How to Tell When the House Party Is Over
By Aaron L. Task
03/22/2002 15:04
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Once more, with feeling.
Next to inflation, few topics generate as much heated feedback as housing and related stocks, where the battle lines are clearly drawn.
As reported in last night's update to yesterday's Midday Musing , a great many readers are pinning their bullishness on the homebuilders' relatively low valuations. The S&P Homebuilding sector is trading with a trailing 12-month price-to-earnings ratio of 8.1, compared with 25.6 for the S&P 500 , according to Baseline. On a price-to-book basis, the ratio of a company's price to its total net assets minus liabilities, the homebuilders are at 1.8 vs. 3.4 for the S&P 500.
Given those figures, several emailers were incredulous at my comparison of the homebuilders to the Nasdaq circa 2000, when P/Es reached triple digits and price-to-book ratios were 30 to 50 for companies that actually had assets worth valuing.
Sensationalism! Irresponsible journalism! A pox on your house!
Hold the pox: It was an analogy , not a direct comparison. I'm not suggesting that the homebuilders are as overvalued as tech stocks were in early 2000, or that they will fall as much thereafter. I'm saying the question is whether the homebuilding stocks are in the sweet spot of the cycle, a la Nasdaq 1996, or nearing the peak, a la Nasdaq 2000.
Rather than literally comparing homebuilders with tech stocks, which is (frankly) an overly simplistic interpretation and (again) not my intent, better to compare where the homebuilders are today compared with past cycle peaks for that industry . Which brings us back to the valuation question.
Although the homebuilders are trading below market multiples, current valuations are "typical for the end of a cycle," according to Barbara Allen, senior analyst at Arnhold & S. Bleichroeder. "Two times book value and 8 to 9 times trailing earnings has been the norm in peak valuation at the end of cycles."
Allen, a longtime observer of the housing industry, agreed that the industry is "less cyclical" than it used to be and gave high marks to management of the sector's bigger players. Toll Brothers TOL , for example, has never suffered a loss in a single quarter, despite various economic environments. Additionally, she noted, financing for buyers is much more accessible, as are the options of loans available, thanks in large part to Fannie Mae FNM and Freddie Mac FRE .
Furthermore, she agreed with the bullish argument that the supply-demand balance favors housing, although she argued that tax-law changes have "next to nothing" to do with housing's recent strength.
Finally, the analyst believes there is "no widespread evidence of bubble-hood" in the industry, noting the absence of stories of people "flipping" houses or frenzied bidding in the resale market -- notable exceptions such as the San Francisco Bay area notwithstanding.
But "the fact is, this is still a cyclical industry and still affected by rising interest rates, which raise the price of buying a house -- any way you slice it," Allen said.
Average rates on fixed 30-year and 15-year mortgages have risen notably in recent weeks in conjunction with the bond market's decline, which was resuming at midday today.
Those touting the homebuilders' ability to withstand rising interest rates have short memories, Allen quipped. After rates rose in 1994, all but three of 11 companies for which she was able to confirm data reported declining earnings in 1995. All three that did have increases, D.R. Horton DHI , Lennar LEN , and Toll Brothers, posted lower-than-expected results.
More tellingly, "virtually every stock fell 50%, hitting book value or less," and the market made "no discernible difference" between companies that posted earning gains and those that underperformed, she noted. (Furthermore, as impressive as recent earnings for players such as K.B. Home and Lennar have been, think how much tougher the comparisons are going to be going forward.)
Allen currently has "reduce" recommendations on D.R. Horton, Lennar, Toll and K.B. Homes KBH , and "neutral" recommendations on Centex CTX , Pulte Homes PHM and Standard Pacific SPF .
Arnhold & S. Bleichroeder has not done underwriting for, and Allen holds no positions in, any of the aforementioned.
"With each new report showing greater-than-expected strength in the economy, the risks in owning these stocks rise," she wrote in a recent report. "We continue to recommend selling any that are valued at 2 times book; when the prices drop to book value and below, we expect to be aggressive buyers."
Que Sera, Sera
Most homebuilding stocks were on the rise at midday today, no doubt giving heart to the sector's bulls. But perhaps it's merely the beginning of the quarter-end markup process Seabreeze Partners' Doug Kass described yesterday at RealMoneyPro.com .
"The time to sell homebuilders is when it is emotionally the hardest to do so: amid rising prices, rising estimates, strong trading volumes and lots of discussions that mistake normal cyclicality for a secular change," Allen concluded.
Anecdotal evidence suggests selling homebuilding stocks today is as emotionally difficult for many readers as selling tech stocks was back in ... oh, never mind . |
