How to Trade on Homebuilders' Profitibility

I’m still working on the research here, but I’ve come up with an idea on profiting from the homebuilders’ continued weakness, and overselling.

It’s fairly simple: just buy the builders, such as Beazer (BZH), or Comestock Homebuilding Companies (CHCI), who are trading below book value, and then short an appropriate amount (i.e. buy puts on) of the S&P/Case-Shiller Housing Price Index.

The thesis is as follows: several of the builders are trading at mere fractions of book, largely due to the fact that investors anticipate plenty more write-offs of inventory, consisting of unsold homes, and land, going forward. This inventory comprises the vast majority of these companies’ tangible asset values, so it naturally makes sense that discounts to book are largely due to fear that the asset values are overstated. Normally I’d simply buy, and hold such cheaply priced companies, but the truth is that I haven’t a clue where housing prices are headed in the future, or how much in charges to inventory the builders will take.

What I do know is that a company like Beazer Homes, for instance, has a geographically diversified portfolio of decidedly normal homes which I believe, on average, to be well-representative of the typical American house. The average unit price is listed on the company’s books at around $220,000, and, interestingly, the average composite home price can be shorted using Case-Shiller, at around the same price.

This means a savvy investor can effectively profit from the spread/discrepancy between the book value, and the price of Beazer’s stock by hedging out the write-down risk via a short position in the Case-Shiller composite. While I’m not positive, I’m fairly confident that an inefficiency in the smaller homebuilders’ pricing exists since most investors are not considering how they can come close to eliminating the risk of write-downs. Of course, this is assuming that investors are also willing to stomach the risk of heavy debt, poor management, for example, but for some it may be worth these risks.

BZH vs CHCI 1-yr chart:

Disclosure: I do not currently have a position in Case-Shiller futures, or any homebuilding stocks.

Comments

[phdinsuntanning]

profit i billy? you will go down with the titanic billy,
dont confuse oversold with overbroke
profit ability, the ability to get profits,
yo dont do that buying scrap or dead corpses,
except maybe copper scrap...
or selling the organs to surgeons,
the question is who are the surgeons?
they are invested in euros by now...