QE Or Not, These Housing Stocks Are Winners
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Federal Reserve chief Ben Bernanke lifted the mood of the markets as he announced that the end of the quantitative easing is still some time off in the future. This acted as a sentiment booster for interest rate-sensitive sectors such as housing, which fell some time ago when markets assumed that the central bank was about to wind up the stimulus program. Included among the prominent gainers are NVR (NYSE: NVR), D.R. Horton (NYSE: DHI), and Toll Brothers (NYSE: TOL). However, there is more to these stocks than just sensitivity to interest rates.
NVR shows strong growth
Shares of Virginia-based homebuilder NVR have dropped more than 10 percent over the last three months, but have started looking up after Bernanke’s comments. In line with the general recovery in the housing market, the company has been posting strong growth in sales and profits – a trend that continued in the first quarter ended March 31. In terms of trading valuations, it is available at an attractive forward price earnings ratio of 12.8, while a price by sales ratio of 1.37 indicates that the stock is reasonably priced.
A high interest rate regime is certainly not conducive for homebuilders, but NVR has got an ace up its sleeves in the form of a debt-equity ratio of just 0.39. For a capital-intensive business such as contracting houses, anything less than 1 is the cherry on the cake. This low reliance on debt allows the company to better navigate a high interest rate environment.
Captive mortgages financing units beef up the fortress
Similarly, D.R. Horton is a homebuilding company whose stock saw a sharp correction towards the end of June before gathering some momentum after the latest assurances that the central bank will keep printing money. Still, the stock remains down 9 percent over the last three months. Fundamentally the company continues to do well, and that’s the reason most analysts have positive calls on the stock with target prices close to $30 – reflecting potential upside of 33 percent from current levels.
It trades at a forward price earnings ratio of 12.4 and has a debt-equity ratio of just 0.87. At the same time, the price-sales ratio sits comfortably at 1.3. Another positive with the company is a solid mortgage unit. D.R. Horton’s captive business through D.R. Horton Mortgage increased to 86 percent in the latest quarter, up from 82 percent in the same period last year. A dedicated mortgage unit acts as an effective tool to decrease the burden of high interest rates by passing on the additional costs to buyers.
Toll Brothers is the best place to hide from Bernanke
Toll Brothers is probably best placed in terms of a company capable of dealing with interest rates. The company has a strong focus on constructing luxury homes – a segment that has proven to be resilient to interest rate cycles. Its annual performance is up nearly 20 percent but still trades at a 13 percent discount to its 52 week high scaled in May. Like other stocks mentioned here, Toll Brothers also has an advantage of a lean capital structure, as debt comprises only 78 percent of its equity.
In the year ended Oct. 31, 2012, the company recorded growth of 27.6 percent in sales, but profits grew manifold from $39.8 million to $487 million. This momentum continued in the latest quarter, and going by the fundamentals in place there is no reason to believe it won’t continue in future. As the economy continues to recover, Toll Brothers is expected to be in the front row of strong performers.
Foolish bottom line
In a nutshell, these companies are fundamentally strong players and offer some immunity to surging interest rates. Even though high interest rates eventually translate into reduced demand for homes, companies with lower dependence on debt have one factor less to worry about.
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Jacob Wolinsky 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!