It's either a brilliant play or wildly naïve. What is it? It's the fact that homebuilding stocks are the third best-performing group of the year so far out of more than 200 that I follow. The S&P 1500 Homebuilding Index is up 13.3% year to date versus the S&P 500 Index's 3.3% year-to-date loss. (Thinking about buying a home? This real estate investment provides unique advantages - and challenges. Check out Buying A Condo.)

IN PICTURES: Biggest Stock Scams

Worth it? Great question. On the one hand, yes, I think we're in an economic recovery, which should ultimately be beneficial to homebuilding stocks.
On the other hand, with the lingering credit struggles, the so-called phantom real estate market overhang and a sheer excess capacity for building homes given the increased amount of foreclosures, homebuilding stocks aren't necessarily on the verge of finding solid ground.

Read The Fine Print
Are any homebuilding stocks generating more revenue now than they were a year ago? While earnings are important, I think we need to be careful about applauding a swing to profit in light of Beazer Homes USA (NYSE: BZH) and KB Homes (NYSE: KBH).

Last quarter, Beazer earned $1.17 per share versus a loss of $2.08 per share a year earlier. Good news? Not so fast - an income tax benefit of $2.24 per share was the reason for the accounting profit. Without it, Beazer would have actually lost over $1 per share, which was greater than the 90 cent loss expected by analysts. KB Homes posted a profit in its Q4 as well, but only thanks to the one-time tax benefit. The same goes for Meritage Homes Corp. (NYSE: MTH), Ryland (NYSE: RYL) and others that were helped by this benefit.

You get the idea - better bottom lines. Careful, though - the tax benefit is a one-time refund and is not a reliable source of continuous business operations. Given the confusing nature of the refund, a top line comparison may be more telling.

Mixed Message
Back to the original question: Are revenues actually picking up for the industry, or even orders for homes? This is where it gets tricky.

For investors who want to see the glass as half full, there's plenty of supporting data. For instance, December's pending home sales were up 6.3% from November. Homebuilders saw some of that same strength. Pulte Homes (NYSE: PHM), the new owner of Centex, saw orders increase by 32% in 2009. Furthermore, D.R. Horton's revenue was up 23% on a year-over-year basis. MDC Holdings (NYSE: MDC) saw a solid increase in Q4 revenue as well and bumped up orders by 82%.

On The Flipside
The armor does have flaws. KB Homes watched revenues fall 27%, and other companies are facing similar conditions. New home sales (not pending ones) actually fell in December by 7.6%. In fact, new home sales fell 23% for the year to the lowest number since 1963.

And that last factoid really underscores a key point - that "better" is all relative. We're now marginally better than 1963's real estate activity. Big whoop. It's far from conclusive evidence that homebuilders are actually investment-worthy at current prices.

What Investors Are Eyeing
All right, so let's all at least agree that both sides of the table have a decent argument. That would at least imply a stalemate for stock prices. Yet these equities have clearly been on the rise. So what gives?

Though not a lone reason to own any stock, the homebuilders' best-kept secret may be what investors are flocking to.

D.R. Horton (NYSE: DHI) is sitting on $1.97 billion in cash; not bad for a company with a market cap of $4.2 billion. Hovnanian (NYSE: HOV) is holding $550 million in cash and expects to reap more than $250 million worth of tax refund next year. What's amazing is that its market cap is a mere $300 million. The same cash-heavy attribute applies to most of these companies.

No Actual Growth Yet
With an average forward P/E of 42.8 for the biggest five companies in the group, these stocks are pushing the valuation envelope as it is. Plus, many of these companies have already told us they don't foresee any actual growth yet.

To be fair, I'm not one of those gloom-and-doomers who expects homebuilding to disintegrate. In fact, I think the analysts are right about their assumptions of a return to operating profitability in 2010. I just don't like the fact that there's no margin for error, and that the strength is at least partially stimulated by an expiring government stimulus or loads of cash.

Now, following the big run-up, even the smallest disappointment could turn things sour real quick. Investors better hope the balance sheet strength offsets that.

See The Problem?
Most investors understand one piece or another of the complex puzzle; however, very few have laid down all the pieces. If they had, they probably would have come to a similar conclusion about the fundamental flaw in homebuilders' earnings - there's not enough operational revenue/profit longevity yet to justify the optimism, current or future. (Home price appreciation is not assured. Can you withstand the volatility in this market? To learn more, refer to Why Housing Market Bubbles Pop.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Filed Under:
Tickers in this Article: BZH, MTH, RYL, KBH, PHM, MDC, DHI, HOV

comments powered by Disqus

Trading Center