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Homebuilders have been on everyone's radar lately, and for a good reason: They have been outperforming the S&P500 by a wide margin. The good news is that the rally has been propelled by an improvement in the industry and company fundamentals. The bad news is that the last time the sector was on everyone's radar was 2007. We all know what happened to the sector shortly after. Does it men that investors should stay away from the sector?


(Click to enlarge)


(Click to enlarge)

It depends on the profile of different investors. Conservative investors may want to take some profits here, especially if they did get in early. Aggressive investors may want to stay with the sector, as the fundamentals of the industry continue to improve. Home prices, for instance, rose by 5 percent in November, as inventories of unsold homes are at record low. Mortgage rates continue to stay below 4 percent, while unemployment rate is below eight percent. Lennar (NYSE:LEN) and DR. Horton (NYSE:DHI) have reported record revenue, earnings, and new order growth; and are trading at reasonable valuations. Most notably, short interest is still high for the sector, especially for Hovnanian (NYSE:HOV) -- 53 percent of the float -- and Standard Pacific (NYSE:SPF) -- 33 percent of the float, indicating that they are still doubters who may end up pushing these stocks higher, should the fundamentals continue to improve.

Company

Forward PE

Operating Margins

Qtrly Revenue Growth (yoy)

Earnings Growth (yoy)

Lennar (LEN)

18

9.97%

41.40

310.70

DR Horton

17.28

5.98

21.70

179.60

MDC Holdings (NYSE:MDC)

28.55

1.22

58.10

--

M/I Homes (NYSE:MHO)

23.30

23.21

47.50

--

Hovnanian

12.14

6.20

42.6

--

Standard Pacific

29.24

5.72

32

--

Source: Yahoo.finance.com

A word of caution: Homebuilders and materials suppliers are highly economically sensitive sectors. This means that an economic slow-down could hurt the sector, especially if it results in a slow-down in employment growth or a spike in mortgage rates-the most important drivers of home demand.

Source: How To Trade The Homebuilder Stocks