4 Reasons to Build Your Portfolio With This Stock

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

It’s rare when you come across a situation where a company is perfectly positioned to benefit from a turnaround in an industry. For the last few years, there has been a steady improvement in the housing market. Though there have been doubters along the way, many home builders have been reporting strong growth for multiple quarters. Even today, there are doubts as mortgage rates have risen and pundits are calling for more challenging days ahead. The good news for investors in the sector is, the choice of the best stock is simple, and there are four clear reasons to choose Lennar (NYSE: LEN).

The Doubters Are All Wrong
When looking at the housing market, you have to keep a long-term perspective. Short-term thinking led some to think that the housing market wouldn’t recover. Some even suggested that the American dream of buying a home was dead. Other analysts suggested that it would be many years before the housing market recovered.

The problem with all of these ideas is they assume that short-term issues will change long-term trends. While it’s true that the Great Recession put a damper on home buying, once house values corrected and interest rates dropped, it became more cost effective to buy than to rent. Once that line was crossed, buyers would have been crazy to stay on the sidelines.

When it comes to the current interest rate threat, short-term thinking suggests that the rise in mortgage rates from around 3.5% on a 30 year to about 4.5% will derail the housing recovery. This also is misguided as even at 4.5% interest rates are still near historic lows. Though house prices have begun to recover, there are still many homes that are valued significantly below their highs before the correction occurred. As long as interest rates stay relatively low, and house values are low, buyers should continue to enter the market. Many home builders will benefit from these positive trends, but in every industry there are winners and losers.

4 Times Better
Sometimes leadership in an industry is clear, and it appears that Lennar is the clear leader among home builders. While the company faces significant competition from companies like Toll Brothers (NYSE: TOL), PulteGroup (NYSE: PHM), and KB Home (NYSE: KBH), Lennar operates in a class of its own.

One reason Lennar looks like a long-term winner is the company’s high margins. In fact, among their peers, Lennar led the way with an operating margin of 13.3%. By comparison, PulteGroup finished in second, and managed an operating margin of just 7.49%. When you realize that KB Home's and Toll Brothers' margins were just 4.69% and 1.81%, you can see just how dominant Lennar’s margin lead really is.

The second reason investors should consider Lennar is the company’s consistent increase in selling prices. Over the last couple of years, Lennar has been consistently reporting a rise in the average selling price of their homes. In the current quarter, Lennar continued this trend with an increase of 13%. The only company to report a greater increase in average selling price was KB Home, with a 25% increase. Looking at PulteGroup’s 10% increase and Toll Brothers’ 3.6% increase, it seems clear that home builders of all stripes have pricing power.

Another key reason investors should consider adding Lennar to their portfolio is, Lennar is simply the best when it comes to backlog growth. In the last three months, Lennar reported a 76% increase in backlog revenue, which was better than the 69% increase from Toll, 52% at PulteGroup, and the 19% increase at KB Home. Lennar also reported stronger unit growth than their peers with a 55% increase in units. By comparison, only Toll Brothers came close with a 52% increase, but Pulte and KB Home couldn’t keep up with increases of 35% and 6% respectively.

The fourth reason to consider Lennar might at first seem like a weakness until you put the numbers into proper perspective. Lennar’s cancellation rate was 14% in the current quarter. While it’s true that Toll Brothers’ cancellation rate was just 3.4%, the comparison is a bit unfair. Toll Brother’s average selling price is significantly above $500,000, whereas the rest of these companies' average selling price is closer to $300,000.

Among their $300,000-and-under peers, PulteGroup doesn’t report a cancellation rate, and KB Home’s cancellation rate of 25% is significantly worse than Lennar's. With PulteGroup and KB Home’s backlog growth coming in lower than Lennar, their questionable and higher cancellation rates mean Lennar is the leader of the pack.

The investment case for Lennar is very simple. It is growing fast in the mainstream housing market just as the housing market is beginning a long-term recovery. The company’s relatively lower cancellation rate means more of these homes will be sold. Lennar’s higher operating margin means the company should keep more of these sales as earnings. When you add in the company’s strong increase in selling prices, investors have a right to expect big things. Smart investors looking to capitalize on the housing market should add LEN to their Watchlist immediately.

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Chad Henage has no position in any stocks mentioned. 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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