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Option1307 (29.75)

Is it time to Sell Homebuilders?

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March 27, 2013 – Comments (7) | RELATED TICKERS: HOME

I have been a big proponent of homebuilding stocks for the last 2-3 years now (see here). I gobbled them up by the bucketful in 2010 and 2011 and that has so far paid off handsomely. However, recently I have begun to wonder if now is the time to start selling the homebuilders off? Many of them have double, tripled, or more since their 2011 lows and it begs the question, “where do they go next?”

Many people probably still think that homebuilding stocks are a terrible investment and that real estate and housing in particular will never recover in the US. I disagree and think that people misunderstand the argument for homebuilder stocks in general. Hopefully this will provide a touch of clarity and we can exam whether they are still good investments currently.

Let’s try and summarize the key points for initially investing in homebuilder stocks and see if any of those are still pertinent today.

1) This is probably the key point to understanding all of this. The early 2000’s were the hay day for builders across the nation, housing starts increased rapidly, cash was pouring into builders and, their stock prices soared. It is certainly a fact that as a nation we overbuilt homes in the early 2000’s, with average annualized housing starts around 1800 for several years. That is just far too many homes for us to consume. However, for as much as we overbuilt in the early 2000’s we probably underbuilt by the same amount in the late 2000’s. In 2009-2011 we saw annualized housing starts in the 550-600 range, that’s crazy low and not sustainable. If you look back the last 60 years the US has averaged something like 1500 housing starts on annualized basis and this doesn’t even take into account the population growth. The general idea is that we will need to get back to a more normal level of annual housing starts, ~1500/year, in order to be in a sustainable situation.

     --> We have seen a significant uptick in housing starts the last few years. The first few months of 2013 have shown annualized housing starts of ~900 which is markedly improved from the depths of the housing crash but still well off what we need to be “normal” and sustainable.

 

2) Homebuilders that have survived the worst RE crash in the history of the world are using this opportunity to scoop up real estate deals on the cheap. They are buying land like nobodys business at incredibly depressed prices. When things eventually do normalize homebuilders will be able to turn massive profits as they have a huge inventory of land etc. obtained at fire sale prices.

 

3) Homebuilders are losing money like it’s going out of style, however this is a cyclical industry and any uptick in homebuilder activity will return them to profitability. It’s also important to realize that homebuilders are very leveraged, so with small improvements in homebuilding activity there will be large jumps in profit. In 2007 and 2008 MDC (one of my favorite builders) was losing $8-14/share. That’s not a type-o, they were getting crushed.

     --> Things have markedly improved for homebuilder in general and MDC in particular. Full year 2012 actually was profitable for MDC, EPS of 1.28. This is certainly a step in the right direction.

     --> For comparison, during the early 2000’s (excluding the peak year 2005 (EPS ~11.0) MDC was pulling in EPS of ~4.0. So as you can see we are nowhere even close to those numbers.

 

Homebuilders certainly have come a long way in terms of sock price and overall function. MDC turning a full year profit in 2012 was a huge accomplishment. However, I still believe my original thesis about homebuilders has not been fully realized or changed significantly.

Housing starts have definitely improved from the 2009 lows but we are not even close to an average number. I’m not suggesting we should be at ~1500 housing starts right now; the economy likely can’t handle that currently. My point is that builders still need to keep increasing their output over the next 2-5 years just to get back to “normal” levels. Along this same point, while builders have started to become profitable again, there is still a long ways to go for earnings to become normalized. I’m not even talking about the bubble years in 2003-2005, I’m just talking about regular run of the mill normalized earnings.

Homebuilder stocks have been on fire the last 12-18 months and as such I don’t find them particularly good buys at this point. The risk/reward just isn’t there as much as it used to be. They have priced in a decent amount improvement in the overall economy and housing sector specifically. MDC as an example is sitting at a P/E of ~30 currently which is definitely pricing in some RE improvement. However, I firmly believe there is still a long way to go in the overall housing starts per year figures and that this will translate to significantly more EPS for homebuilders. I don’t foresee this happening this year or even next, but I do believe it will eventually happen.

Considering everything above, I don’t see any reason to sell homebuilder stocks at this point. I do expect things to get a bit bumpier in terms of stock price, but I continue to expect the overall tend to be upwards.

Thoughts from other Fools?

Selling or buying homebuilders?

7 Comments – Post Your Own

#1) On March 27, 2013 at 12:29 PM, awallejr (81.55) wrote:

Well as I said in your other thread I still see room for them to grow because of QE and improving employment. Also today's drop in contract signings for existing homes is interesting. 

The 2 reasons I heard was tight inventory and stricter borrowing requirements.   That actually can help a stock such as MDC since it is not just a homebuilder but offers financial services as well. Right now they seem to be going through a correction which they need to do in light of their run-up. 

As for taking a profit that is your call.  But if you doubled or tripled your money you might want to at least put stop losses to protect those gains.

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#2) On March 27, 2013 at 1:42 PM, Option1307 (29.75) wrote:

Awallejr,

Thanks for commenting.

I agree with your thoughts that they have more to run, certainly continuing to keep interest rates low/QE/etc will put upward pressure on home sales. This, while may not be ideal for our economy long term, would help homebuilders improve even more.

As a whole things have seemed to cool off in the sector the last month or so. I welcome this as I definitely think the entire sector needs to consolidate and relax a bit before any upward movement.

In regards to taking profits, that is something that I have been debating lately. I'm leaning towards selling out of a position or two, or at least trimming them back, but I don't think I will close out the sector bet entirely. I'm still debating this and haven't sold anything at this point.

I'm generally not a huge fan of trailing stops and think they are even more difficult with volatile stocks like homebuilders. 10-15% swings are the norm in this sector.

Thanks again for your thoughts, always good to hear from other Fools. 

 

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#3) On March 28, 2013 at 3:42 AM, valuemoney (99.99) wrote:

I would be a seller. I comment in 2010 on florida builders caps page. He is one of your favorites. It was on his pitch for TOL. I even gave the market cap TOL should be trading at. It is at the low end of the range right now but it is only three years since the comment. That being said housing will rip these next couple years and earnings will sore. But I think over the next 7 years you will only see about a 50% gain ON AVERAGE with the homebuilders. Now that might seem like a lot but I like a double on my money every 4 to 5 years which means you are getting 15% compounded. Homebuilders as a whole I don't think will give you that. I am talking about fair value though. Moment could drive prices of the stocks much higher but they are not worth it in my opinion. I could state the numbers to show you why but I am not going to. You could see it for yourself look at earnings for previous years when building was good. Then factor in share count for most builders went up. Put a multiple on earnings ( price you would buy the entire company at ) and figure yourself what the market cap of the particular homebuilder you like SHOULD be trading at. Pretty simple. Then you can tell if you should be buying, holding or selling. I do it with every stock I buy. It aint about what I think or feel....it is about the numbers (earnings power). Remember if you buy a company you get the GOOD earnings along with the BAD. Well good luck.  If you want to put up another post with the homebuilder in ? state the numbers you think it will put up and then we can debate a price we think it should trade at. Well good luck. I have to sleep. 

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#4) On March 28, 2013 at 4:16 AM, valuemoney (99.99) wrote:

If I had to guess and I just glanced at MDC I would GUESS they will have about 300 in EBIT and after taxes which a normalized tax rate which I would guess would be about 35% gives it a net income of roughly 195 million which last year it was only 62.7 million with a favorable tax rate of negative 2%. Slap a multiple on that lets say 15 which gives you a market cap of 2.93 billion. Which translates to 62% upside at full value. So IDK. I would check out VALUELINE at your library and see what they think. Maybe my numbers aren't even ballpark. That was a quick glance off the top of the dome. I would have to dig much deeper to give a real fair value. Now I have to sleep for sure!

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#5) On March 30, 2013 at 5:45 AM, jiltin (28.65) wrote:

I hope you have seen this blog. 

 http://beta.fool.com/shwetadubey/2013/03/24/investing-in-these-3-homebuilders-will-not-disappo/27785/?source=TheMotleyFool

 

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#6) On March 30, 2013 at 6:10 PM, Option1307 (29.75) wrote:

Valuemoney

Thanks for reading and the thoughts, much appreciated. I've run the calculations as you suggest and I've concluded that at present earnings the homebuilders are likely fair valued. Thus I wouldn't really be buying them now as is. However the question is what are their future earnings potential in a normalized environment and how likely are we to see that in the near future, say 2-5 years??

In this post I showed that on "back of the napkin" calculations there is probably significant upside for most homebuilders in a normalized environment which I also argued we will see somewhat shortly. 

Thanks again for your thoughts!

jiltin

Thanks for reading and the link! 

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#7) On April 26, 2013 at 12:23 PM, jiltin (28.65) wrote:

Personally, I have invested KBH,DHI,RYL,SPF,HOV and they are are all good as long term returns as housing market started recovering. DHI reported recently earnings and my shares simply jumped 10%.

This is best time to continue to hold until FED pulls of QE3 (Quantitive easing 85bln/month) or FED interest rate.

Looks like interest rate hike will be slow as FED is exploring impact on banks and whole economy whether it can withstand FED rate increase.

If any one happens, better to pull out from Builders. I have been in real estate more than 10 years. This year 2013 is a turnaround for real estate.

 

 

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