By Adil Yousuf
Given the significant returns in the Housing sector over the past year, it may be tempting to have a bearish outlook. However, a quick look through housing indicators, recent earnings, and brewing investor confidence suggests that this might just be the beginning of a potentially bigger move.
The Homebuilders ETF (XHB) surged more than 50% in 2012, significantly surpassing the S&P 500 Index that produced a meagre 13% return in comparison. The U.S. housing sector has been buoyed by a string of positively-received data: New and existing home sales have picked up significantly and prices have firmed. More importantly, inventories are down, suggesting that housing prices will continue to strengthen.
A sound residential real estate market driven by record-low interest rates1 will probably resonate through the economy this year, spurring home sales and causing appreciation for homebuilding sector stocks. A company in this sector that looks well poised to deliver strong gains is D.R.Horton, Inc. (DHI).
For Q1 2013 D.R.Horton reported a blow out quarter. Revenue for the firm climbed 41% to $1.2 billion. More importantly, earnings jumped 122%, thanks to a 5.3% increase in pre-tax income margin to 8.5%. And pricing cooperated nicely as well, increasing 10% from a year ago to $236K per home.
The company CEO Donald Tomnitz's enthusiasm was best summed up in his own words, during the earnings call on January 29th 2013: "D.R. Horton is in the best position it has ever been in its 35-year history."
Those are some bold words from a leader who has endured a fair share of cyclical housing booms and busts. CEOs typically tend to be over optimistic about their firms' future, but these numbers speak volumes and strongly justify his stance on the company.
Based on Market IQ's pro metrics D.R.Horton is likely to outperform its peer group. Market IQ places D.R.Horton in the top right quadrant of the Quality – Value chart (see below), indicating high Quality and good investment Value. D.R.Horton's fundamental stock Quality is better than 78% of its peer group, mainly due to robust revenue growth, strong financial position, and impressive record of earnings per share growth. Moreover, Estimate Momentum (a key metric used in the calculation of Quality) is strong as consensus estimates witnessed an upward bias following solid first quarter results.
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Among residential construction stocks, D.R.Horton offers a modest valuation and shows a lot of potential over competitors who have priced in future earnings and revenue much more strongly (see below) 2.
The company exhibits a largely solid financial position with a reasonable debt level. Additionally, based on Profitability, D.R.Horton outperforms more than 71% of its peers - a notable Return on Equity of 27.55% greatly exceeds the performance of the industry average 3 and the S&P 500.
Investing in big builders such as D.R. Horton is a smart move, despite the run-up in their stock prices. However, investing in this industry is a macro play. If you firmly believe that the U.S. job market will continue improving and interest rates will stay slow, then D.R. Horton deserves a place in your portfolio.
2 (P/S) under 2 shows very solid value, and a future PE of 15 is a level of value as well. Based on the valuation metrics, DHI is cheaper relative to its peer companies: Lennar Corp. (LEN) and Toll Brothers (TOL).
3 The average return on equity for the homebuilder stocks is 13%.
This commentary is for informational purposes only and does not constitute investment advice. The opinions offered herein are not recommendations to buy, sell or hold securities. Market IQ expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.