The Housing Recovery Is Offering Lucrative Investment Opportunities

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The housing market is definitely on the mend. Depending on how you want to slice the cattle, you can make a lot of money. I think though that not every investor is interested in or willing to take on an inordinate amount of risk. Because of this, I am going to lay out some key macroeconomic indicators, and get to the meat of the argument as to whether or not investors should even have a position in housing stocks.

The economics, can’t ignore these

Source: Ycharts

The trend is your friend and the housing market is picking back up again. In certain areas of the United States, the amount of money spent on a mortgage is cheaper than the price of rent. Assuming that the number of people employed increases and the economy continues to recover, the housing recovery should be well on its way.

Source: Federal Reserve

Going forward, the real gross domestic product is projected to grow at a 2.3% to 2.5% rate. If that is the case, investors should position themselves in housing because the housing stocks would appreciate rapidly in a cyclical economic rebound.

KB Home just announced earnings

KB Home (NYSE: KBH) reported a fairly strong quarter. The company was able to increase its revenues by 73% year-over-year (this is a significant improvement; I wonder where all the bears went on this one.) The company is continuing to recover.

The company’s deliveries were up by 39% year-over-year, and the average selling price of homes grew by around 25% year-over-year. The company’s property backlog is up by an additional 19%. Perhaps back logs are up because investors are fearful of missing out on the next leg-up in the property market.

The company reported a loss of $0.04 per share versus a year-ago period loss of $0.31 per share. It also reported net income growth. Because revenues were up by $221 million, costs were comparatively up by $197 million. The net difference between the two was what contributed to the company's net income. Analysts on a consensus basis were anticipating the company to report a $0.06 loss for the quarter, but KB Home beat analyst estimates by $0.02.

Investable insights & another alternative

Investors should consider buying a home. Ignore bonds and enjoy the safety of an appreciating real estate portfolio. Now I’m not saying that a home should be your only investment; I am saying that homebuilders are selling homes for ever higher prices. You want to buy on an up-trend. The trend is your friend, after all, and it is obviously the time to own a bit of the American dream.

If owning a home is a little bit risky, however, why not consider Home Depot (NYSE: HD)? The company is exposed to the housing sector through home improvement sales. After someone buys a home there’s usually a lot to fix, a lot to upgrade, and a lot to buy. Everything from gardening improvement, paint changes, pipe fixes, toilet replacement, and counter top changes can all be done at Home Depot.

The company's stock currently trades at a bit of a hefty valuation (with a 20.5 forward earnings multiple.) In 2012, the company was able to grow its earnings per share by 21.5%. The growth in earnings was driven by operating profit margins improving by 93 basis points to 10.39%. The company also repurchased $4 billion in shares, which also contributed to earnings-per-share growth.

Analysts are pretty optimistic about the company’s future. Disciplined cost management, paired with stronger macroeconomic indicators and share buybacks, will grow the company’s earnings going forward. The company's stock is projected to grow its earnings by 14.61% per year over the next five years.

Why not own the bank?

I think that Bank of America (NYSE: BAC) could be the most well-positioned bank in terms of earnings growth (I’ll have a separate article dedicated towards the financial sector soon.) The company has a large portfolio of higher-risk securities because in all likelihood, higher-rated (safe) securities are being dumped in favor of riskier assets. The risk premium on BBB-rated bonds is 1.57 currently, which is below the long-run average of 1.867. Assuming that Bank of America accumulated its BBB mortgages and bonds when risk premiums were above the long-run average, you can basically assume that the company is better positioned than other banks.

Source: Bank of America

Around 57% of the bank’s assets are below a BBB rating, which implies that the bank is less exposed to coupon note depreciation. It is assumed that the interest rates from the lower-rated securities could make up for the bank's mark-to-market accounting losses from depreciating AAA-rated securities. After all, treasury bonds are AAA-rated assets and those are declining in value right now. What a bank should own are lower-rated securities that pay a higher rate of interest. Those higher rates of interest would make up for the depreciation on higher-quality debt. Fortunately, Bank of America has positioned itself for this already.

The CEO, Brian Moynihan, also plans to cut back on spending by $8 billion by the year 2015. This is why analysts on a consensus basis anticipate that the company will grow its earnings by 23.39% per year over the next five years. The stock has 41.3 earnings ratio right now, which is reasonable when considering the projected rates of growth.

Conclusion

Investors need exposure to housing in their investment portfolio. Owning an actual house could be the most lucrative choice right now, but there are other options as well. The home ownership population has declined and the total number of households have gone up, so there's a lot of pent-up demand which can be reflected in the backlog figures presented by KB Home.

Using that, as a leading indicator, we can also assume that demand for mortgages and home improvement will be up as well. Therefore, investors should consider a position in companies such as KB Home, Home Depot, and Bank of America.

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Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Home Depot. The Motley Fool owns shares of Bank of America. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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