Homebuilding Stocks' High Rise Not That Sturdy
By Odette Galli
Columnist
02/08/2002 09:58 AM EST
URL: thestreet.com
There's no place like home. Many people seem to share that feeling these days, with the fear of terrorism still fresh, and a war with no end in sight.
So I guess it should come as no big surprise that the housing market has been so resilient in light of the recession, the terrorist attacks and a gyrating stock market. Likewise, the homebuilders' stocks have also proven to be a safe harbor for investors who have been recently spooked by high-profile bankruptcies and accounting shenanigans.
A Nice Build-Up
Although I don't see any reason for housing stocks to collapse now, they've had a big move in a short time. While some analysts argue that these stocks still look cheap on a price-to-earnings basis, it's hard to believe that earnings growth can get much better. I wouldn't chase them, and if I owned them already, I'd take profits.
The return in these stocks has been nothing short of phenomenal. Since November, when I wrote a column about the homebuilding sector, the whole group, as measured by the Dow Jones Home Construction index, has risen nearly 38%. The one name I highlighted, D.R. Horton (DHI:NYSE - news - commentary) , has soared 61%. It slipped less than 1% in Thursday trading to close at $35.94.
This has been very frustrating for the short community, which was betting that consumers would run out of steam and that housing stocks would plummet. (In some stocks, like Toll Brothers (TOL:NYSE - news - commentary) , the short interest ratio is 23% of the outstanding float.)
That didn't happen. Even though I wouldn't load up on the shares at these levels, I still don't think they're a compelling short idea, either. The economic picture is brightening, and the housing market looks firm. That should help protect the downside in the shares. For example:
Income growth hasn't collapsed. Despite a jump in the unemployment rate to 5.8% in January, hourly wages are still rising 4% annually.
"If we're still in a recession or at least the tail end of it, and all hourly wages did was stay close to 4% growth, that's got to be the floor, and it could even inch up," says Conference Board economist Ken Goldstein.
This bodes well for real disposable personal income, or DPI. Even with a likely increase in the unemployment rate in coming months, perhaps to as high as 6.5%, Goldstein still expects real DPI to decline just 1.3% in the first quarter, to flatten out in the second quarter, and to rise in the 4% to 5% range in the second half of this year and into next.
Consumer confidence is recovering. The Conference Board's index of consumer confidence bottomed out in November at 84.9 but has since jumped back to 94.6 in December and to 97.3 in January.
Perhaps more importantly, the measure of consumers' expectations for the economy improved dramatically from a low of 70.7 in October to 96.9 in January, the highest level in more than a year. "There won't be a lack of willingness for consumers to take out mortgages," says Goldstein, who adds that consumers "had money to spend in 2001, and they'll have it this year."
Interest rates are still historically low. The current rate on a 30-year fixed-rate mortgage is 7.04%, just slightly above the 2001 full-year average of 6.97%, which was the second-lowest level (after 1998) since Freddie Mac started tracking the rates in 1971. Most economists aren't predicting a big rise in rates this year, either. Goldstein, for one, expects mortgage rates to be as low in November or December as they are now.
Home prices remain strong. Over the past few years, the housing market has been a much better place to invest than the stock market. Last year, existing home prices appreciated 5.5%, according to estimates by the National Association of Realtors. The association also predicts that home prices will appreciate another 4% in 2002.
The inventory of homes for sale continues to be relatively low, and this should help support strong pricing. The supply of homes on the market is about 4.2 months, according to the National Association of Realtors. (This statistic measures the inventory of homes that are unsold on the market.) That's still a historically low level, particularly when compared with a high of more than nine months back in 1991.
Opening the Book
Homebuilders' price-to-book value nears record highs
Source: Baseline
A Look at the Numbers
But to really like the stocks here, you have to argue that they deserve to trade at higher multiples than they have in past housing cycles. Certainly the companies appear to be better managed, with cleaner balance sheets than in the early 1990s, but a higher valuation is a big leap of faith to take in today's jittery market.
D.R. Horton currently trades at a price-to-earnings ratio of 9.5 times 2002 per-share estimates of $3.90. That may look cheap, but these stocks typically trade at P/E multiples between 6 and 12, with an average of 10. Because we could be at or near the cycle's peak, the P/E should be lower, not higher. D.R. Horton's earnings are expected to be up nearly 20% this year, but next year's per-share estimate of $4.44 represents just 13% growth. Clearly, the cycle is running out of steam.
Another measure to look at is price-to-book value. As the chart below shows, according to Baseline, the homebuilders group, which includes D.R. Horton, is selling at 1.9 times book value. Shares are certainly close to the all-time high of 2.3 times book value. Again, compared to other sectors, a ratio of 1.9 may look inexpensive, but for a cyclical group like homebuilders, it suggests a valuation that's close to a cycle peak.
I don't see a big near-term collapse in the prices of these stocks, but their upside is fairly limited. Take D.R. Horton, for example: Perhaps its stock will trade into the low $40s -- or to a P/E of close to 10 times 2003 estimates. That's maybe another 10% to 15% up from here.
If you're looking to build up your portfolio, you might find better returns elsewhere.
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Odette Galli writes daily for TheStreet.com. In keeping with TSC's editorial policy, she doesn't own or short individual stocks, although she owns stock in TheStreet.com. She also doesn't invest in hedge funds or other private investment partnerships. |
