Toll Brothers, Inc. (TOL)

TDRH (99.99) Submitted: 12/14/06 9:07 AM

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This earnings for this company will continue to slide as they sell off "excess inventory", and the price earnings ratio will adjust accordingly.
Fool's Opinion
I believe that the correction for the recent residential housing boom will last at least a year and a half. If the fed increases the discount rate as a hedge against inflation you could see an even larger correction and consolidation. Through home equity mortgages and moving up to larger homes, many families are "upside down" are will be unable to sell their homes for what they owe.

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echofarmer (95.49) Submitted: 12/14/06 5:56 PM

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Hey, my first reply! Thanks. And you make several good points.

I'm not sure I'd disagree with any of what you have to say. I happen to think that TOL has maintained good levels of FCF over the four quarters ending July 31 (Net + Amortization - Capex = $4.90/sh.) That period includes part of the prime home-selling season, which was very bad this year. If I plug that number into a discounted cash flow calculator and use the historic 11% S&P return as a benchmark, TOL wouldn't have to show any growth at all over the next five years to justify a price 33% above where it sits today. I can't think of a worse scenario than zero growth over five years (well, except for negative growth, but I can't plug that into my calculator - I'll have to work on that,) and I don't think there's reason to be nearly that pessimistic about TOL.

Alternatively, if TOL's FCF for next year dropped, but it managed to grow after that at the 11% rate that analysts predict (http://finance.yahoo.com/q/ae?s=TOL), FCF/sh could drop as low as $2.30/sh, and still justify the current stock price. That's less than half the ttm FCF/sh. I'm willing to bet they do better than that.

I absolutely agree that the housing market is doing badly. It's happened before, and it will happen again. People will be badly effected, just as you point out. As an aside, home prices have continued to rise in my neighborhood, but I understand that's the exception. Also, government and FED policy will have an influence, and a major raise in interest rates could hit TOL pretty hard. I'm not going to try to predict that. Possibly, TOL hasn't hit rock bottom yet.

I just think that, bearing all that in mind, the price of the stock has gone much lower than the situation calls for. As long as TOL can maintain Cash Flow, reasonable Nets and juggle the Balance Sheet - and they definitely need to drive inventory down - then I think they'll outperform the S&P over five years.

Also, I know this is a contrarian call. The stock is out of favor. For what it's worth, my hunch is that it's too out of favor.

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