Can You Judge A Homebuilder By Its Book Value?

There is a fascinating article in Monday's WSJ about a contentious valuation debate: Homebuilders judged by their book value. What makes this intriguing is the combination of players in the space: The Homebuilders are loved/hated by an odd amalgam of value investors, technicians and short sellers.

Over the past year, I have been amazed that every bounce and short squeeze after a major drop has been declared proof of a bottom in Housing. With the biggest problem in the residential homebuilding sector being the enormous competition from the huge overhang of inventory for sale, I suspect the Homebuilders have a ways to go before they are attractive again.

Meanwhile, as this debate plays out, the ISE Homebuilders Index made a new multi-year low on the weekly charts:

ISE Homebuilders Index

Source: Stockcharts.com

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Here's an excerpt from Monday's Journal:

"A year ago, home-building companies looked like bargains. Looks can be deceiving. Many companies were trading near book value -- a rough estimation of what they would be worth in liquidation and typically a green light to investors to buy the stocks. Turns out it was a faulty signal, and one that is flashing to hopeful investors again.

Value-seeking investors bought into the sector, and the builders' stocks surged toward the end of last year. But the subprime debacle and a rising supply of unsold homes have sent home-builder shares plummeting, erasing most of their gains.

So, this time around, investors may be gun shy about following the old rule of thumb of buying the home builders at book value and selling after the shares have appreciated to at least twice book value.

The problem is that book value is more of a moving target than a sure sign of a bargain. Book value is a company's assets minus its liabilities. Typically for builders, their largest asset is land, which in some cases, amid falling home prices, is no longer worth what they paid for it. That has forced builders to write down the land on their books. Meantime, the builders are still paying down the debt that they used to buy much of the land.

At the end of June, for instance, homebuilders were trading at 1.1 times book, with some large companies, such as Beazer Homes USA (BZH) and Hovnanian Enterprises (HOV), going as low a multiple as 0.6, or 60% of book value, according to Morgan Stanley."

Fascinating stuff . . .

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Can you judge a Homebuilder by its Cover?


chart courtesy of WSJ
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Source:
Rule of Thumb Hammered
Judging Home Builders By Book Value Can Sting As Write-Downs Mount
MICHAEL CORKERY and KAREN RICHARDSON
WSJ, July 9, 2007; Page C1
http://online.wsj.com/article/SB118394489186360570.html

Comments

[Johnny Bitc...:]

Barry -

This is not fascinating at all.

Can you be more specific about the fascinating elements of the WSJ article and your link with chit-chat ?

Don't you realize that the Wall Street Journal is readily available to anyone that wants to read it ? Is your link with a phony claim that it is fascinating really needed in the chit-chat marketplace ?

One gets the feeling that you don't do any work, but think that links to readily available journalism is some kind of service.

Now, if you wanted to do work, you might have provided some kind of basis for your "suspicions" about whether there is value in the homebuilders.

Has there ever been a market chit-chatter that has said so little with so many words ?

John

2007 Jul 10 06:09 PM

[yourfilled:]

Barry,
Gee. O thought the article was great. I am short the builders and know that book value means nothing when it comes to builders. The question is would a home builder stock be worth more tomorrow than today. I think not. Or the other question, do you think your home will be worth more or less within a year or so? As a futures trader here in Chicago a 50% retracement is no big deal for a coomodity and certainly not for a stock.

Thanks,
[e-mail]

2007 Jul 10 10:19 PM

[wixeywaxy:]

John, your memesis, shows himself to be a discusting jerk even if he is a mental case for whom perhaps we should cut some slack. All that venom he uses to express his opinion offends me as well and I'm sure everyone else who is exposed to his poision. Vic.

2007 Jul 11 12:11 PM

[wixeywaxy:]

Now comment to the point: I think that it's a big mistake to put any importance on book value. I worked in property accounting for a large corporation for several years as a young man so feel that I have an informed opinion. First of all the book value means nothing in bankruptcy for many reasons. The lawyers will get most of it. The assests may be and ususally are somewhat to totally obsolete even though they aren't fully depreciated. An asset may be of no value to any other organization. The cost of dismatling them and reinstalling them very often is far more expensive than simply buying a new and not worn out piece of machinery etc. That doesn't exhaust all the negatives. Book value is an accounting creation and those who put a lot of importance on it are ill informed. The only way to evaluate a business is to have experts specifically knowledgeable with the particular properties and lawyers who can evaluate the legal entanglements of liquidation, environmental clean up etc. Vic

2007 Jul 11 12:23 PM

[Paul Meisel:]

I generally agree. If you already know a lot about the company you may have a good idea where it should trade to book, or maybe not, but just looking at the numbers in isolation?

2007 Jul 11 05:15 PM

[Johnny Bitc...:]

Vic -

Your foolishness is eclipsed perhaps only by chit-chat master Ritholtz.

Book Value is is an extremely important number, most especially for companies which are not profitable or cash flow positive, as is the current case for the homebuilders.

The challenge is to make sure it is based on current market values, and this is a formidable challenge when land and / or housing inventory values are falling. And naturally you have to project where that fall might level out. Valuation challenge and a moving target ! Nonetheless a very important number.

As far as your blah, blah, blah about bankruptcy goes, there is currently no immediate danger of bankruptcy and the industry will do a big time consolidation before that happens. Jobs will be lost, many at the administrative overhead and executive levels......and competition will be reduced until these newly consolidated entities are healthy and profitable (probably a 3 year process).

Book Value is the single most important metric for value buyers which might be attracted to these companies, but predicting the trajectory of land and housing stock values on the balance sheet is not easy.

Therefore, it is quite likely that many of these companies will fall below book value and the actual honest accounting (impairment charges) will lag by a quarter or 2 or 3 depending on the forthrightness of the company accounting policies and the negative impact of honest accounting on the debt covenants.

Hold your horses on the bankruptcy talk........you are starting to emulate Ritholtz the emotional stock market chit-chat queen.

John.

P.S. I have no personal animus against Ritholtz. It's his foolish and repetitively irrelevant, casual, and non-constructive commentary that bothers me. Perhaps someday he will admit that his generally negative views over the course of many years have been a result of his personality and not any particular work that he's done. But hey, if you can figure out a way to make money by providing URL links to the Wall Street Journal followed by opinions like "fascinating stuff"......more power to ya. Clearly his return on effort must be high, because there is little evidence that Ritholtz does work

2007 Jul 11 03:17 PM

[Paul Meisel:]

John -- Barry puts his stuff on his own blog, where no one is forced to go read it. The Seeking Alpha editors pick up some, not all, of his blog posts. Your beef is with them.

It's a free country, ignore Barry if you want. I seldom agree with him myself, but I like to hear different opinions sometimes and that's why we are in America.

2007 Jul 11 05:17 PM

[Johnny Bitc...:]

Paul -

Never said I wanted to ignore him. I would prefer to help expose his "arguments" as phony, casual, and lazy market chit-chat.

The general thrust of his arguments have been wrong for many years, but if you read his self-congratulatory crapola you get the feeling he thinks he's been right about something.

Of course he never goes on the record with anything that would stand as a clear statement of belief - just backward looking chit chat and insinuation.

Ritholtz seems to be a randomly created personality created by appearing on CNBC, but his so-called analysis is so thin.....that one must assume his clients or readers are fools. I really wonder whether he makes money by posting his b.s. - is he selling advertisements or other junk at his blog site ?

I presume that he gives Seeking Alpha permission to pick up his chit chat.

Anyway, it's good that Seeking Alpha provides this forum to help expose market charlatans. Alright, maybe charlatan is a little strong, but Ritholtz arguments are so loosely supported that he seems no better than a bored retiree hanging out watching CNBC all day.

john.

2007 Jul 12 08:44 AM

[psvoltz:]

First of all John, the only negative prick around here is you. Beat it.

Second, I am an MAI trained commercial real estate appraiser with many publicly traded developers as my clients. In addition to being part of the boots on the ground brigade, my degree is in Finance and I earned an MBA. I am as qualified as anyone to have an opinion. My practice is located in a high growth area of southern California. I also trade the XHB.

All values are anticipations of cash flow. Period. Book Value is irrelavant.

The outlook is not bright for development for the forseeable future until the subprime loans roll in 2008 and 2009. The only bright spot is the long-term growth of the population, particularly in California.

2007 Jul 12 01:59 PM

[Johnny Bitc...:]

Cal State MBA Boy with other meaningless 3 letter acronyms:

re: All values are anticipations of cash flow. Period. Book Value is irrelavant.

Just for your information, book value can be an important component to consider when projecting future cash flows:

1. If a company does not produce sustainable and positive cash flows, as will likely be the case with many homebuilders, and becomes a takeover target.

2. In a bankruptcy dissolution where assets are sold off to payoff creditors and employees in hopes that value remains for shareowners.

While it is possible that many of the stronger homebuilders will return to sustainable positive cash flow and earnings, at which time one will be in a better position to predict the relevant cash flows.

However, at the moment these are value investments and value investors do, in fact, care very much about book value, and even a clown like yourself should care as well (though we can suspect you will pretend that your Fullerton MBA has taught you something about Finance - don't fool yourself, your words convey a pretty limited understanding).

I highly doubt you are as qualified as anyone, but your confidence in the face of your limited understanding is admirable in a somewhat pathetic way.

And I presume from the term "practice" that you are referring to some kind of commission based job where you try to convince people to buy things you don't understand - right ? Just remember , you a salesman.....people don't fall for terms like "practice" "clients" "consultant" - just be proud to admit you are a salesman and didn't learn a lick about Finance at Fullerton, and this MAI thing is handed out to any clown that wants to pay for it.

Am I wrong ?

John.

2007 Jul 12 11:21 PM

[Paul Meisel:]

John:

In one word: Yes

In two: circular argument.

2007 Jul 13 07:19 AM

[psvoltz:]

John,

1) Exactly which publicly traded homebuilders have entered bankruptcy, hinted at bankruptcy, either in this real estate cycle or the last cycle? Good luck trading on your book value theories though. I don't think, nor does the board seem to agree, that your book value trading theory holds much merit.

I am not a broker or in any way commission based and my MBA is from one of the most prestigious private colleges on the West Coast.

You are a smug elitist. Probably an Ivy Leaguer. And a Democrat.

I made a killing on New Century puts. How did you do?

2007 Jul 13 11:51 AM

[Paul Meisel:]

As our "president" has shown us, you don't need to be a Democrat to be a smug, mis-informed Ivy Leaguer.

2007 Jul 13 12:44 PM