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Background: I have made two macro calls on housing stocks while writing for Seeking Alpha.

First, on May 28, with the iShares Home Construction ETF (ITB) trading at $25.47, Seeking Alpha published my article titled 5 Reasons For Caution On Housing Stocks. ITB is $21.91 as I write this, so that was a lucky call.

Next, I published an InstaBlog on July 29 in which I changed my view of ITB to neutral. ITB was $21.75 then, so that was also a lucky call.

I'm now going to express a more nuanced view of the housing stocks.

Much of what I write will be relevant to a highly-correlated ETF that owns housing-related stocks, SPDR S&P Homebuilders (XHB). Despite its name, XHB owns many more non-homebuilding stocks than does ITB. Given the breadth of stocks XHB holds, this discussion focuses only on ITB and home construction stocks specifically. ITB itself is not an absolutely pure play on homebuilders, as two of the top 10 stocks it owns are Home Depot (HD) and Lowe's (LOW).

Discussion: The top 5 holdings of ITB by value are homebuilders, as this list from Yahoo! Finance shows:

CompanySymbol% Assets
Lennar Corporation Class A CommLEN9.95
PulteGroup, Inc. Common StockPHM9.75
D.R. Horton, Inc. Common StockDHI9.39
Toll Brothers Inc. Common StockTOL8.51
NVR, Inc. Common StockNVR7.01

Let's look at what a shareholder of each of these stocks actually owns. This has traditionally been paramount to homebuilder stock analysis. An old rule of thumb has been to sell homebuilders at 2X book and buy them at or below 1X book. There is good reason for this, and it worked in the bubble and crash, as well, though of course the many large writeoffs meant that book value one year was much larger than book value the next year. The rationale is that most of the book value of homebuilders is inventory of homes under construction or awaiting sale. As one of the mostly highly cyclical industries there is, homebuilding has been a difficult area for investors to participate in.

In addition, earnings simply cannot be predicted from one year to the next, and dividend payouts are scarce. Unlike a consumer non-durable company that we expect to continue to maintain its share of supermarket and convenience store shelf space (and mindshare), to most people, a home from one large homebuilder is comparable to that from another, so there is no brand loyalty. It's "one and done" for the homebuilder, so stock valuations should be stringent.

The top five homebuilders are now discussed in this manner, focusing on asset value. After the symbol, share price is provided as of Friday's close. Data provided is from Value Line and is their projected full-year earnings, annual dividend, and year-end book value. Thus in every case the book value presented somewhat exceeds currently-reported book.

LEN ($34.82): $2.00 EPS, $0.16 dividend, $20.95 book.

In other words, LEN yields about one-half percent and is projected at year-end (November fiscal year) to be trading close to twice book. The entirety of book value is comprised of inventory. Value Line gives LEN a mildly below average financial strength rating of 'B'. The stock traded in the $12-14 range merely two years ago.

PHM ($16.11): $1.20 EPS, $0.20 annualized dividend (recently reinstituted), $6.80 book.

Also rated 'B' for financial strength, PHM has rebounded from a low of $3.64 or so about two years ago. Value Line projects that by about 2017, book value will finally approximately equal the current share price.

DHI ($18.65): $1.35 EPS, dividends were $0.15 yearly but 2013 dividends were "paid" in 2012 for tax reasons, $12.50 book.

DHI merits a 'B+' rating for financial strength from Value Line. It is more conservatively valued by the Street in a variety of ways than is LEN or PHM. This may relate to DHI's typical clients, who are often buying their first homes. This has been a difficult area post-Great Recession, as we know. DHI is nearing full taxation on its profits, suggesting a higher quality of earnings.

DHI is the first of the stocks ITB owns reviewed so far that I feel is fairly valued- though not undervalued.

TOL ($31.47): $0.80 EPS, has never paid a dividend, $19.40 book.

The stock is trading at about 2X estimated sales per share for the current year, ending Oct. 31. Value Line estimates sales per share will not reach the current share price until about 2017, at which time it estimates book value will equal $29.70. Financial strength is 'B+'.

Meanwhile, over a decade ago, TOL would routinely post record earnings and typically trade at perhaps 30% above book. Value Line estimates Toll's operating margin this fiscal year to only be 7.5%, which is 4 points lower than that of D.R. Horton. So, despite Toll's reputation of selling high-margined homes to the affluent, reality appears to be different right now. Insiders have been busily selling their stock or exercising options and then selling.

I fail to see current investment merit in TOL relative to the market as a whole.

NVR ($912): $50 EPS, has never paid a dividend, $367 book.

NVR's price:book appears more elevated than it should appear, as it has had a practice of buying in stock rather than paying dividends. Shares outstanding have shrunk by 1/3 over the past decade, and as the purchases have been above book value, accounting conventions have mandated that book value take the hit.

I actually like NVR. It receives an 'A' for financial strength and an above-average Safety ranking from Value Line, the only homebuilder Value Line follows to receive either rating. NVR typically does not speculate in land purchases. Its preferred strategy is to take out options on land.

NVR was the only homebuilding stock I know that hit an all-time record post-crash, doing so last year and again this year. The stock is trading at around 1X current year projected sales per share.

If I had to buy and hold one homebuilding stock for the next seven years, it would be NVR.

Summary of the above: Of the five homebuilding stocks that comprise about 45% of the total value of ITB, three appear to me to be richly-valued, and only DHI and NVR appear reasonably valued- but not cheap. The stocks have benefited from unusually aggressive governmental policies (the Fed is a government agency and is therefore included in that statement), but government support can turn to neglect with little warning. Therefore, on fundamental grounds ITB may "need" some more time to let improving fundamentals catch up with valuations.

Let's look at the chart of ITB.

Technical considerations: ITB came into existence just as the housing bubble had begun to burst. Here is its entire chart:

Chart foriShares U.S. Home Construction ETF (<a href=

One can look at a chart any way one wants to, of course. This one is skewed because it makes ITB appear severely depressed. This is not so. Here is a long-term chart of LEN:

Chart forLennar Corp. (<a href=

Splits: Feb 26, 1992 [2:1], Apr 21, 1994 [3:2], Jan 21, 2004 [2:1]

That puts things in better perspective.

From a trading perspective, ITB rallied on Friday back toward its 50, 150 and 200 day exponential moving averages, but remains slightly below them. Thus ITB is now lagging a market that is near its all-time highs, and this action does not suggest that it is a standout for a new money purchase.

Interim summary: Homebuilder stocks may indeed trade higher starting right now and over time, such action could well prove to have been appropriate based on a number of profitable years. However, the housing sector of the economy did not merely suffer a bear market as it did in, say, 1990-1991 and 2001. A bubble occurred, and bubbles are, or at least used to be, rare occurrences. When the Tech Wreck occurred, bursting the NASDAQ bubble, investors were unwise to chase the recovery into 2006-7. The NASDAQ collapsed again, but in that collapse, it showed great relative strength, foreshadowing its leadership position since 2009.

My bias today is to be cautious about the housing sector (I think banks are better ways to be part of the presumed ongoing upturn), but we can all see the potential upside on the charts if housing really starts another up-leg. For that reason and for personal reasons, I own one smaller homebuilding stock. What follows is a brief description of M.D.C. Holdings (MDC).

MDC ($29.02): As the chart shows, MDC has been a success story:

Chart forMDC Holdings Inc.

Splits: Feb 1, 2001 [11:10], Dec 13, 2001 [110:100], May 8, 2003 [11:10], Mar 4, 2004 [11:10]

What the chart does not show is MDC's investor-friendly dividend policy. It has paid dividends every year going back at least to 1997, where Value Line's data begins. Even during the recent difficult years, MDC maintained the $1/share dividend it first paid in 2006. Last year, it paid the 2013 dividend at year-end last year, but the expectation is that quarterly payouts will resume next year. The share count barely changed since the housing bubble popped. Debt levels are expected to end the year at 2007 levels, with working capital only a few hundred million dollars below 2007 levels. These data are consistent with the general view that this Denver-based homebuilder is a solid company.

Value Line gives MDC a 'B' for financial strength. Income tax rates are expected to normalize next year at 38%, when expectations are that it will earn $2.30-2.40 per share. Since guessing homebuilders' earnings next year is really a wild guess, it makes sense to continue to focus on fundamentals.

MDC is expected to end the year with a book value around $25/share. Sales per share may be over $32/share, with operating margins around 9%. P/E on this year's earnings will be skewed by a very large favorable tax benefit of $3.80/share, but excluding that, the company may earn $2.80/share.

The expectation that earnings will decline from one year to the next used to be reported as a positive for future price performance, as it keeps momentum traders away; whether that has been true in recent years in unknown to me.

The major knock on MDC is that it has a relative shortage of buildable lots, and will have to pay up to catch up to competitors in that regard.

My own take on MDC is that it is a reasonably well-run company trading at a relatively cheap valuation, and that the shortage of lots probably can be overcome without destroying MDC's relative valuation advantage over better-known competitors. MDC reached $42/share both last year and this year. Over time, I think it's reasonable to look for book value to climb to $30/share and for the stock to trade at or above 1.5X book. If the company continues its $1/share dividend policy (or raises the payout), the wait can be pleasant.

MDC certainly has risks, and a relative shortage of lots is not a trivial matter. Overall, though, the company is participating in the industry's rebound and has enough fundamental support to make it my one holding in the sector.

Conclusion: It is not easy to get a read on a post-bubble, post-crash sector that has received unprecedented governmental support. It is also unclear what home buying power the traditional group of buyers- young couple and families moving up to larger homes- will have in the next few years.

Even though stock prices and home sales are depressed from their peaks for the industry as a whole, this burst bubble is a phenomenon to be treated with respect. The earnings picture for the companies discussed above is unpredictable, and tincture of time may be needed before the stocks are sounder buys. In addition, the technical situation of ITB and its constituent stocks is not ideal. That said, homebuilding is an absolutely core part of the economy. Thus I'm comfortable trying to pick one specific homebuilding stock to own. As discussed briefly above, I have for now gone with MDC as a rebound play with the hope of decent dividend income to cushion whatever wait there may be for it and the sector to return to favor in investors' eyes.

Source: Assessing A Homebuilder Stock ETF; Why I'm Long M.D.C. Holdings

Additional disclosure: Not investment advice. I am not an investment adviser.