Since I started looking at possibility of buying the home-builders in July 2006, they went up considerably, but have dropped back down in the first few months of 2007, so that they’re back around their July 2006 levels. Meanwhile, the rest of the stock market also dropped off and all the talking ehads are talking about the risks of sub-prime mortgages and so on. So, I decided that I better not wait; six months from now, the pessimism may disappear.
Since Bill Miller had opted for PHM, I was tending toward that choice, but decided to look at some of the competitors: TOL (sells more expensive houses), DHI (sells slightly less expensive houses), and CTX. Here’s what I found:
Firstly, I found that all four companies are pretty good and pretty similar. CTX has the best 10 year fundamental averages, but they swing all over the place, so I’m discarding them rather than expect myself to be able to figure out if that swings are about seizing the moment, or about poor prediction. So, I’m left with three that have very similar patterms of profit movement. Of these, though I was slightly predisposed to PHM, I’m now a little wary of their Michigan exposure. A look at the numbers shows PHM having dived a bit more than the other two.
The S&P analysts use book value and a multiple while evaluating these builders. I prefer to use a normalized EPS approach. In my estimate, the normalized 5-year EPS for these three are: (PHM = $ 2.60, TOL = $3.0, DHI = $3.30). With a normalized home-builder P/E of 8, that gives me valuations as follows: (PHM = $ 20.8, TOL = $ 24, DHI = $ 26.4). The prices today, 3/22/2007, are: (PHM = $ 27.50, TOL = $ 29.50, DHI = $ 23.50).
The top-line and bottom line growth rates are pretty good for all three, not much to go on there. So, I bought a little DHI, and …surprize, surprize, when I checked Gurufocus, I found that the Sequoia Fund had bought a little PHM in 2005, but they recently bought a larger chunk of DHI. With that second opinion, I plan to add to the DHI holding in the coming weeks.
My original plan was to buy and see if it goes down further, with the growing nervousness. However, the Fed might be coming near a turning point, and if they start to reduce rates, people might assume it’s good for home-builders, sending the stocks up.
DHI also comes with a 2.6% dividend yield, so I can see myself holding onto it for 5 years or so, though a whole cycle.
Update Jan 2009: The market went down as expected, but almost nobody expected how bad it would be. The S&P500 was down 45%. The excess home inventory shows no sign of abating. I took my loss, and got out of the one home-building stock I owned (DHI) some time last year.