Are These 7 Housing Stocks Fairly Priced?
Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Home prices in the United States have seen a broad increase in the last few months. There are many ways to play a housing recovery. Investors could consider homebuilders, home-improvement retailers, or online real estate search stocks Zillow (NASDAQ: Z) or Trulia (NYSE: TRLA) as turn-around plays. Which, if any, represent the best investments for a recovering housing market?
The real estate market in the United States seems to be improving, based on confidence among U.S. homebuilders, sales volume, and increasing home prices. Housing sales are at a decade-high. The builder confidence index is at a 4-year high and is currently at 46, 5 points up from its October level of 41. According to a Bloomberg survey, many economists forecasted no change to the market, which is good news after a bounce.
Another report that came out indicated that the sales of owned houses in the United States increased 2.1% to a 4.7 million annual rate in the previous month. Mortgage rates at a record low are also helping bring buyers into this real estate market. Inventories of foreclosed and distressed properties are beginning to come down across various markets in the country and that is the reason the demand for new houses is increasing.
Hovnanian (NYSE: HOV) Chief Financial Officer Larry Sorby believes the future is bright for homebuilders. Mr. Sorby said, “It’s clear to us that the industry is in a period of recovery. We’ve bounced off the bottom.”
Hovnanian is a homebuilder that once appeared to be a candidate for bankruptcy only one year ago. Now its outlook is positive and the market value of the company’s bonds rose 30% in 2012, which implies that lenders have much more faith in the company. Bond prices over the past five years indicated how the chances of Hovnanian facing a default were as high as 91%. The rise in bond prices by September 2012 suggests that market participants view the likelihood of a negative credit event are less than 45%. Equity investors may have seen the worst and may profit from the company’s strategy of buying land even as home selling prices were declining.
Home Improvement Retailers Improving
America’s second largest home improvement retailer, Lowe’s (NYSE: LOW), saw boosted third quarter earnings from higher retail spending in construction and the improving housing market. Sales increased by 1.8% to $12.1 billion, beating analysts’ growth forecast of 0.8% to $11.9 billion. A slash in promotions and reduction in slow moving inventories lifted gross margin from 34.1% last year to 34.3%. The company eliminated more than 500 of its staff this year and closed 27 of its stores, keeping operations lean. Net profit for the quarter ended at $396 million up by 76%. Lowe’s earnings per share was $0.40 per share versus analyst estimate of $0.35 per share. Home Depot likewise benefited from the improving housing market, as net income went up by 1.4% to $947 million.
Shares of Lowe’s achieved a 6.2% record gain to $33.96 after the quarterly earnings announcement. Greg Melich, an analyst at International Strategy & Investment Group, rated the stock as a hold. “Lowe’s made progress on recovering some of the gross margin over the last year and comps were up,” he said.
Trulia’s Successful IPO
Trulia operates the popular real estate website Trulia.com which lists residential properties. It raised over $100 million in its recent public offering. Trulia’s userbase has been growing, and this growth has generated some revenue by selling subscriptions to smartphone and tablet apps. Trulia stated that its mobile aps and website are being used by over 20 million people monthly.
Conceptually, online search is a much better business model than the homebuilding business model. No inventory is needed, so there should be higher return on assets. Moreover, housing is essentially a commodity market in which homebuilders are forced to compete on price. Websites that connect buyers and sellers can act as networks that avoid price competition for advertisers and content providers. They don’t have to compete on price for traffic on the most popular platforms. This ability to avoid pure price competition is also a big plus for online real estate search sites.
Unfortunately, excitement over the Trulia initial public offering seems to be driving shares beyond reasonable valuations. The initial public offering valued Trulia’s total debt and equity over $400 million, which is a high valuation of about 8.8 times last year’s sales of over $50 million.
The success of Trulia’s IPO has been attributed to how the U.S. housing market is showing broad evidence of a recovery. This popular line of reasoning rests on the idea that investors are thinking of Trulia as though it is in the residential real estate business.
Let’s consider how these real estate stocks stack up:
Homebuilder Lennar is trading at price multiples that are too high to be attractive. As a cyclical stock it braves terrible risks, yet it has a price-to-earnings ratio that is roughly the same as that of the S&P 500.
KB Homes is too risky since it has a huge debt-to-equity ratio and has not generated a profit for the last twelve months.
Investors should be dissuaded from investing in Hovnanian based on its negative accounting equity. (This is why the firm has incalculable P/B and D/E ratios). Proponents may say that “it’s just a number,” but stocks with negative book values for equity have underperformed other stocks historically.
Trulia and Zillow are not investible at their high price multiples. Their price-to-earnings multiples are in the triple digits or incalculable. They have price-to-sales multiples which are very high, near eight. These firms are just too pricey.
Of home improvement retailers, Lowe’s is a potential buy. Investors can buy more sales per dollar than they can from Home Depot stock, which is trading at a higher price-to-sales multiple. Unlike many firms involved in real estate, it turned a profit for the past year.
Lowe’s provides an acceptable entry into real estate. Many other real estate plays are overpriced based on valuation or are too risky for their price multiples.
StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Zillow. Motley Fool newsletter services recommend Lowe's Companies and 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!