When it comes to streaks, Baltimore is the home to some of the more famous ones. In baseball there’s "The Streak" put on by Cal Ripken and in football there’s the one by Johnny Unitas that’s every bit as impressive as the one by Joe DiMaggio.
The Colt quarterback threw for a touchdown pass in 47 consecutive games–a mark that may never be broken.
But aside from sports, Baltimore also is the home to one of the most impressive bits of investing streaks the markets have ever seen. It belongs to Legg Mason’s Bill Miller. His Legg Mason Value Prime (MUTF: LMVTX) mutual fund beat the S&P 500 for 15 straight years, making him a legend in his own right–deservedly so.
But as great and impressive as Miller’s run was, it ended just like those other streaks did. Miller’s fund finished 2006 with a 5.6% return while the S&P delivered 15.8%. And in part, it was a series of bad bets on home builder stocks that marked the end of the line.
Home Builder Stocks End the Run
Miller’s bets on Beazer Homes USA, Inc. (NYSE: BZH), Centex Corporation (NYSE:CTX), Pulte Homes, Inc. (NYSE: PHM) and the Ryland Group, Inc. (NYSE:RYL) all turned south on him last year as housing began to tumble. And while the companies certainly fit in well with Miller’s style of buying when the chips are down, those home builders, it turned out, had even further to fall.
In fact, I wrote about them last February as those same home builder stocks started to slide in a story called Buyer Beware: Homebuilding Stocks on the Brink. In it, I argued that the builders still had a ways to fall.
Since then the major home building stocks have plunged an average of 67%.
Here’s a look at some of the carnage in the home building sector since then:
· Hovnanian Enterprises, Inc.(NYSE:HOV) fell from $35.17 to $8.63–a loss of 75%
· Lennar Corporation (NYSE:LEN.B) fell from $54.82 to $17.48–a loss of 68%
· Centex Corporation (NYSE: CTX) fell from $53.67 to $23.35–a loss of 56%
· Pulte Homes, Inc. (NYSE: PHM) fell from $33.82 to $10.54–a loss of 68%
· DR Horton, Inc. (NYSE: DHI) fell from $29.70 to $13.20–a loss of 55%
· Beazer Homes USA, Inc. (NYSE: BZH) fell from $43.42 to $8.63–a loss of 80%
So with losses like those among the builders, what was it exactly that made the famed Miller grab that falling knife in late 2005?
Home Builder Stock Lesson: Proper Valuations Defy Even the Best
Well, for one thing, like a lot of great analysts, he probably underestimated the role that the mortgage bubble played in the last run-up put on by the builders from January 2003 to the peak in July 2005. Because without the unbelievable and irresponsible lengths that the lenders went to make deals in those days, the final leap in home values and builder share prices would not have been possible.
That meant that at their heights the builders were completely overvalued because of the credit bubble created by overly easy finance. In short, it was completely unsustainable and the builders have since paid the price.
But what he also may have missed was this: Homebuilding stocks are not growth stocks.
They never have been and they never will be–even though they did act like it for a stretch during the bubble.
That’s because historically the homebuilding business has always been one of booms and busts. And while the booms are spectacular, the busts are just as dramatic. In them, numerous builders go out of business.
That’s why any valuation based on price to earnings and price to sales falls flat during the down cycle, because during the busts earnings and sales become fickle and unreliable–a very different scenario from what happens in the up cycle.
In fact, even book value is useless these days, since much of that value is tied up in land prices that are falling.
A perfect example of this is what happened to Lennar this week. The builder took a 20% hit to its book value when it sold 11,000 lots at 40 cents on the dollar, losing some $775 million in an effort to raise cash.
So with book value, price to earnings, and price to sales being nothing more than gigantic moving targets, how exactly do you value the sector and the stocks?
Well, In Short… You Can’t
At least at the moment. Because when you strip it all away, in today’s market what every one of these home builders builds is illiquid, overpriced and hard to move without a margin-crushing fire sale.
That means that the bottom for the sector is completely dependent on the overall market conditions, which don’t favor them one bit since they are buried knee deep in the vicious cycle now. Oversupply, falling demand, tighter money and dropping prices are strong headwinds for the business and getting stronger.
What’s more, there are the massive amounts of debt that nearly every one of these home builders amassed during the run-up–debt that has become harder and harder for them to feed in the downturn.
That has significantly raised the risk of insolvency throughout the sector, as "cash burn" becomes an issue for all the home builders… and their stocks. Defaults are sure to follow.
Those looming factors are what make this sector still nearly impossible to bottom-fish in.
The worst, in other words, may still be to come. Attractive? Not hardly, even at these levels.
So how is Bill Miller doing this year?
Well, he’s behind the S&P again at the moment. But this time it’s the financials that are dragging him down.
But the great Bill Miller is hardly alone. The housing bubble has humbled a lot of investors. He’ll be back.
Wishing you happiness, health, and wealth,
Steve Christ, Editor