While there are several hurdles to faster U.S. economic growth, the housing market's lackluster response to the substantial monetary policy stimulus has been a notable impediment. Still, the rebound in housing this year is remarkable. Year-to-date, single-family housing starts are running 21% higher than over the same period last year. There have been consistent increases in both home sales and prices as buyers are taking advantage of substantially improved affordability. New home sales were up nearly 28% year-over-year in August, while new home prices rose 11% over the same period to the highest level in more than five years. Existing home sales were up 9.3% in August over the year-ago levels, while prices were up 9.5% over the same period.
The improvement in housing has been a boon to the housing stocks. Equity analysts at Goldman Sachs upgraded the sector last month, citing home price improvements, low inventories, and reduced risks of major additional foreclosure waves. Several housing market-related stocks that pay dividends are going to benefit from the new trend. Here is a closer look at five such dividend plays that are likely to gain from a continued recovery in the housing market.
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MDC Holdings (MDC) is a $2-billion homebuilder and provider of mortgage loans and third-party insurance products to the homebuyers. It builds single-family detached homes for first-time buyers and people moving up. MDC Holdings pays a dividend yield of 2.5%. While the company operated at a loss over the trailing 12 months, it has returned to profitability in the first quarter of this year. The company has maintained its dividend at a rate of $0.25 per quarter since 2007, even though, on average, the homebuilder's earnings were deep in the red over the past five years. The company is expected to boost its EPS at an average rate of 10% per year for the next five years. Based on the forward earnings, the company's payout ratio is about 100%; however, it is likely to decline as earnings improve in the forthcoming period. MDC Holdings is on Goldman Sach's conviction buy list, boasting the highest rating because of its strong balance sheet and the perceived analysts' underestimation of orders. MDC Holdings beat analysts' estimates in the second quarter by nearly 300%. While the company's forward P/E is well above the average for the industry, the company pays the highest dividend yield among its peers. For the reference, Lennar Corp. (LEN) and D.R. Horton (DHI) pay dividend yields of 0.4% and 0.7%, respectively. Among fund managers, value investor Chuck Royce and billionaire Israel Englander hold stakes in the stock.
Williams-Sonoma Inc. (WSM) is a $4.5-billion specialty retailer of home products. The company pays a dividend yield of 2.0% on a payout ratio of 38%. Over the past five years, the company's EPS and dividends grew at average rates of 4.4% and 14.0% per year, respectively. Analysts forecast that the company's EPS will grow at an average annual rate of 13.2% per year for the next five years. Given the company's relatively low dividend payout ratio, the acceleration in EPS growth bodes well for continued dividend hikes in the future. For the reference, competitor Pier 1 Imports Inc. (PIR) pays a dividend yield of 0.8%, while Bad Bath & Beyond Inc. (BBBY) does not pay regular dividends. Williams-Sonoma Inc. beat analyst estimates in the second quarter due to its top-line growth driven by a double-digit growth in the direct-to-customer segment. The company is also expanding internationally, with a market entry into Australia. As regards the company's valuation, on a forward P/E basis, Williams-Sonoma Inc. is trading below its respective industry and on par with the broader market. The stock has a free cash flow of 3.6%, ROE of 19.5%, and return on invested capital [ROIC] of 19%. It is up 17.4% year-to-date. Fund managers John Armitage (Egerton Capital Limited) and Robert Joseph Caruso (Select Equity Group-check out its top picks) are bullish about the stock.
Home Depot (HD) is the largest U.S. home improvement retailer with a market cap of some $95 billion. The company is paying a dividend yield of 1.9% on a payout ratio of 42%. Its main competitor, Lowe's Companies (LOW), is paying a dividend yield of 2.1%. Over the past five years, HD's dividend grew at an average rate of 5.2% per year, even though the company's EPS was slightly in the red. The housing rebound is expected to boost the company's EPS to an average annual rate of 14.5% per year for the next five years. This could bode well for higher dividend payouts in the future. HD beat analyst earnings estimates for the second quarter, with EPS growing 17% over the past year's level. The company has maintained its top-line growth of 4.6% year-over-year and has raised its earnings projections. As the stock price has reached an all-time high, the company's valuation has become lofty. On a forward P/E basis, HD is trading at a premium to its industry, including its main competitor. The stock has a price-to-book and price-to-sales ratios substantially higher than those of its peer group on average. HD's free cash flow yield is 3.6%, ROE is 24%, and ROIC is 15%. The stock recently saw some insider buying, as one of its Directors acquired 1,667 shares in the open market.
Lowe's Companies is the second-largest U.S. home improvement retailer, with a market cap of $36 billion. The stock pays a dividend yield of 2.1% on a payout ratio of 43%. This yield is higher than that of the company's main competitor, Home Depot. Over the past five years, Lowe's grew its dividends at an average rate of 20.3% per year, even though its EPS shrank at an average annual rate of 6.3%. Now that the housing market has rebounded, the company is expected to boost its EPS at an average annual rate of 14.7% for the next five years. The acceleration in Lowe's EPS bodes well for future dividend hikes. Lowe's comparable sales and profit have been relatively weak, underperforming Home Depot's. The company's recent $1.8-billion bid for Canadian home improvement retailer Rona, which was supposed to expand Lowe's Canadian operations, was rejected. Standard & Poor's estimates that now Lowe's will use all its discretionary cash flow for share repurchases. As regards its valuations, Lowe's forward P/E is below that of its main competitor, Home Depot. The company also has price-to-book and price-to-sales ratios below those of its peer group on average. The stock has a free cash flow of 4.1%, ROE of 11.5%, and ROIC of 7.6%. Among hedge fund managers, Edgar Wachenheim (Greenhaven Associates-see its top picks) and Tiger cub John Griffin (Blue Ridge Capital) are the largest investors in the stock.
Stanley Black & Decker (SWK) is a $13-billion company selling power and hand tools, mechanical access solutions, and electronic security and monitoring systems. To a large part, its fortunes are tied to the construction industry. The company's dividend yields 2.6% on a payout ratio of 56%. The company's main rivals Danaher Corp. (DHA) and Makita Corporation (MKTAY) pay dividend yields of 0.2% and 3.3%, respectively. Over the past half decade, Stanley Black & Decker's EPS and dividends grew at average annual rates of 4.1% and 7.3%, respectively. Analysts forecast that the company's EPS growth will accelerate to 12.5% per year for the next five years. Recently, analysts at Morgan Stanley upgraded the stock to "overweight" from "equalweight" based on the assumption that the company's EPS will rise 18% in a year if the U.S. construction industry recovers modestly, and as much as 66%, if the recovery is robust. The company is attractive on valuation. Stanley Black & Decker is currently trading at a major discount to its respective industry. On a forward P/E basis, the stock is trading on par with its peer group on average but well below its five-year average ratio. The stock has a free cash flow of 2.8%, ROE of 8.8%, and ROIC of 6.1%. Activist investor Richard Breeden (Breeden Capital Management) and fund manager Christopher Medlockjames (Partner Fund Management-check out its top positions) are bullish about the stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.