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Construction workers on a Toll Brothers home in Boca Raton, Fla. Toll and other home builders currently trade near book value.
Joe Raedle/Getty Images
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The housing market is still robust, but home-building stocks have been rocked this year as investors worry that surging mortgage rates will dampen activity later in 2022 and in 2023.
The result is that the industry now has the lowest price/earnings ratio in the stock market, at around four times projected 2022 earnings.
With the sector so inexpensive, the risk-reward equation looks favorable, given that many stocks are trading at, or near, book value.
Thirty-year mortgage rates have risen to almost 4.7%, from 3% in late 2021. Should they start to slide back, the stocks could rally. And the shares could gain, even if rates hold at current levels—should favorable industry trends continue.
Home-building stocks are the second-worst performing group in the
S&P 500 index
this year—only home furnishing stocks have done worse. The
iShares U.S. Home Construction
exchange-traded fund (ticker: ITB) is off 28.5%, to around $59. Industry leader
D.R. Horton (DHI) is off 31.3%, to $74.51.
Barron’s wrote favorably on the group in late 2021 in what appears today to be a badly timed article. The stocks are down sharply since then.
Housing bull Stephen Kim, an analyst at Evercore ISI, says the stocks are cheap and that the companies’ land values should help put a floor under them. Demographics also look favorable, as millennials move out of city apartments in search of more space in the suburbs.
Book value has often underpinned the stocks in the past, and book value could now be understated industrywide because of older, lower-priced land carried on company balance sheets. Kim wrote that the stocks “are trading well below their implied liquidation value.”
| Home builder / Ticker | Recent Price | YTD Change | 2022E P/E | Price to Book Ratio |
|---|---|---|---|---|
| KB Home / KBH | $32.38 | -27.6% | 3.1 | 1.0 |
| Taylor Morrison Home / TMHC | 27.22 | -22.1 | 3.3 | 0.8 |
| Tri Pointe Homes / TPH | 20.08 | -28.0 | 3.8 | 0.9 |
| PulteGroup / PHM | 41.90 | -26.7 | 4.1 | 1.4 |
| Toll Brothers / TOL | 47.02 | -35.1 | 4.5 | 1.1 |
| D.R. Horton / DHI | 74.51 | -31.3 | 4.6 | 1.7 |
| Lennar / LEN | 81.17 | -30.1 | 5.0 | 1.2 |
E=estimate
Sources: Bloomberg; FactSet
Toll Brothers (TOL),
KB Home (KBH),
Tri Pointe Homes (TPH), and
Taylor Morrison Home (TMHC) trade near book value, while
Lennar (LEN), one of the two industry leaders, now trades for 1.2 times book. D.R. Horton, the No. 1 home builder in the country, fetches 1.7 times book and
PulteGroup (PHM) is around 1.4 times, according to Bloomberg.
The industry is probably in its best shape ever, with strong balance sheets and increasing capital returns to shareholders, mostly through stock repurchases. Lennar bought back more than 2% of its stock in the latest quarter. Dividend yields generally are under 2%.
So what’s the problem?
So what’s the problem? “Investors are understandably skittish, given [that] the combination of higher rates and elevated prices makes homes less affordable,” J.P. Morgan analyst Michael Rehaut wrote in a recent note. “While the current fundamental backdrop remains healthy, at the same time, we believe investor concerns regarding rising interest rates and the sustainability of earnings are likely to persist over the near to medium term.”
The J.P. Morgan analyst is “less constructive” and more selective on the stocks, favoring Horton, Lennar, and Pulte. Home builders are contending with shortages of materials like garage doors.
Lennar stock could benefit from the company’s plans to separate non-core businesses including multifamily rental operations later this year. Kim has written that the spinoff value could be over $20 a share.
Lennar has two classes of stock. Its less-liquid, supervoting class B shares trade at about a 15% discount to the more liquid A shares. The class B stock ended at $68.35 Thursday, against $81.17 for the A stock.
The B stock, largely held by Lennar Chairman Stuart Miller, could ultimately be merged into the A shares, benefiting B share holders. Barron’s has written that the B shares are a good alternative to the A stock for individual investors. The B shares trade below book value and for just four times projected earnings in Lennar’s fiscal year ending in November.
Toll shares, which ended Thursday around $47, trade for 1.1 times the company’s book value of nearly $45 in its quarter ending in January. Toll is differentiated from its peers thanks to its luxury focus. The affluent buyers of its high-end homes—whose average price is close to $1 million—tend to be selling homes that have appreciated and are thus less sensitive to changes in mortgage rates.
If Toll CEO Doug Yearley is accurately describing the housing market as he did in the company’s earnings press release in February, the industry could be on a multiyear run.
“This market is being propelled by strong demographics, the substantial imbalance between the tight supply of homes and continued pent-up demand, growing equity in existing homes, migration trends, and the greater appreciation for home,” he said then. “We believe these long-term tailwinds will continue to support demand for new homes well into the future. With our significant and well-located land holdings and our unique niche in the luxury market, we are well positioned for continued growth.”
Write to Andrew Bary at [email protected]
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