Calling A Housing Bottom

By Matthew McCall | March 02, 2012 AAA

The most recent numbers from the National Association of Realtors (NAR) shows January pending home sales increasing by 2% from December and are up 8% year-over-year. The Commerce Department reported that sales of previously occupied homes rose to their highest level in nearly two years and are up more than 13% in the past six months.
It is true that the number of homes sold in 2011 is still well below what many experts believe is considered a healthy home market; the good news is that the trend is improving. This bottoming pattern is what I will call the bottom of the national housing market. Or at worst, a level at which the downside is limited and the upside outweighs the downside risk.

SEE: Key Reasons To Invest In Real Estate

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Homebuilder ETFs
The homebuilders have been perking up along with the action in the housing numbers. The SPDR Homebuilders ETF (ARCA:XHB) is up 17% in 2012, easily outpacing the gain of 9% for the S&P 500. The ETF hit the best level in over three years, in early February, as money began really flowing into the high-risk sectors, such as the homebuilders.

The ETF is made up of 35 stocks in the homebuilding and related sectors. Homebuilders make up 27% of the allocation, followed by building products (24%), home furnishing retailers (18%), home furnishings (14%), home improvement retailers (9%) and household appliances (7%). The top holding is not what most investors would suspect with mattress maker, Tempur-Pedic (NYSE:TPX) making up 5% of the allocation. The ETF charges an expense ratio of 0.35% and the current SEC yield is 0.76%.

A more true to its name ETF is the iShares Dow Jones U.S. Home Construction ETF (ARCA:ITB), which has 65% of its allocation in the home construction sector. Of the top ten holdings, seven are homebuilders and 12 of the 27 total stocks are in the sector. The ETF is up 17% year-to-date. Investors willing to pay the reasonable 0.47% expense ratio to gain exposure to the homebuilding sector should look to ITB versus XHB.

Homebuilder Stocks
There are only three homebuilders in the top ten of the allocation and therefore the name of the ETF can be considered a misnomer for investors. One of the stocks in the top ten of XHB is Lennar Corp (NYSE:LEN), a homebuilder based in Florida. The stock is up 19% this year and is trading just below a four-year high and sitting on support at the $22 area. With a PEG ratio of 1.15 and a forward P/E ratio of 18, the stock appears an attractive buying opportunity.

Toll Brothers (NYSE:TOL), a homebuilder based in Pennsylvania, is known for its higher-end homes as well as age-qualified communities. The stock is up 15% in 2012 and it is trading just below a multi-year high with its support at the $23 area. Its forward P/E is pricier than LEN at 31 and it has lagged its competitor.

The Bottom Line
While home prices only fell by 2.4% in 2011 and actually rose during the fourth quarter, this does not suggest the absolute bottom is here for the U.S. housing market. What it does tell me is that we are much closer to a bottom than a top and that now may be the "sweet spot" for the homebuilder stocks. Granted, they have rallied well off the lows, but if the bottoming process continues, it will lead to higher prices for the sector and the stocks should continue to be leaders in a market environment that prefers risky assets.

SEE: 5 Must-Have Metrics For Value Investors

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At the time of writing, Matthew McCall did not own shares in any of the companies mentioned in this article.

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