Recently Updated Articles
- Side-Step the Selling With These 5 Big-Name Trades
- 3 Stocks Breaking Out on Big Volume
- 4 Stocks Rising on Big Volume
- 3 Stocks Spiking on Unusual Volume
- A Small Stocks to Play the Ukraine Crisis
Why I Like Homebuilders This Fall -- But Hate the ETFs - views
BALTIMORE (Stockpickr) -- I like homebuilders right now. There, I said it.
Maybe hesitant is an understatement. Let’s face it: Most investors were too nervous to buy homebuilders at the start of the year when the housing data started turning, and they’re even more nervous now that homebuilding stocks have made such a big run. >>5 Stocks Everyone Hates – But You Should Love But I think that those are both bad reasons to ignore homebuilders right now. And I think that a few names in particular are worth buying. More on that in a minute.
First, the data is good. Really good.
Housing starts, the number of new homes builders are laying hammer and nail to, are up 21.5% in the last year. And they’re up 56% from the bottom back in the middle of 2009. The nationwide S&P/Case-Shiller Home Price Index has been making a turn higher too, ticking higher since the start of the year, when it looks like it too found a bottom.
And if sentiment is looking down for homebuilders, no one has told them lately. The NAHB/Wells Fargo Housing Market index, a datapoint that measures sentiment homebuilders (for business conditions, not share prices), popped up to 37 in August. That’s the highest the level has been in five years. >>5 Stocks to Buy to Be Like Buffett Why shouldn’t sentiment be good, though? While it’s clear that a rising tide lifts all ships in the housing market (we’ve already seen the effects of the falling tide, remember), new homes and pre-existing homes are two very different animals. New homes are just bouncing back at breakneck pace right now. In fact, capacity is basically the biggest constraint that homebuilders are facing in most markets. After paring down their balance sheets after the crash, they don’t have the project sites or the skilled labor to build homes fast enough.
And it’s worth noting that while housing starts have rebounded, they’re still far below their historic averages. In fact, they’re still lower than they were at anytime between 1959 and 2008. Even in a recession, the housing market can absorb more inventory than is coming online right now.
Let’s not forget that interest rates are near zero, inflation’s tipping 2.2%, and debt-to-disposable income here in the U.S. is now at one of the lowest rates of all OECD countries. So banks have lots of free cash, but they’re getting penalized for holding onto it, and there are a bunch of borrowers who are a whole lot more credit worthy than they were just a few years ago. There’s probably a way to connect those dots.
Have Homebuilders Rallied too Far?
A lot of folks are worried that homebuilders have already rallied too far. I understand the concern, but I don’t buy the logic.
Here’s the bottom line: Who cares if a stock is “more expensive” today than it was yesterday as long as it keeps getting more expensive until you sell it?
From a relative strength standpoint, the homebuilder rally isn’t showing any signs of fizzling out yet. In fact, relative strength lines for many homebuilders have been accelerating in the last month or two. Statistically, that indicates to higher ground yet to cover in 2012.
So which stocks make sense to buy? >>5 Big Stocks Set to Slingshot Higher I like the big ones, namely Toll Brothers (TOL), Lennar (LEN), and NVR (NVR). For starters, the big ones have a lot of eyes on them. That’s important -- maybe more important than you’d think.
In the wake of the “Great Recession,” suddenly all of the new homes and empty land sitting on builders’ balance sheets had to be written down substantially -- and the persnickety auditors at Big Four accounting firms were going over those asset lists with a fine-toothed comb. Big is important for two reasons: it means that more eyes are on the balance sheet and it means that accountants have a higher volume of transactions to use to value the rest of these firms’ assets.
In 2008, the stock market crashed and in 2009 in bounced back hard. The real estate market has been doing a slower, version of that same song and dance too. But here’s the thing: By and large, GAAP accounting rules only let homebuilders mark their assets down, not back up (unlike firms that own stocks, for instance). So as home prices make a slow ascent, the folks who buy homebuilders now are going to get bigger realized gains as a result of that one-way street in accounting.
The big names also tend to be better at owning a niche. Take Toll Brothers, for example. The $5.6 billion firm focuses on building high-end homes -- last year, the average selling price was more than $500,000. That positioning gives Toll Bros. access to a market that’s filled with qualified, bargain-hungry buyers.
While the recession did shake out the weaker-handed homebuyers, it’s left a group of consumers who are more apt to take on mortgages at record-low rates, and are more likely to relocate for new job opportunities. Toll has been one of my favorite homebuilders for the last year -- and it’s still the one that tops my list.
NVR is another strong choice, especially for investors who are still a little queasy about homebuilder stocks. The firm didn’t have to take the same sized write-downs that many peers ate because they didn’t over-leverage themselves with speculative land in the first place. Instead, NVR was consistently one of the best-run homebuilders leading into the housing bubble, and today the firm carries essentially no debt on its balance sheet, a rarity for the industry.
Better still, NVR’s business is focused around one of the strongest housing markets in the country: the Baltimore-Washington corridor. That geographic positioning spared NVR from taking severe write downs to its existing inventory. Plus, the company thinks it’s cheap too. The firm has been aggressively buying back shares in the last couple of years, deploying significant free cash to eat up almost 20% of its outstanding shares.
Meanwhile, Lennar is the value proposition in the homebuilder business. It sells homes that are skewed toward the low to middle end of the spectrum, focusing on first-time homebuyers and move-up purchasers. One important factor in Lennar right now is its short-interest ratio: with so many people betting against LEN this stock could be a prime short squeeze candidate.
Like the other two homebuilders I’ve mentioned, Lennar is in solid financial shape, with $1.4 billion in cash and investments offsetting a $4 billion building debt position. And that balance sheet is likely way more conservative than the short sellers are willing to admit. The firm’s blockbuster second quarter earnings are evidence of that.
Don’t Buy Homebuilder ETFs
With the price action homebuilding stocks have seen so far this year, homebuilding ETFs have been getting a lot of attention. The SPDR S&P Homebuilders ETF (XHB) and the iShares Dow Jones US Home Construction ETF (ITB) are two popular funds that a lot of people have been looking at. Don’t buy them.
Both of these funds own homebuilding stocks, but they also own a bunch of randomly related businesses, from home improvement retailers to mattress companies. Ironically, maybe half of the stocks in each of these funds aren’t homebuilders at all, but I get that “The Homebuilders and Some Other Stuff ETF” doesn’t have the same ring to it. Managing such a big portfolio is a big job -- and the ETFs charge you management fees for their trouble.
If you want real homebuilder exposure, skip the ETFs and stick with the stocks.
To see my homebuilder stocks in action, check out the Homebuilder Stocks Portfolio on Stockpickr.
Twitter and become a fan on Facebook.
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.