The crash of the U.S. housing market - and housing stocks - a decade ago might make some investors skeptical about the industry's seemingly robust recovery. But rather than a repeat of the subprime meltdown of 2007-08, investors should expect continued gains in stocks of home builders and building supply companies, Barron's reports. "Housing is in the third or fourth inning of a nine-inning game," as Bill Smead, lead manager of the $1.3 billion Smead Value Investor Fund (SMVLX), told Barron's. "This is a normally cyclical business in a secular growth trend," he added.
Smead's fund holds only 28 stocks, according to Barron's, including shares of home builders Lennar Corp. (LEN) and NVR Inc. (NVR). Barron's also cites Meritage Homes Corp. (MTH) and home improvement retailer Lowe's Cos. (LOW) as two other attractive stocks.
Crash and Rebound
From the close on January 3, 2007 through the close on March 6, 2009, all these stocks suffered steep declines against the background of the unfolding subprime meltdown and the ensuing financial crisis of 2008. For these four stocks, see below their declines, subsequent rebounds through the close on March 5, 2018, and their current forward P/E ratios, per adjusted close data from Yahoo Finance:
- Lennar: -87%, +930%, P/E 8.5
- NVR: -47%, +802%, P/E 13.5
- Meritage: -80%, +393%, P/E 7.7
- Lowe's: -57%, +858%, P/E 14.0
As a point of comparison, the S&P 500 Index (SPX) fell by 52% and then rose by 298% during these same two periods. Even with the overall market's gains, the Investopedia Anxiety Index (IAI) records very high levels of concern about the securities markets among our millions of readers worldwide.
Positive Macro Forces
Low unemployment and low interest rates are the main macro forces driving strong demand for homes, Barron's indicates. Additionally, while housing inventory is low relative to demand, annual price increases generally have been relatively modest, at mid-single digit rates during the past six years, Barron's adds, which is helping to keep demand healthy. As long as this scenario persists, many industry experts believe that the housing market's recovery can continue for several years, Barron's says. The biggest uncertainty, they note, is whether interest rates will spike on mortgages.
Concerns about rising interest rates have spurred a sell-off among shares of home builders, home improvement retailers, and building supplies companies, Barron's notes. For example, the SPDR S&P Homebuilders ETF (XHB), which tracks all these categories, per Barron's, is down by 13% from its recent high as of its January 22 close through its close on March 5.
Barron's indicates that home builders as a group trade at an average valuation multiple of about 10, significantly below the forward P/E ratio of about 17 for the entire S&P 500. This is despite earnings per share growth forecasts that are in the double digits for both 2018 and 2019. As a result, Barron's adds, bullish analysts and investors are anticipating stock price gains for the group in the range of 10% to 15% in 2018.
Here's a look at the four stocks that may benefit the most.
Meritage is based in Arizona and also operates in Texas, Florida, Georgia, and the Carolinas. Job growth and housing demand look strong in these markets, Barron's indicates. Also, the company's decision to make entry-level homes the focus of 35% to 40% of its developments lines up well with the fact that employment of young people in the 25-to-34 age bracket is at record highs, Barron's adds. The company projects double-digit earnings growth during the next few years, per Barron's. Credit Suisse has a price target of $60 on the stock, Barron's says, 38% above its March 5 close.
Lennar is based in Miami, but operates nationwide. Sandy Sanders, senior portfolio manager of the John Hancock Fundamental Large Cap Core Fund (TAGRX), told Barron's that total housing starts may rise by 25% or more, and Lennar is "very well positioned to capture that growth, but the stock is not capturing that." After a recent acquisition from which it expects to achieve significant cost savings, Lennar will be among the top three builders in 24 of the 30 biggest U.S. housing markets, per research from JPMorgan cited by Barron's. Sanders has a price target of $80, 37% above its March 5 close.
Virginia-based NVR has had a superior return on equity (ROE) of about 35% over the past two years because, unlike many competitors, it does not develop much land, which reduces its capital requirements significantly, as Smead told Barron's. NVR operates in 14 states, concentrating its efforts in the Washington, DC to Baltimore corridor, Barron's says, adding that analysts are projecting 20% annual earnings growth in 2018 and 2019.
Shares of home improvement retailer Lowe's took a recent hit after missing analysts' estimates of fourth quarter earnings. Lowe's has lagged rival big-box home improvement and building supplies retailer The Home Depot Inc. (HD) in terms of profit margins, returns on invested capital, and valuation multiples, Barron's reports. Meanwhile, activist hedge fund D.E. Shaw has won three board seats, and is expected to press for improvements in Lowe's results, Barron's adds. Those improvements, of course, could help bolster Lowe's share price.