There is no doubt that the housing recovery has slowed this year, but the evidence suggests that it's more of a temporary adjustment than the start of a decline. With that said, investors should be paying attention to which homebuilders are building the most in the marketplace today. Read on to find out why.
Which company is building the most homes these days?
The U.S. homebuilding market remains fragmented, with the top 10 companies contributing around a quarter of all new-home sales in 2013. However, there have been some pretty significant shifts within the top 10 in terms of homes sold. The following table shows market share and the percentage increase in homes sold from 2010-2013. The total increase in homes sold in the period is 33%, so any homebuilder that grew sales below that figure has obviously lost market share, and vice versa.
Market Share of Homes Sold (%)
Increase in Homes Sold 2010-2013 (%)
Source: Bloomberg Industries.
Let's take a deeper look at the top five homebuilders. Lennar has made the biggest increase in the period, and D.R. Horton has kept pace with industry growth, while PulteGroup and KB Home are noticeable laggards, and NVR is a slight laggard.
What does this mean for investors?
The investment community has wasted tomes trying to explain how the homebuilding sector works, but in the end it's quite simple: The sector tends to move in the direction of house prices. In other words, if you are bullish on house prices, then you should be looking at homebuilders, and if you are bearish, then you'd be better off avoiding the sector. For those looking for a viewpoint on where house prices could go, I would suggest reading this article .
The following chart demonstrates the relationship between house price movements and the sector.
With that said, valuations always matter in investing, and the most commonly used valuation technique for the housing sector is the price-to-book ratio. This represents the market cap of the stock over the value of the company's assets -- including the housing and land stock on its balance sheet. Some readers will, no doubt, wonder why, if the price-to-book ratio is so important for valuation methods, does the movement in the sector depend on house price movements?
The answer is simple: It's because the book value (including houses and land on the homebuilders' balance sheets) is going to rise and fall with house price movements.
The winner is... whoever builds houses in a bull market
Continuing this logical argument, it should follow that the homebuilders that have been aggressive in building houses are the ones that have won out, because they have been creating assets at a time when those assets have been appreciating. In other words, whoever has been building the most houses from 2010-2013 should be the winner. Let's see if it's true.
Increase in New Homes Sold 2010-2013
Share Price Increase 2010-current
Source: Bloomberg Industries, author's analysis.
The relationship appears to hold, but what of valuations?
When looking at the price-to-book values in the chart below, two things are clear. First, the leading stocks (excluding NVR) currently trade at a price of 1.5 to 2.0 times book value. Incidentally, two other homebuilders, Ryland and Meritage , trade at 1.7 and 1.5 times book value. Second, the price-to-book value in 2010 mattered less to future stock price performance than the ability and willingness to build houses in a bull market did. In other words, when you buy stock in a homebuilder, you are still taking a bet on house prices and whether or not the company is aggressively building at the right time.
The following graph demonstrates that the sector is not looking particularly cheap right now.
I've picked out Lennar, D.R Horton, and PulteGroup in order to better demonstrate that valuations are similar to the 2000-2006 period -- when house prices grew aggressively. In other words, the market seems to be assuming house price growth going forward.
The bottom line
If you are resolutely bullish on house prices, then a stock like D.R. Horton, Lennar, or Meritage Homes might look attractive, due to a combination of price-to-book value and their willingness to build new homes. The key to investing in the sector is buying into which company is building houses at the right time. However, value investors -- or those not willing to take a strong view on house price movements -- might want to avoid the sector altogether, because it doesn't look particularly cheap right now.
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The article Do You Know Who's Building the Most Homes in the U.S.? originally appeared on Fool.com.
Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Ford and Tesla Motors. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .
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