Homebuilders Laying The Foundation For Growth

by: Todd Campbell

The U.S. Census Bureau gave homebuilders (NYSEARCA:XHB) additional good news today. January's housing permits came in at an annualized 676,000 rate, good enough for 0.7% growth from December and a more impressive 19% uptick from January 2011.

Similarly, housing starts also improved. They came in 1.5% above December and 9.9% above last year. Admittedly, housing starts data have a huge margin of error. But the direction is nonetheless encouraging for investors eager for signs the housing market has troughed.

The improvement comes following bullish information released at the end of January, which showed a decline in both inventory for sale and days on the market.

Investors have anticipated an improving housing market this year, bidding shares of building stocks higher since last fall's market low. Across a broad sampling of building stocks, returns have far outpaced the S&P 500 since the end of September, with both Hovnanian (NYSE:HOV) and KB Homes (NYSE:KBH) increasing by more than 100%. Ryland (NYSE:RYL), Lennar (NYSE:LEN), Toll Brothers (NYSE:TOL) and D R Horton (NYSE:DHI) have all gained more than 50%.

Symbol 9/30/2011 2/15/2012 % Change
HOV $1.22 $3.02 147.54%
KBH $5.77 $12.39 114.73%
RYL $10.60 $20.47 93.11%
LEN $13.48 $23.56 74.78%
TOL $14.43 $23.57 63.34%
DHI $8.99 $14.53 61.62%
SPY $112.44 $134.56 19.67%

Some will worry valuations make investing in homebuilders too risky. However, those worries don't consider price to earnings ratios of cyclicals, including home builders, are typically highest at the bottom, not the top. And, while stocks have moved significantly higher over the past few months, they remain well below their cyclical peaks, suggesting additional upside.

It's also important to consider these stocks, for the first time in years, are back on technician's radar. Long term downtrends have been broken to the upside and monthly stochastics have turned positive. This will put additional pressure on short sellers, who are betting foreclosure activity will keep a lid on pricing and profits.

But, with an expanding economy and improving job growth, the glut of inventory will eventually be worked off. Absent a double dip in our economy, these stocks are unlikely to see those cyclical lows again - at least until the next cyclical trough. And that means housing related stocks could enjoy tailwinds for years rather than days.

Disclosure: I am long KBH, LEN.