The Contrarian in Me Made Me Buy KB Homes

Includes: KBH, TOL
by: David Neubert

I spent a week away and this usually means movement in prices that create opportunities. I'm having a hard time finding shares to buy that I don't already own.

Home Builders: This weeks news is full of the following: Lower earnings reports, Home Sales Declines, decline in home prices, CNBC talking about the end of housing all day, cover stories about the end of the housing bubble in Barrons and the Economist, and stock prices down 50% in an up market. The contrarian in me has forced me to take a look at the home builders.

I'm not ready to buy a home builder outright but I did short a small amount of puts on KB Homes (NYSE:KBH) (price = $40.40). I sold the April 30 strike puts at $1.50; that gives someone the right to force me to buy the stock at $30. Why did I chose that strike price? I looked at where the stock traded before the housing mania really took off (between $20-$30). I also looked at old earnings and found that earnings of $4.40 for 2003 still translates into a p/e of 6.8. When I looked at First Call earnings estimates for 2008 of $6.20. That still translates into a p/e of less than 5.0 vs. $30 put strike (and a p/e of 6.6 vs. current market price of $40.40). According to Yahoo Finance, the book value of KB Homes is $37.66 per share; even with some losses on current contracts I think that the book value going below $30 is unlikely.

I will continue watching KB Homes and Toll Brothers (NYSE:TOL) for the right time to buy outright and in size. For now, I'm just putting on small positions so that I pay attention to the sector. One thing I do know about real estate cycles is that they tend to last about 15 years. That means this bubble may take as much as 7 years to unwind. But in that vein, the home builders do seem a better deal than REITS (Real Estate Investment Trusts).

KBH 1-yr chart:

KBH 1-yr chart

Disclosure: I am short April 2007, 30 Strike Puts on KBH. I may buy additional shares or engage in options strategies in KB Homes (KBH) or Toll Brothers (TOL) at any time based on market conditions.

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