Is it time to Sell Homebuilders?
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?