By Martin Tillier
One of the most frustrating things about investing and trading is having an idea, not acting on it, and then feeling that you missed your chance. I am sure many people feel that way about the housing market right now.
When I moved to the coast in 2003 the property boom was in full swing. It seemed that everybody who owned a hammer was a home builder and everybody who owned land saw themselves as a potential developer. When the crash came, it hit hard. At the end of last year, however, the mood began to change. Builders I knew started to report a trickle of new orders for homes in golf course communities, indicating that homes in the Northeast and Mid-West were beginning to sell again. The beautiful sound of nail guns in the early morning resumed. All the signs were there. With 20/20 hindsight I should have been advising everybody to pile into homebuilder stocks, but I didn’t.
My reasoning was sound. The housing market had been bumping along the bottom for a long time. It was not inconceivable that even the bigger companies could announce bankruptcy any day, before they could benefit from improving conditions. In other words, the downside risk was hard to control and absolute. The anecdotal evidence of a turnaround was there, but the plural of anecdote is not data, and the Case-Shiller index and Housing Start numbers were still depressed. The question is, as the numbers start to improve, has the move already happened and the opportunity gone? In this case, I don’t believe it has.
I divide opportunities into three categories; range trades, contrarian trades and momentum trades.
Range trading is generally a short-term, everyday tactic for traders. With longer term, more strategic trades, it is sexier to call a contrarian trade early and hit the bottom, but usually safer to wait for some momentum to develop.
The two VectorVest charts above are both for the SPDR S&P Homebuilders ETF (XHB). The one-year chart on the left would seem to indicate that the opportunity has gone and the move has already happened. On the right, the chart for XHB since its launch in 2006 tells a different story. We are testing previous resistance levels, but are in a solid, if bumpy, upward trend, with some way to go. The contrarian opportunity to buy at the lows may have gone, but over the longer term it would appear that the upward momentum can be maintained.
Now that I have realized that I can stop kicking myself, and that there may be some meat left on the bone, my next question is how to trade it? I am usually a fan of sector ETFs such as XHB. They offer some mitigation of risk through diversification, but in this case, with companies being in very different stages of recovery, a more focused approach makes more sense.
Some home builders, such as DR Horton (DHI) and Pulte Homes (PHM) have already turned the corner into profitability. VectorVest's estimates of leading 12 month EPS are $1.21 and $0.69 respectively, and both are rated a buy based on VectorVest’s proprietary indicators. These two are well placed to take advantage of continuing improvements in the market, and I expect their upward momentum to continue over the next few years. Others, however, are still losing money.
Beazer Homes (BZH), for example has forecast EPS of $-0.95. It is tempting to recommend a still depressed stock in an improving sector, but high exposure to the worst hit markets of Florida and Arizona resulted in serious losses (the stock fell from highs over $80 to a low of $0.24) and increasing debt that could still take a long time to recover from. I would wait on BZH to show signs of a return to profitability before buying. Once again, the downside is unpredictable and could be absolute.
KB Homes (KBH) is also still losing money, with a forecast EPS of $-0.08, but a high and improving earnings growth rate.
The 1 and 10 year charts for KBH (above) look very different to those for the sector as a whole. KBH still has significant debt, with a debt to equity ratio of over 4. This looks good compared to BZH at over 8, but is still high for the industry and helps to explain the lack of a bounce in the stock.
Spreading an investment between the two stocks that have returned to a profit (DHI and PHM), and the more risky KBH would be my preferred strategy. Bear in mind that the recent rally has priced in some growth expectations, so you are looking for the situation to continue to improve. Also this would be a long term trade, so in this case don’t set tight stops or be tempted to take a quick profit. For those that have the time and a beneficial trade fee structure, averaging in over a period of time would be optimal.
Sometimes, in life as well as in investing and trading, we make the wrong decision for the right reasons, but erring on the side of prudence is usually not a bad thing. For those that are looking at homebuilders stock with regret that they didn’t jump recklessly in earlier, don’t give up. There may still be opportunity. One of the first lessons I was taught about running position in the FX market was that just because you may not hit absolute tops and bottoms, don’t dismiss a trade idea. Calling the big one before anybody else is, as I said, sexy. It is also rare, and attempting to do it all the time can be bad for your wealth. You never will be perfect, and for traders, perfect really is the enemy of good.