Top 10 Pick: Buy Hovnanian Enterprises

| About: Hovnanian Enterprises, (HOV)

Depending on your situation, this advice might be more valuable than any of my 10 stock picks for 2013: If you don't own a home and you're capable of buying, then drop whatever you're doing and get started looking. Right now. If my read of the cycle is correct, prices are going up in a meaningful way over the next couple of years. In fact, my bet is that you won't see prices this cheap again in your lifetime. You'll never see mortgage rates this low, either. So, get after it (if you can).

Now, if you've got dollars to allocate to the stock market as well, then that's where I can be of help. I've got a few ideas. Ten of them, in fact.

I posted the first pick to my Top 10 list for 2013 last week -- see my article on Amazon here. In this article I'll discuss my second pick for the list, Hovnanian Enterprises (NYSE:HOV), America's sixth largest homebuilder. By the way, my plan is to post one pick per week, which should take us to the end of the calendar year. To see how last year's list performed, take a look at my blog here.

To help you understand Hovnanian, I'll discuss the homebuilding industry in general terms. This pick is very much a "theme" pick, as were my 10 picks last year. To get your arms around Hovnanian, you really need to grasp what is going on in the homebuilding industry. Growth in housing is just getting started, and by this time next year you'll see it have a profound impact on the economy, job growth, and even the stock market.

Homebuilders Are Back -- and in a Big Way

Since World War II, housing starts have averaged roughly 1.5 million per year, in line with demand. The credit crisis of 2008 caused that to drop to about 500,000 per year for the last few years, with an uptick to about 750,000 this year. To give you an idea of just how bad the last five years have been, the other "disaster" in real estate, precipitated by the S&L crisis in 1989, saw home starts drop from 1.5 million down to 1 million, followed by a relatively quick recovery.

Now, it's true that housing starts have increased a lot this year, but it's off a historically low base. And it's nothing compared to what's coming. In a couple years, maybe sooner, we'll be back to normal at 1.5 million starts per year. According to a Harvard study on housing, we need to average 1.6 million starts per year over the next 10 years in order to meet demand.

What's the impetus behind the rebound in 2012? Here's how I explained it in an article earlier this year:

Don't listen to the real estate doomsayers who try to frighten you with things like supply/demand imbalances and the big nasty know as 'shadow inventory.' It's all a bunch of hooey. With all due respect to academicians like Robert Shiller, the key with real estate is not inventory, it's price. There is a certain price point at which animal spirits get unleashed…

To put it another way -- in an absurd way -- if house prices were $50 each, it wouldn't matter if there were 30 million homes in shadow inventory. Everybody would be clamoring to buy. That, in a nutshell, is what has happened. Prices are so low that inventory is not an issue. In many areas, mortgage principal and interest payments are less than half of prevailing rents for equivalent properties. If you are capable of buying, it literally makes no sense to rent. It's the reason why Warren Buffett recently said he'd buy 100,000 homes and rent them out if it if he could think of a practical way to do it.

Should You Buy Hovnanian Stock?

All of the homebuilders are facing an amazing confluence of positive variables, not the least of which is the most benign competitive landscape ever. Most private homebuilders are out of business, and even the few that managed to survive don't have access to the capital they need to compete. It's up to the publicly traded homebuilders to satisfy the demand.

Hovnanian, the sixth largest builder in America, is a well-diversified builder operating in 17 states. Its stock is also the cheapest, given that the builder ran into trouble with debt in recent years and had to dilute the equity in order to raise cash. Now that the balance sheet is on better footing, the company is back to reclaiming its base of business. I expect Hovnanian's revenue will at least double over the next two to three years, while posting peak cycle profit margins.

Unlike the other homebuilders, Hovnanian stock is essentially priced as a call option on homebuilding. If you agree with me that the cycle has already turned up and it's time to ride the upswing, then you should consider this stock.

Disclosure: I am long HOV, AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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