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One of the odder aspects of the stock market this year has been the weakness in housing stocks. With a solid stock market (even with recent volatility), low unemployment and high consumer confidence, one would think homebuilders and construction-related companies would be doing well. In fact, they are.
The numbers so far in 2018 look reasonably strong. And yet, housing stocks have been crushed. The iShares U.S. Home Construction (BATS: ITB ) exchange-traded fund (ETF) is down 30% so far this year. That's despite the fact that over 10% of the ETF comes from consumer plays Home Depot (NYSE: HD ), Lowe's (NYSE: LOW ) and Sherwin-Williams (NYSE: SHW ), which combined are about flat year-to-date. The average commercial stock in the ETF, then, is down about one-third in less than ten months.
The declines are coming from sentiment - not performance. Earnings multiples have come down across the sector. Investors are worried about higher interest rates - which can raise mortgage payments and snuff out demand - rising costs, and a potential cyclical macroeconomic swing.
From here, however, the sentiment looks too negative. Quality companies in the space are trading at multiples that suggest the good times are ending pretty much immediately. That seems far too bearish.
For investors who see an opportunity in the space, there is no shortage of targets to pick. Here are six plays that at least are worth a long look for those searching for housing stocks to invest in.
Source: -v via Flickr (modified)
Lennar (LEN) and D.R. Horton (DHI)
The simplest way to play the thesis that homebuilders are oversold is to buy the biggest and the best. That would be D.R. Horton (NYSE: DHI ) and Lennar (NYSE: LEN ), No. 1 and No. 2, respectively, in the U.S.
From a valuation standpoint, the case looks reasonably simple: Both housing stocks are dirt cheap. DHI trades at 8x forward earnings, and LEN 6.3x. LEN, in fact, now trades at under 1x book value - something that hasn't happened since 2011. As I noted back in June, analysts have argued for big upside in both stocks and still do … even with price targets having come down some over the past few months.
From a technical standpoint, admittedly, both stocks look terrifying. LEN and DHI both traded at 52-week lows on Friday, with each stock dropping nearly 4%. The chart for each looks like a classic falling knife - and investors might want to tread carefully when trying to time the bottom.
Still, the selloff looks overdone. It's not as if housing supply has been overbuilt over the past few years. Demand trends seem reasonably strong and so does pricing. At a certain point, the selloff will have gone too far, particularly for two of the best housing stocks to invest in. That point appears to have arrived (and then some) - but timing will be key.
Century Communities (CCS)
The other way to go (with perhaps more reward and more risk) is to target the smaller players in the space. There, too, there are ample stocks that look ridiculously cheap. One of the more intriguing is Century Communities (NYSE: CCS ). CCS, too, trades at a 52-week low, after falling 3%-plus on Friday. The stock now trades at 0.8x book, and 4.5x 2019 analyst EPS estimates. A price target near $40 suggests roughly 80% upside from current levels.
A smaller homebuilder does have more risk, but Century has an attractive geographic footprint. The company focuses primarily on growing markets, with a heavy presence in states like Colorado, Texas and Nevada. Debt is an issue, and so is Century's focus on entry-level buyers. Still, the selloff looks overdone.
There are other small-cap plays to consider as well. At the beginning of the month, I called outBeazer Homes (NYSE: BZH ), William Lyon Homes (NYSE: WLH ) and M/I Homes (NYSE: MHO ). All four stocks look undervalued at this point. And with Lennar and D.R. Horton both still in the market for acquisitions, at least one of the four could be a takeover target in the not-too-distant future.
BlueLinx Holdings (BXC)
Building products distributors like BlueLinx Holdings (NYSE: BXC ) have been absolutely hammered of late. The combination of demand concerns, rising input costs, and tariff worries has decimated the space.
Several distributors look attractive at current levels. I've personally tried to the time the bottom with wallboard distributor GMS (NYSE: GMS ). Beacon Roofing Supply (NASDAQ: BECN ) is at a three-year low. But BXC stock looks particularly attractive at the moment.
BlueLinx, after all, was the second-best performing stock in the entire market in the first quarter (with a market capitalization over $250 million). A merger with privately held Cedar Creekled the stock to more than quadruple on the way to June highs. The combination added significant scale and a larger earnings base to support BlueLinx's heavy debt load.
There's still good news here. Margins are thin but improving. The combined entity owns quite a bit of a real estate , which can be monetized to further deliver and protect BXC stock in a downturn. And yet, BXC stock has fallen by nearly half from those June highs. The declines across the sector look like too much - and BXC, considering its leverage, might have the highest upside when those declines reverse.
American Woodmark (AMWD)
Cabinet manufacturer American Woodmark (NASDAQ: AMWD ) highlights perfectly the battle between performance and sentiment in the construction space. The stock has jumped after each of its last two earnings reports, thanks to healthy bottom-line beats relative to Street consensus. In both cases, however, the gains were short-lived, and AMWD stock kept falling. The stock now has lost more than half of its value so far this year.
There is a category concern here worth watching. Demand appears to be moving toward the low end of the cabinet space. Combined with higher costs, that pressures American Woodmark's margins. With a decent amount of debt on the balance sheet, margin pressure could send earnings downward going forward - even if that hasn't happened quite yet.
But at 7x forward earnings, even that pressure looks priced in. And renovation and remodeling demand provides some diversification away from reliance on new construction. Like so many stocks on this list, AMWD looks just too cheap.
Quanex Building Products (NX)
Window and cabinet component maker Quanex Building Products (NYSE: NX ) has seen the same pattern as AMWD. Two straight earnings beats have sent the stock toward $20; sector weakness has pulled it back toward $16. That weakness is covering a nice story here. Quanex continues to deleverage, lowering interest payments and increasing cash flow. A 16x forward P/E multiple perhaps doesn't look that cheap. But free cash flow numbers are much better, as high depreciation impacts numbers.
NX might not have the upside of other housing-related plays, but it doesn't have the risk, either. The $16 level has held as support for years now. Balance sheet concerns are minimal. And input costs will be passed onto customers, given high switching costs for window and cabinet manufacturers.
There's a nice opportunity here for a bounce to $20-plus, and earnings in early December could provide a catalyst … as they have the last two times around.
As of this writing, Vince Martin is long shares of Quanex Building Products and GMS Inc. He has no positions in any other securities mentioned.
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