With our government doing everything it can to prop up the housing market, and the Federal Reserve practically begging borrowers to take out record low interest mortgages, it's not surprising that homebuilding stocks have rallied nicely since the subprime meltdown and financial crisis of 2008. Major homebuilders like DR Horton (NYSE:DHI), Pulte (NYSE:PHM), and Lennar (NYSE:LEN) aren't quite back to their pre-crisis peaks, but they've all doubled or even tripled from their bottoms.
These big industry players may continue to rise as the housing market (hopefully) continues to recover, but their biggest gains are likely behind them, as the market has already priced in expectations of better days to come. But that doesn't mean there aren't opportunities out there. I went homebuilder shopping recently and I quickly moved into one fast-growing company with a solid foundation: Houston's LGI Homes (NASDAQ:LGIH).
As the old saying goes, there are three keys to success in the real estate business: location, location, and location. The same is true when it comes to picking the best homebuilding stocks. Investors should focus on companies building homes where people want them the most. These days, that means the Southeast (especially Florida), the West, and of course my favorite region of all in recent years: Texas.
DR Horton, the nation's largest homebuilder, is headquartered in Fort Worth, and its home state is booming. Scores of companies have relocated there in recent years, bringing thousands of new jobs and prospective homebuyers with them. Florida has also been experiencing an ongoing population boom. These demographic trends show no signs of abating, either. A study just released by the U.S. Conference of Mayors projects that five of the ten fastest-growing metro areas in the country over the next six years will be in those two states.
Like DR Horton, LGI Homes is based in Texas and builds a lot of homes there and in Florida. Unlike DR Horton, its small size, low stock price and healthy growth prospects make it a potential two to three bagger in the next 18 months. It came public roughly nine months ago, yet it has surprisingly miniscule forward price-to-earnings and market capitalization-to-revenue multiples, probably because of its modest annual revenues (only $241M in 2013) and poor coverage by Wall Street (only five analysts).
At its current price of roughly $18.50/share, LGIH sells for only 15x, 8x, and 6x consensus 2014, 2015, and 2016 earnings per share. If that's not a textbook definition of a "Growth-at-a-Reasonable-Price" stock then I don't know what is. And that growth is only going to accelerate as more people continue to move into its prime areas of concentration. Best of all, its currently small revenue base means LGI's growth will produce eye-grabbing gains on a percentage basis, which will compel more analysts to cover it and rate it a buy.
Another important factor that helped close the deal for me when it came to buying LGIH was the value the company offers potential customers. The median price of its homes is $154,000, considerably lower than the new U.S. median home price of $270,000. That's a huge savings, especially for young and first-time homebuyers. LGI expects to sell 2200 homes in 2014 and 3200 homes in 2015. Those numbers seem conservative to me, given the red-hot job and population growth in Texas and Florida. I think it's likely LGI outpaces those estimates, perhaps by wide margins--just as it did in the March 2014 quarter. Wall Street was estimating EPS of 13 cents for that quarter. LGI demolished those figures and came in at 22 cents.
Finally, LGI Homes only has 21 million shares outstanding, so its market capitalization is a smallish $388 million. As the company's earnings and share price increase, a more sizable market capitalization will enable larger real estate-focused funds to initiate meaningful positions in its stock. That will only boost it higher. Put all of these factors together, and LGI should build itself into a very solid investment.
Disclosure: The author is long LGIH. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.