One Homebuilder Screams Value


In investing, as in life in general, it is easy to ignore the obvious. The fact that something is staring us in the face devalues it in our eyes. In a market sense this is even more pronounced. If it’s that obvious, the thought process goes, then it must be already priced in, but that isn’t always the case.

It is logical, some would say obvious, that the construction industry and homebuilding in particular, is seasonal. Many projects around the country are held up or cannot be started at all during the winter months. When spring begins to creep slowly northward things begin to pick up on both sides of the supply and demand equation.

These thoughts came to me as I was casting around for some value in a market that, while as I said yesterday, I don’t see as overbought, is certainly approaching fair value. The SPDR Homebuilders ETF (XHB) is down around 10% on the year, even as both the S&P 500 and the Dow are feeling out new all time highs, so that was a logical place to start.

The main reasons for the fall seem to be disappointing mortgage origination and housing start numbers over the last few months, but both of these make perfect sense if you step back and consider the big picture. We had a winter of extreme weather in the US, so builders delaying starts and families and individuals delaying purchases should really come as no surprise. I know that this is stating the obvious and some will no doubt dismiss it as shallow analysis, but that is my broader point. Depth does not always equate to relevance.

If you believe that homebuilders’ stocks are set to recover lost ground over the next couple of months, whether because of seasonal factors or a natural tendency for markets and sectors to revert to the mean, there is always the time honored question for investors; how best to profit? The aforementioned XHB is probably the obvious choice, given that I am talking of sector underperformance, but as I look a little deeper there is one housing stock that stands out as value.

DR Horton (DHI) is the largest builder of new homes in America so logically stands to gain the most if the sector as a whole recovers. Conversely, though, it also makes sense that, should the pessimism induced by the numbers turn out to be true, they have the most to lose. Little wonder, then that DHI has been hit pretty hard in the last few months.

This underperformance has come in spite of the fact that DR Horton have beaten estimates in each of the last two quarters. In April, the company reported an 18% revenue increase, a 19% EPS increase, an 18% sales order backlog increase and improved margins, despite the Q1 weather. The stock is down about 4% since that release. It begs the question, if growth and profit aren’t enough, what is?

When I saw this, my reaction was that this must in itself be a correction from an overbought state, but no. In a sector with an average forward EPS of around 19, DHI is currently trading at around 11.76 times forward earnings.

I was taught a long time ago that, particularly where money is involved, if something looks too good to be true it probably is, but, try as I might, I can’t find a good, logical reason not to buy DHI. It is the largest business in a sector that is set to get a seasonal boost, has a history of profitability and is growing. There is even a close logical stop loss level just below the $21 support. Actually that stop may be too close given the volatility of the sector, but it gives a good level at which to review the position in the event of further weakness.

Homebuilders’ stocks have had a rough couple of months in a buoyant market. It doesn’t necessarily follow that an underperforming sector will correct, but as I started to analyze the reasons for the drop, it did begin to seem like a case of missing the forest for the trees. On that basis, with solid fundamentals and with good support close by, DHI screams value to me.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Investing Ideas , Economy , ETFs

Referenced Stocks: XHB , DHI

Martin Tillier

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