What To Buy To Capitalize On The Growing Housing Market

Includes: DHI, KBH, LEN, PHM, TOL
by: Sean Sullivan

The housing market is bouncing back. As reported by CNBC, home prices in July rose 1.2% and increased again in August -- the fifth month in a row that prices have risen. August witnessed strong growth in sales of previously owned homes, and construction of single family homes has reached its highest level in two years. Perhaps most significant of all, the Fed's announcement a few weeks ago to buy $40 billion of mortgage backed securities every month will keep mortgage rates at all time lows.

The latest data regarding new home sales, just released on Wednesday, states that new home sales declined slightly in August. This is insignificant, however, since sales were down only 1,000 from July and the July numbers were revised up by 3,000. Home prices rose by 11% from July. The year-to-year sale price has now increased by 17%. Some suggest this might account for the decline in sales in August.

The home builder stocks took a major hit Wednesday after the Census Bureau numbers were released, as analysts were disappointed that the results had missed expectations by 7,000. Some have suggested that it is time to start shorting home builder stocks. I don't believe this is the case, since August still had good home sales numbers and other data indicates that the market is still growing. According to the Census Bureau, housing permits are up 24.5% from one year ago, and new home starts are up 29%. I believe Wednesday's downturn was an emotional reaction by the markets, making now the perfect time to buy stocks in this sector.

Here are a few stocks in the home building sector worth considering:

PulteGroup Inc. (PHM)

Pulte stock has grown 300% in the last year, astronomically better than big media stocks like Apple (NASDAQ:AAPL) or Google (NASDAQ:GOOG). Pulte's net income has improved from a $1.05 billion loss in 2010 to a $210 million loss in 2011, and the company is on track to significantly improve on that number in 2012. In the second quarter of 2012, Pulte posted a net income profit of $42 million compared with a loss of $55 million in the same quarter last year. The estimate for Q3 EPS is .20 -- up from a loss of .34 per share in Q3 of 2011.

The fact that Pulte is just recently turned a profit causes me some concern. However, the company has been steadily improving its profitability over the last couple of years. Even though the stock has risen 300%, I think there remains room to grow. Pulte stock is still $30.50 of its all time high in 2005. I would advise buying this stock.

Toll Brothers Inc. (TOL)

Toll is a luxury home builder and its stock is up roughly 200% over the past year. Its annual report states that its revenue has decreased from $4.6 billion in 2007 to $1.4 billion in 2011. However if we compare profitability in those same years, we see that Toll had a huge increase in profit margins from only $35 million in 2007 to $39 million in 2011. 2011 was the company's first year of profitability since 2007. In addition, Toll had a net income of $61.6 million in the three month period ending July 31, 2012, compared to net income of $42.1 million over the same period last year.

While initially these numbers are very encouraging and tempt me to buy, I'm wary for a couple of reasons. First, according to the annual report, not only was revenue lower in 2011 compared to 2007, but revenue has declined every year since 2007. This isn't too surprising considering the state of the economy, but I would have expected revenue to improve from 2010 to 2011. Toll also has a P/E ratio of 63.96. This is unusually high, and I would be cautious in investing in this stock.

KB Home (KBH)

KB focuses on building smaller homes, and its average sale is about $224,000. Its stock is up 137% over the past year. Revenue declined from $1.59 billion in 2010 to $1.32 billion in 2011, and KB had a net loss of $178.8 million in 2011, compared to a loss of $69.4 million in 2010. This was due in part to KB purchasing 5,000 more parcels of land in 2011 than 2010 that will be held for future development. In addition, strategic reductions in its workforce have also resulted in increased costs for KB over the last few years.

I think this is a stock worth avoiding, as it is still emerging from some major restructuring. The fact that the company hasn't posted a profit in recent years, even as the market has improved, is also concerning, as with Pulte. However, Pulte's profits are steadily improving while KB has seen a major increase in its net loss from 2010 to 2011.

Lennar Corp. (LEN)

The stock is up 164% over the past year. According to the annual report, revenue grew 1% from 2010 to 2011, and net earnings in 2011 were $92 million. The most recent quarterly report states that earnings before income taxes were $52 million in the three months ending May 31, 2012 compared to $25 million during the same period in 2011. Earnings per share in Q4 2011 were 0.16, and are expected to be 0.37 in Q4 2012. It has a P/E ratio of 13.6.

This stock seems pretty calm to me. Toll seems to be a good solid company, but its flat revenue suggests that it probably won't be seeing a significant increase in stock price. I don't think there is a strong reason either to buy or sell this stock, and would advise holding at this time.

DR Horton Inc. (DHI)

The stock price is up 130% over the past year. It builds reasonably priced single family homes. Horton's annual revenue declined from 2010 to 2011 from $4.4 billion to $3.6 billion. Net income also declined over the same period, from $245 million to $72 million. However, the Q2 results from 2012 were very promising, as income was $72 million compared to $29 million in the same quarter last year. EPS is expected to grow from .11 to .28 in Q4. Horton has a P/E ratio of 7.8. This stock is still $20 below its all time high in mid 2005.

This stock is my favorite in this sector. Even though revenue and profits declined from 2010 to 2011, it still had strong profits in both years, something that almost no other company in the home building sector has achieved. Horton explains the decline in profits from 2010 to 2011 by blaming, "U.S. housing conditions, including the lingering effects of the expiration of the 2010 federal homebuyer tax credit." I also like the expected strong EPS growth and the low P/E ratio. This company is a definite buy, as I see potential for growth over the next year.


None of these companies is worth investing in if the housing market doesn't continue to recover. However, Toll Brothers is optimistic about the market. It wrote, "We believe the housing recovery is bring driven by pent-up demand, low interest rates and attractively priced homes." I think this will continue, and recommend buying PulteGroup and DR Horton.

Disclosure: I 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.

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