It has been a roller coaster ride for homebuilders the last several years. A spectacular boom in the housing market was followed by a tragic collapse. Not only did prices plummet, but the number of new homes being built plunged to levels around half of what they were in the 1960's - back when the United States had more than 100,000,000 fewer people living in it.
After some very dark days, homebuilders finally started to see some signs of life in 2012. You can see a solid rebound in the number of new housing starts recently:
In May 2013, new housing starts ran at an annualized rate of around 900,000. But many experts believe that in order to simply keep up with population growth, around 1,500,000 new housing units are needed annually. This means that the rebound in new home construction could very well be in its early stages.
But someone forgot to tell that to Mr. Market.
Rates Rise, Housing Stocks Fall
Homebuilding stocks had been among the best performing group of stocks since early 2012. But when the Federal Reserve mentioned publicly that it could start tapering the amount of mortgage backed securities and Treasury notes it has been buying later this year, long-term interest rates rose in a hurry - and homebuilders took a big hit.
This rise in the 10-year T-note yield has led to higher mortgage rates - and a big drop in mortgage applications. In the latest survey from the Mortgage Bankers Association, the Market Composite Index, which is a measure of mortgage loan application volume, fell 23% year-over-year. Ouch.
But this could just be a temporary reaction to rising rates. If interest rates at least level off here for a while - which I believe they will considering that the Fed may hold off on tapering QE - then my guess is that mortgage loan application volume will pick back up as buyers come off the sidelines. It's worth noting that the yield on the 10-year T-note has already pulled back 17 basis points from its recent high amid talks of postponing "tapering".
Strong Earnings Momentum
From an earnings momentum perspective, homebuilders are among the best. The 'Building - Residential / Commercial' industry currently ranks 8th out of the 265 industries that Zacks ranks. That puts it in the top 3%. The overall increase in demand for new homes has meant that many homebuilders have been able to reduce incentives and even raise prices while leveraging their fixed expenses. This has led to significant earnings growth in the industry and significantly higher earnings estimates from analysts.
Nonetheless, many homebuilders are still trading well below their "pre-taper" highs, despite the recent pullback in interest rates. If you believe that the long-term trend in new housing starts remains in tact, then this could be a wonderful long-term buying opportunity.
4 Homebuilders on Sale
So which homebuilders look the most attractive following their recent selloff? Here are 4:
MDC Holdings (MDC)
MDC Holdings is a homebuilder that has been building under the name "Richmond American Homes" for 40 years. It primarily operates in the Western and Mountain regions of the United States with some exposure in the Eastern United States. Over the last 4 quarters, MDC has delivered an average earnings beat of 74%. It is currently a Zacks Rank #1 (Strong Buy) stock.
Despite the strong earnings momentum, shares of MDC are down more nearly 20% since Bernanke first hinted at tapering on May 22. This has driven valuations to very attractive levels. Shares of MDC are trading at just 13x 12-month forward earnings, a discount to the industry median of 16x. While shares may remain volatile over the coming months, the recent pullback could prove to be a great opportunity for long-term investors.
D.R. Horton (DHI)
D.R. Horton is the largest homebuilder in the United States with operations in 78 markets in 27 states. The company has delivered 6 consecutive positive earnings surprises, prompting analysts to revise their estimates significantly higher for D.R. Horton over the last several months. It is a Zacks Rank #1 (Strong Buy) stock.
Shares of DHI are also down about 20% since May 22, which has led to attractive valuations. The stock currently trades around 14x forward earnings, which is less than the industry median of 16x. Given the favorable long-term industry trends here, this could be a good time to get in.
Ryland Group (RYL)
Ryland Group is a homebuilder headquartered in southern California with a market cap of $1.9 billion. Consensus earnings estimates have risen significantly higher over the last several months as it has delivered 3 consecutive positive earnings surprises. It is currently a Zacks Rank #2 (Buy) stock.
Despite strong earnings momentum and growth prospects, shares of RYL are down almost 20% since May 22. But the stock is now trading at just 12x forward earnings. Investors willing to live with some volatility in hopes of strong capital gains should consider RYL.
PulteGroup is headquartered in Bloomfield Hills, Michigan and operates in 60 markets across the United States. This homebuilder has been crushing earnings estimates too with an average earnings beat of 59% over the last 4 quarters. Consensus estimates have risen sharply over that stretch, sending the stock to a Zacks Rank #1 (Strong Buy).
Shares of PHM currently trade at 14x forward earnings as the stock has fallen more than -17% since May 22. But given the strong fundamentals here, this seems like an overreaction.
The Bottom Line
Rising rates may have put a damper on the housing market. But this is likely to be just a temporary slowdown, especially when you consider that the Fed has been discussing holding off on tapering for a while. For the long-term investor, the recent selloff in homebuilders could present a great buying opportunity.
Todd Bunton is the Growth & Income Stock Strategist for Zacks Investment Research and Editor of the Income Plus Investor service.
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