Toll Brothers Earnings Preview: The Stock Appears To Be Setting Up For Another Bullish Run

About: Toll Brothers, Inc. (TOL)
by: Rick Pendergraft

Toll Brothers is scheduled to report fiscal second quarter results on Wednesday.

The company has solid fundamentals and the stock is in an upward trend.

There is a similarity in the current chart pattern and the pattern from late 2016 and early 2017.

The sentiment toward the stock is extremely bearish.

The homebuilding industry struggled in 2018, but it seems to have turned a corner in the last six months. Investors are hoping that Toll Brothers (TOL) reaps some of the benefits of the rebound when it reports fiscal second quarter earnings on Wednesday.

Analysts expect Toll Brothers to report earnings of $0.75 per share. That would be a slight increase over the $0.72 EPS the company reported in the second quarter of 2018. Revenue is expected to come in at $1.54 billion and that is down slightly from last year.

Over the last three years, Toll Brothers has seen earnings grow by 36% per year and they grew by 19% in the first quarter. Revenue has grown at an annual rate of 19% per year in the last three years and it was up 16% in the first quarter.

The company's management efficiency measurements are good but not great. The return on equity is at 15.4% and the profit margin is at 13.1%.

I mentioned in the opening paragraph that the housing industry seems to have turned a corner in the last six months. The housing starts report for April was released earlier this week and it showed an increase of 5.7% on a month over month basis. The seasonally adjusted annual rate for housing starts was at 1.235 million. The other part of the report is building permits and those increased by 0.6% in April and the annual pace came in at 1.296 million. This is the first monthly increase since December.

New home sales will be released on May 23 and I am hopeful that the trend will continue to move higher. You can see on the chart below that new home sales peaked in November 2017 and then trended lower throughout 2018. The readings seemed to hit bottom in October 2018 and have been trending higher since. The March reading was the highest reading since the peak.

New Home Sales BMR.jpg

The Chart Shows a Similar Pattern to Late 2016

The weekly chart for Toll Brothers is an interesting one. The stock has been moving higher since October and the 13-week moving average just recently made a bullish crossover of the 52-week moving average. The stock is now facing a little resistance from the 104-week moving average.

TOL SA.png

Looking back at the end of 2016, we see that the stock was forming a similar pattern. The 13-week moving average crosses bullishly above the 52-week and then stalls a little at the 104-week moving average. The stock broke above the 104-week in February '17 and the stock was trading around $33. It would go on to rally all the way up to almost $52 by January '18.

The weekly overbought/oversold indicators are high right now with the stochastic readings in overbought territory and the 10-week RSI above the 60 level. However, the readings were also high back in 2017 when the rally started, so that shouldn't be a deterrent for buying the stock.

Bearish Sentiment on a Stock with Good Fundamentals and an Upward Trend

If you have read my articles before, I have described the perfect setup for buying a stock as one with great fundamentals, in an upward trend, and bearish sentiment toward the stock. That is almost what we have with Toll Brothers - I would describe the fundamentals as good, but not great. Even with that in mind, we have an upward trend and negative sentiment.

There are 19 analysts following Toll Brothers right now and only five rate the stock as a "buy". There are 12 "hold" ratings and two "sell" ratings. Looking at the number of buy ratings as a percentage of the total number of ratings, the buy percentage is only 26.3%. That is well below the normal range for a company with the fundamental strength listed above.

TOL Analysts Ratings.jpg

The short interest ratio for the stock is 4.3 currently. This isn't a huge number, but it is certainly above average and in the context of the fundamental analysis and the upward trend, that makes it seem even higher. What is really interesting is that the short interest jumped from 5,082,300 shares to 5,915,300 shares in the second half of April. That is an increase of 16.4% and indicates that the bearish sentiment is growing rather than declining.

The put/call ratio is yet a third sentiment indicator that is reflecting bearish views from investors. The current reading is at 1.55 with 16,642 puts open and 10,751 calls open. Not only is this a high reading in general, but it is also considerably higher than the 1.18 reading on February 26 when Toll Brothers last reported.

My Overall Take on Toll Brothers

If you haven't picked up on it yet, I am pretty bullish on Toll Brothers. The company has solid fundamentals and the housing market seems to be improving since the Fed stopped hiking interest rates. The industry is very sensitive to interest rate cycles and with the Fed becoming more dovish in recent months that should help the industry as a whole.

I like the way the chart is setting up and the way it resembles the pattern from late 2016 and early 2017. We may see the stock hold under the 104-week for a few more weeks based on the previous pattern, but once it breaks above, it could be off to the races.

The bearish sentiment toward the stock is the icing on the cake. The possibility of analyst upgrades and short covering could help propel the stock higher in the coming months.

With the sentiment being as negative as it is, I am comfortable suggesting that investors buy the stock ahead of the report. Even if the stock drops after the report, I don't see it dropping by a great deal. I see a greater chance of the stock moving higher after the earnings report.

The stock gapped sharply higher back in August after the earnings report, but it couldn't hold the momentum and the downward trend resumed after the gap higher. Now, the stock is in an upward trend and it was an earnings report in February '17 that pushed the stock through the 104-week moving average.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.