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Friday June 23, 2006
Sifting Through The Homebuilder Rubble
There can be little doubt that US home prices are unlikely to appreciate as rapidly in the immediate future as they did during the last 5-years. Moreover, there is little doubt that with mortgage rates and for sale inventories rising, that speculation by investors looking for a quick return on capital will, at minimum, decline slightly in the immediate term. Conversely, what is in doubt is exactly how deep the housing price collapse will be, how long it will last, and, from an investment standpoint, when the opportunities will arrive. On this last point, the recent action in homebuilding stocks bears watching for potential bargains.
Before exploring any ‘bargain’ speculations, caveats are vital. To begin with, no company can sustain equity growth of 30+% a year. Yet this is exactly what the largest homebuilders in America have accomplished in each of the last 5-years ending 2005.
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To further highlight how spectacular, and unsustainable, the increases in book value at US homebuilders have been, consider that Warren Buffett’s Berkshire has achieved an average per share book value increase of 8.5% over the last 5-years while the largest US homebuilders have averaged 33%. As for the long-term, Buffett has averaged an unbelievable 21.5% over a 41-year period. Although this long-term record is the envy of every manager alive, homebuilders have a streak of even more impressive proportions. To be sure, the largest US homebuilders have averaged a 29.4% increase in equity over the last 8-years! Buffett has never matched this high of an average in book value growth over any 8-year period on record (Buffett’s best 8-year streak was 21.6%, accomplished from 1972-1979).
How can any rational investor conclude that US homebuilders will continue to achieve strong increases in equity in the coming years? They can’t.
With that out of the way, it is important to note that the S&P homebuilding index is in freefall, 7 homebuilders (HOV, SPF, TOA, WCI, MHO, CHCI, and DOHM) currently trade below tangible book value, short interest on many builders is increasing rapidly, and with an average P/E of 4 (larger builders) the average homebuilder stock may be pricing in little more than survival. This action is why homebuilders warrant a look by contrarian and value minded investors.
Safety in homebuilding stocks? Laugh if you want, but after the dust starts to settle and capitalism’s ripped open chest still contains a beating heart, investors may recognize that the real estate assets held by money losing homebuilders are worth more than the companies trade at.
As for the timing of this potentially historic opportunity, Hovnanian Enterprises and many other homebuilders have not posted an annual decline in shareholders’ equity since 1997, Dominion homes has not posted an annual loss since 1995, and DR Horton has not registered an annual EPS decline since 1993. Yes, the carnage in homebuilding stocks has, for the brave, presented some bargains. But after a decade of great times it is difficult to contend that a couple of poor quarters mark the end of the bad times. The interested homebuilder investor probably has some time to wait before opportunity knocks, because the rubble, at least from a financial statement perspective, has only just started to pile up.
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