Building A Profitable Home Construction Portfolio

01/09/13 08:17:57 AM

by Matt Blackman

After the real estate bubble burst, homebuilding stocks suffered a multiyear drubbing. But the landscape has changed and things are looking up, especially for the industry leaders.

Security: NVR, LEN, PHM
Position: Buy

It has taken a while for homebuilders to find the comeback trail, but the future for this industry is looking a lot brighter these days. Interest rates are expected to remain low for the foreseeable future and the economy continues to mend and the stock market has been a big beneficiary. Since March 2009, the Standard & Poor's 500 has gained an impressive 112%. But that pales in comparison to housing sector stocks as represented by the PHLX Housing Sector Index (HGX), up an incredible 225% over the same period. See Figure 1.

FIGURE 1: HGX, WEEKLY. Here's a comparison of the Philadelphia Housing Sector Index (HGX) with the S&P 500 (blue line) since March 2009.

Graphic provided by: TC2000.com.

So what are the strongest performers in this space? Pulte Homes Inc. (PHM) is the main contender, up more than 200% since March 2009. Beazer and Lennar are two more companies that have done very well since bottoming.

In a recent Comtex news release, NVR, PHM, and LEN were ranked highest of the homebuilders in terms of operating margins with NVR taking top spot with a margin of 9.6%. Next was PHM at 8.6%, followed by LEN with an operating margin of 8.5%. Unlike its two rivals, NVR has not had to carry land on its balance sheet and instead optioned the land on which it builds homes according to Bloomberg, which gives the company a distinct advantage. As well, the company has just 4.9 million shares issued compared to 191 million for Lennar and 386 million for Pulte. See Figure 2.

FIGURE 2: COMPARISONS. Here's a daily chart comparing the performances of NVR, Pulte Homes (PHM) in blue, Lennar Homes (LEN) in red, and the residential construction industry in green.

Graphic provided by: TC2000.com.

So why has it lagged the other two leaders as well as the industry in the last 12 months? One reason is share price -- with so few shares, the stock price has remained expensive, above $900 a share for most of the year compared to around $40 a share for LEN and $19 a share for PHM.

As long as interest rates remain low and the US continues its slow but steady economic growth, the demand for new homes will continue to grow despite the still-high inventory of foreclosed homes. As margin leaders, Pulte, Lennar, and NVR should continue to lead the pack for the foreseeable future. However, NVR appears to be the most attractively priced given its fundamentals and has the greatest potential of experiencing strong gains just to catch up to its rivals, especially if the company executes a stock split.

Matt Blackman

Matt Blackman is a full-time technical and financial writer and trader. He produces corporate and financial newsletters, and assists clients in getting published in the mainstream media. He is the host of TradeSystemGuru.com. Matt has earned the Chartered Market Technician (CMT) designation. Find out what stocks and futures Matt is watching on Twitter at www.twitter.com/RatioTrade

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