For the average investor, the urge to buy low is practically etched into their DNA. That’s why anything that is supposedly on the bargain rack is just too tempting to ignore for most retail buyers.
But as wise as that strategy obviously is, it is often a temptation that leads to disaster-particularly when buying in the universe of the former high flyers.
That’s because when a stock has fallen heavily from a very high price to a much lower price, some investors just can’t seem to help themselves.
"It’s an absolute bargain," they say to themselves as they "scoop up" what they are sure are great values.
But more often than not those former big winners turn out to be nothing more lead weights around their ankles as the shares of those companies continue to get "cheaper". In short, they are not values, but value traps.
That, of course, is one of the big dangers these days when it comes to investing in the shares of home builder stocks , even though most of them have fallen as much as 90% off of their all time highs.
Home Builder Stocks Have Fallen for a Reason
The challenge then for all "value" investors is in determining if a company’s misfortune is either temporary or if it reflects protracted problems with the business itself.
That’s what makes the home builder stocks so difficult to buy even at these levels, because as a heavily cyclical industry, the builders are ready made value traps as their revenues decline and their earnings turn negative.
Their share prices, after all, have fallen for a good reason.
And that reason is pretty simple-the builders have gone from boom to bust. Moreover, it is a bust that will absolutely last for some time, because as a business that is really only as good as its last deal, the sharp decline in buyers means nothing but further pain for the industry as it struggles with a massive over supply of homes on the market.
As a result, the end of that steady stream of buyers that all of that easy credit produced will mean that for the most part the group will likely fall back to its pre-bubble days.
Here’s why.
At the height of the bubble, builders carried P/Es and profit margins that will never be repeated. Lennar Corporation (NYSE:LEN.B) for instance, carried a PE as high as 14.10 on margins as high as 9.7% during its peak.
Those are numbers that are historically unheard of but are typical of what was going on within the industry as Wall Street came to believe that these were growth stocks instead of cyclical companies.
The result has been an overvaluation that continues to this day, even though these stocks look like "bargains" now.
In fact, according to historical analysis, on average the sector still has a risk of about 50% to the downside as gross revenues fall, margins shrink, and their PE’s return to "normal".
That’s because when you eliminate the distorting effects of the housing bubble on these companies, they have historically carried price to earnings ratios of 5-8 on margins of 3-6%.
And by applying those figures to an anticipated reduction in revenues of 20% for the next two years, even at these lows the sector is still heavily overvalued at present.
So Where’s the Value?
Here’s what that same analysis shows when it’s applied to six of the nation’s biggest home builders. In short, it leaves you wondering…where’s the value?
Hovnanian Enterprises, Inc.(NYSE:HOV)
· Avg. 5 yr. Pre-Bubble Profit Margin………………………3.62%
· Avg. Pre-Bubble PE…………………………………………5.84
· Estimated 2009 sales w/ 20% yoy declines……………$2,582,400,000
· Estimated Net Profit 2009 @ 3.62% margins………….$93,482,880
· Estimated EPS 2009………………………………………..$1.50
· Implied 2009 Share Price………………………………..$8.77
Lennar Corporation (NYSE:LEN.B)
· Avg. 5 yr. Pre-Bubble Profit Margin………………………6.18%
· Avg. Pre-Bubble PE…………………………………………7.47
· Estimated 2009 sales w/ 20% yoy declines…………..$5,800,000,000
· Estimated Net Profit 2009 @ 6.18% margins…………$358,440,000
· Estimated EPS 2009………………………………………$2.23
· Implied 2009 Share Price………………………………..$16.65
Centex Corporation (NYSE: CTX)
· Avg. 5 yr. Pre-Bubble Profit Margin………………………4.32%
· Avg. Pre-Bubble PE………………………………………….7.16
· Estimated 2009 sales w/ 20% yoy declines……………$7,692,000,000
· Estimated Net Profit 2009 @ 4.32% margins………….$332,294,400
· Estimated EPS 2009………………………………………..$2.73
· Implied 2009 Share Price………………………………….$19.57
Pulte Homes, Inc. (NYSE: PHM)
· Avg. 5 yr. Pre-Bubble Profit Margin………………………..4.18%
· Avg. Pre-Bubble PE…………………………………………..5.95
· Estimated 2009 sales w/ 20% yoy declines……………..$5,830,000,000
· Estimated Net Profit 2009 @ 4.18% margins……………$243,694,000
· Estimated EPS 2009………………………………………..$0.95
· Implied 2009 Share Price…………………………………$5.66
DR Horton, Inc. (NYSE: DHI)
· Avg. 5 yr. Pre-Bubble Profit Margin………………………5.26%
· Avg. Pre-Bubble PE…………………………………………6.4
· Estimated 2009 sales w/ 20% yoy declines…………..$6,330,000,000
· Estimated Net Profit 2009 @ 5.26% margins…………$332,958,000
· Estimated EPS 2009………………………………………$1.05
· Implied 2009 Share Price………………………………..$6.76
Beazer Homes USA, Inc. (NYSE: BZH)
· Avg. 5 yr. Pre-Bubble Profit Margin………………………3.2%
· Avg. Pre-Bubble PE…………………………………………6.06
· Estimated 2009 sales w/ 20% yoy declines…………..$2,260,000,000
· Estimated Net Profit 2009 @ 5.26% margins…………$72,320,000
· Estimated EPS 2009………………………………………$1.84
· Implied 2009 Share Price………………………………..$11.06
Those historical calculations, of course, assume that these builders can not only remain solvent, but can eventually return to profitability by the end of 2009.
But given that margins in the business continue to shrink and that for the most part earnings have all turned negative returns to profitability within two years at this point seems a bit unlikely.
So are the home builders attractive at current levels?
Well not hardly if you take a realistic look at their future numbers.
In fact, at this point they still look like they are nothing more dead money value traps.
So don’t fall for them. Leave these "bargains" in the basement where they belong.
Wishing you happiness, health, and wealth,
Steve Christ, Editor
