Time to Get into Housing Stocks on the Ground Floor?
Alan Brochstein gives homebuilder stocks a closer look
The wisdom of the investment crowd isn't always what it's cracked up to be. One industry that's been given up for dead but that may be about to see better times is homebuilding. I know that my view, which I am just starting to form, may be premature, but this group has been in a bear market for 6 years now.
We are all familiar with the housing sector's recent history: Easy financing and soaring prices led to oversupply. Over the past several years, though, new home construction has ground to a halt. In the most recently reported month (May), Housing Starts came in at an annualized rate of 560K. While this was a bit higher than expected, it remains in a tight range that has persisted for 2 ½ years now and is well below the 1mm starts twenty years ago that grew to a peak of 2.3mm at the beginning of 2006.
One of the mistakes I think that many economists are making is misinterpreting recent Case-Schiller data on prices. While the media reports that prices have declined by 4% over the past year (reports, I might add, that are true), this figure doesn’t reflect the real picture, which is that housing prices have been bouncing along near the bottom since the beginning of 2009. The comparison of a single month is, in my opinion, just noise. See for yourself:
In fact, if you look closely, the Case-Schiller Index actually increased from where it was in the prior month. In any event, we will eventually get through the shadow supply of homes due to foreclosures. Interest rates remain very low. Improving employment and incomes, stabilizing home prices, and pent-up demand all suggest an eventual robust recovery in home sales.
There are 10 publicly-traded builders with market capitalization in excess of $500mm:
[click on the image above to enlarge it]
(As always: these stocks should not be considered as recommendations to buy or sell, simply suggestions for further research. You should always do your own due diligence before investing in any stock.)
The group as a whole is still seeing business decline, as sales in 2011 are expected to decline for every single company in this list (3rd column from the right). Next year, though, analysts are forecasting a bounce-back that will drive considerable earnings growth if it pans out. I have shared several metrics – let’s take them in order.
Most of these companies carry debt, which isn’t surprising given how much the builders have to pay to construct a house before selling it (land, materials, etc.). I have boxed the four stocks with net debt to capital below 30% (4th column from the left).
Most of the companies aren’t currently profitable – I have boxed the ones that are expected to be so this year. It’s pretty clear that strong balance sheets and some earnings are driving interest in the two names at the top of the list, which are sorted by YTD price return.
The next column is a great metric for beaten-up companies: Price relative to Tangible Book Value. This measures what you have to pay relative to the underlying assets of the company, excluding goodwill. I have boxed the five stocks that are below 1.5X.
While earnings are depressed, sales may be a better metric to consider. I have used Enterprise Value (the market cap plus the total debt less cash) relative to sales and boxed the ones below 1.5X.
Finally, I think the companies that are experiencing the least erosion in 2011 will probably merit more attention than those suffering larger declines in sales.
If you count the boxes in my chart, a few names stand out as meeting at least 4 of the 5 criteria above: Toll Brothers (TOL), NVR (NVR), Horton (DHI) and M.D.C Holdings (MDC). I intend to focus my initial research efforts on these 4 names. Remember, this is not a recommendation. You should conduct your own research and due diligence before investing.
If you like to consider contrarian investments, I believe now may be the time to begin to look at the homebuilders. I have shared some metrics on the entire group, which hopefully gets you started on your own research process. Geographical presence, market segment focus, and management quality are aspects that I hope to understand better.
Regards,
Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator
Disclosure: Alan Brochstein does not currently hold any securities mentioned in this post.
Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Trader Network, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.
Alan Brochstein maintains a business relationship with TradeKing.
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