease up in 2023 which pulled occupancy back down to a more normal level in the mid 90s and stalled out rent growth.
CPT’s renewal rates dropped from +20% in 2022 to about +0% toward the back half of 2023.
CPT
This represented a rapid deceleration of growth, a negative second derivative. This too triggered the market’s alarm bells.
“That looks like late-stage S curve, Camden is going to plateau.”
Naturally, the late-stage signal resulted in a cratering of CPT’s multiple.
It went from 33X FFO in early 2022 to 14.5X FFO today.
If Camden were an S curve type of company, these changes to the multiple may have been correct.
Camden traded as if it were an S curve company, but it is clearly not
In this snapshot in time, Camden’s growth followed the S curve.
That was an anomaly of the circumstances. Camden is absolutely not an S curve kind of company. It is a steady company that grows at a moderate pace continuously over long stretches of time.
S&P Global Market Intelligence
There is some acceleration and deceleration of earnings growth that happens as a result of cycles within the multifamily sector, but it consistently regresses to the mean growth rate.
Camden has linear growth at a moderate pace.
The mispricing
- At the start of 2021, Camden was a linear growth apartment REIT at a 19X multiple
- In early 2022, Camden was a linear growth apartment REIT with a 33X multiple
- Today, Camden is a linear growth apartment REIT with a 14.5X multiple.
Forgive the redundancy in the bullets above, the point is that Camden, unlike S curve companies, has a very steady trajectory. As such, Camden’s multiple should not really move much.
Earnings multiples (or FFO multiples for REITs) should be based on future growth. Camden’s long term growth is consistently positive at a moderate pace. Thus, its multiple should stay in a fairly tight band.
The 33X was far too high in 2022 and the 14.5X is too low now.
The 19X multiple of early 2021 was about right. That is the multiple at which it traded before the market started trading CPT like it was an S curve company. Today, the REIT market in general is cheaper than it was in early 2021 so I think the appropriate multiple for Camden is 17X-18X.
A simple story of consistent growth
Camden is, in my opinion, one of the best managed apartment REITs. It has a conservative balance sheet and consistently positions its portfolio into long term growth markets. In short periods of time within cycles these markets will have periods of oversupply and undersupply which will cause some fluctuation in the growth rate.
- 2021 and 2022 apartments were undersupplied in sunbelt markets
- 2023 and 2024 feature a wave of deliveries which are in lease-up phase and stifling rate growth
- 2025 and 2026 will have almost no new supply as construction starts dropped markedly in 2023.
So you get these little waves of growth. Rapid growth in the last two years, slow growth in the current year or two and then moderate growth beyond that.
CPT is a long-term company. The growth will average out to a moderate pace. That was the case in 2021 and remains the case today. The only difference is that it is now cashflowing at a higher level.
S&P Global Market Intelligence
Consensus estimates call for continued growth going forward.
S&P Global Market Intelligence
In my opinion the 2024 estimate is a bit too high given the magnitude of supply coming in, but there is also significant population and job growth to balance it out so perhaps CPT can manage some growth in 2024.
Longer term, the pace of growth seen in the four years above should be quite sustainable.
Summary of buy thesis
Understanding S curves and the way the market trades earnings multiples around them can be useful for trading rapid growth companies. It can also be useful to spot times when the market has misappropriated S curve logic to steady, mature companies.
That is what I believe happened to Camden as it perfectly fits the way in which its multiple has moved over the last three years.
Pricing an apartment REIT in this fashion is obviously incorrect and has led to mispricing in both directions. Presently, CPT is undervalued at a 14.5X multiple. Given the conservative leverage and steady growth I think a 17X-18X multiple is more appropriate for Camden which portends significant upside from today’s price.
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