The Housing Recovery: 2 to Buy

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

The housing recovery seems to be in full swing; strong enough that there are whispers of an impending mini-bubble on the horizon. While there has been tremendous growth in housing over the past year, the risks of a downturn seem inflated. Motley Fool contributor Morgan Housel discusses this in more detail here, with the key points being that affordability is still relatively high, and between bank-owned properties being put up for sale at a slow rate, and homebuilders still ramping up new construction, there seems to be plenty of pent up demand that will be sustainable for years.

And this is creating some great opportunities for investors to profit, and in more ways than you'd think. Let's take a look.

If you're looking for a home, you'll probably look here

Zillow (NASDAQ: Z) has only been a public company for two years, and shares are up more than 140% in that time, and an incredible 206% YTD. While such a sharp run-up, on the surface, makes Zillow look like just another overvalued tech stock, let's take a look closer at what makes Zillow appealing.

With a market cap of less than $3 billion, and TTM revenues of $116 million, there is a long runway of growth ahead, and plenty of room for shareholders to make money. As an added benefit, the company is already profitable, with $5.9 million in net income over the past twelve months. Compared to competitor Trulia's (NYSE: TRLA) $92 million in revenue and net loss of $7.7 million over the past 12 months, you can see why Zillow is a more attractive investment. 

Zillow, at over 55 million unique visitors per month, has nearly double the monthly traffic of Trulia. And per Alexa, these visitors stay longer and visit 50% more pages on the website. This is a substantial advantage, as users that stay longer and visit more pages drive more revenue and more profits. The value of Zillow's network effect should only grow stronger as housing demand accelerates, and it appears to have a strong head-start over Trulia that it's building on. Earnings on August 6 will tell us even more, but the evidence is strong that Zillow's is further separating itself from the competition. One word of warning about profitability: As of this writing, there are rumors that management is planning to spend aggressively on growth in the upcoming quarters. While this could have a short-term impact on profitability as the effects take time to lift the bottom-line, it will strengthen the long-term prospects. Additionally, it could create a nice buying opportunity if the market responds poorly.

Given time, Trulia could become the Pepsi to Zillow's Coke. But with this market still in its infancy, the smart bet today is on the first mover. Let the market play out before expecting there to be two investments. Keep an eye on Trulia, but it's too early to project success for both companies. 

Potential to build upon

Homebuilders like Meritage Homes (NYSE: MTH) have taken investors on a ride this year, with at least six periods where the stock has gone up 10% or more in less than two weeks, only to match it with the same number of drops of 10% or more. But through all the volatility, shares are up more than 23% YTD, outperforming the S&P by a slim margin on the back of strong demand for new homes.

And while peer high-end homebuilder Toll Brothers is well positioned to grow, its forward PE of 43 means new investors are paying for a lot of forward profits. PulteGroup, on the other hand, carries a forward PE of below 13, while Meritage's forward PE is right at 20. The key difference? Being the smallest of the three, with annual sales of $1.5 billion, to more than $2.1 billion for Toll Brothers, and $5.3 billion for PulteGroup, gives Meritage a much longer runway for growth.

Much of the volatility this year has been driven by concerns over interest rates. Let's be realistic: Historically speaking, rates could go up 70% before approaching the average rate over the past four decades. The numbers that matter? Improving employment statistics, and a recovering economy. It's not a pretty recovery, but it's a recovery nonetheless. 

Foolish final thoughts

This housing recovery looks very real, and the underlying data supports it continuing. Don't let hindsight bias -- looking in the rear view mirror at the recent housing bubble -- cause you to overlook a solid opportunity to profit. Zillow and Meritage Homes are both smaller players in their respective segments of the housing market, and while they aren't cheap, the opportunity for growth positions them as great long-term bets. As to Trulia, it very well could turn into a solid investment. But the Foolish approach is to bet on the first mover that's already profitable, and let the market develop. If there's as much opportunity as we hope, you'll have plenty of time to invest in Trulia once it's earned our trust.

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Jason Hall owns shares of Zillow and Meritage Homes. The Motley Fool recommends Meritage Homes and Zillow. The Motley Fool owns shares of Zillow. 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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