5 Homebuilders Loved by the Smart Money

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There are many different financial indicators that ardent investors must follow, but one of the most important is hedge fund activity. While it’s tempting to think of the smart money’s decisions as insignificant, consider the following: Our empirical research shows that individuals who mimic certain hedge fund activity can beat the market by double-digits year in and year out (see the details of our market-beating strategy here).

Generally speaking, one of the economy’s most bullish macro trends is a continued recovery in housing, and we’re going to take a look at which homebuilders are in hedge funds’ favor. Using our database of the latest 13F filings with the SEC, we can determine how money managers are trading this particular industry.

Of the more than 400 hedge funds we track at Insider Monkey, Lennar Corporation (NYSE: LEN) had the highest level of interest, with 45 funds invested at the end of the last filing period. Lennar doesn’t pay a stellar dividend—about a 0.4% yield—but it has appreciated more than 86% over the past year. One of the homebuilder’s key advantages is its ability to use specialized deals to attain top-tier acreage at attractive prices. The sell-side expects earnings growth of 10-11% a year over the next half-decade, and at a PEG near 1.4, Lennar’s prospects are fairly valued. According to our data, one of the most bullish hedge funds invested in Lennar is Ken Griffin’s Citadel Investment Group (see Ken Griffin’s favorite stock picks here).

Second on our list is PulteGroup (NYSE: PHM), with 32 hedge funds invested. Pulte’s footprint in the housing market is about 25% larger than Lennar’s, and shares of the company have been a better investment, returning 153% over the past twelve months. At first glance, Pulte’s forward P/E (16.7x) and extremely bullish year-ahead earnings expectations of $1.44 a share look supremely attractive, especially considering it’s forecasted to finish FY2012 with a 67-cent EPS. Over the longer term, however, Pulte’s growth prospects trade at a multiple of 4.5; typically any figure above 2.0 signals an overvaluation. With a five-year expected EPS growth rate nearly identical to that of Lennar, Pulte doesn’t look like a great value at the moment.

Next up is Toll Brothers (NYSE: TOL), which had five fewer bullish hedgies than Pulte at the end of the latest filing period. Wall Street’s forecasts for Toll Brothers are more than twice as optimistic as those placed on Pulte or Lennar; analysts expect EPS growth to average 22.4% a year through 2017. At a PEG near 0.5, it’s clear that investors are severely discounting these prospects, and quite frankly, are unfairly treating Toll Brothers as a low double-digit growth stock when it clearly has much more potential.

Toll Brothers is positioned quite nicely in the luxury homebuilding realm, which inherently provides two advantages: Customers have fewer difficulties with interest rate changes, and the high net worth niche itself is developing at a faster rate than the broader housing market. One of the top hedge funds invested in the stock at the end of the last filing period was Steven Cohen and SAC Capital (see all of Steven Cohen’s top stock picks).

Fourth on our list is D.R. Horton (NYSE: DHI), with 25 hedge funds holding interest. D.R. Horton has returned a little over 50% in the past year, far better than its sub 1% dividend yield. While its primary markets are in the western U.S., D.R. Horton has expanded into North Florida. The Street is bullish on this move, as it expects the homebuilder to generate earnings growth of 24-25% a year over the next half-decade. The markets, though, haven’t bought into these forecasts, as DHI still trades at a lowly PEG of 0.31.

D.R. Horton reports its next quarterly earnings on Jan. 29; analysts are expecting earnings of 15 cents a share on revenues of $1.1 billion. These numbers represent growth above 20% from the previous year, but it’s worth noting that the homebuilder’s top line did come in a little light last quarter. Investors would be wise to watch this situation closely, as a beat could mean that more value-based appreciation is in store.

Last but certainly not least, NVR (NYSE: NVR) is the hedge fund industry’s fifth favorite homebuilder. Like Lennar, NVR has a key advantage over its competition with regard to profitability. Generally speaking, NVR avoided the huge losses that its peers experienced in the last housing market downturn because of its decision to acquire land by using option contracts, rather than outright purchases. The sell-side expects decent annual EPS growth of 12.5% over the next five years, but a growth multiple of 2.6 indicates that investors may be better off waiting for a more attractive entry point. Wall Street seems to agree, as its average price target rests near $906, more than six percentage points below NVR’s current market price.

This article is written by Jake Mann and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool has no position in any of the stocks mentioned. 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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