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Lennar Corporation (LEN), Toll Brothers Inc (TOL): Time to Exit the Builder Stocks

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It is time to sell the builder stocks, despite good news in the housing sector. Homebuilders are too pricy, and the low interest rates that feed the industry will climb.

There is no doubt that the U.S. housing market is finally recovering after a severe and protracted slump. For the first time since 2008, the construction and sale of homes will add not only jobs but needed tax dollars as the economy gains strength, thanks to the Federal Reserve’s effort to keep interest rates at historical lows.

Lennar Corporation (LEN)

As seen in the recent January and February housing numbers, the recovery is continuing, with new home sales at the highest level since 2008. No one expected that strong of a number for January. In the West, sales were up an astonishing 45%. Supply stands at a low of 4.1 months, a number not seen since 2005. Multiple offers above asking prices are common in California. Builders scramble to catch up to the demand as permits for new construction rise. In February, sales fell to a yearly rate of 411,000, but this is still 31% more than February 2012.

The housing industry’s increasing momentum is clear. There has been a reversal in the fortunes in the industry and despite a continued high level of foreclosures, even the number of delinquent loans is falling.

It is for exactly these reasons why you should sell your builder stocks and lock in profits. Let’s look at three large builders:

Lennar Corporation (NYSE:LEN). This $8 billion (market capitalization) company, located in Florida, builds single-family homes in 16 states. They also develop and sell land. Management owns 4% of the stock and their sales growth increased for each of the last four quarters by over 30%. Gross margins rose from a negative 10.9% in 2009 to a positive 10.95% in 2012. Nothing is wrong with those numbers.

However, the other number you should watch is the stock price. In August 2011 the stock bottomed at $12.72 and today it is in the low $40s; the price tripled in less than two years.

Toll Brothers Inc (NYSE:TOL). The $6 billion dollar builder constructs single-family homes in luxury communities. Management owns 12% of the stock, so they are particularly focused on growing the company. Their sales grew at 30% or higher for the last four quarters and their profits margins went from minus 11.17% to 18.63%. Like Lennar Corporation (NYSE:LEN), profits steadily increased since 2010.

Their stock bottomed $14.38 in October 2011 and it currently sells in the mid $30s – more than doubling.

M.D.C. Holdings, Inc (NYSE:MDC) is smaller than the other two, with a market cap of $2 billion. They build homes on the lower end, catering to first-time and move-up buyers. They lost money every year since the Great Recession of 2008 and only turned a profit starting in 2012, with earnings per share of $1.28. Their gross margins never fell to negative territory but they are not improving either at 15.32%.

Sales are recovering at a higher rate than for Lennar Corporation (NYSE:LEN) or Toll Brothers Inc (NYSE:TOL), coming in at over 40% for the last four quarters. Their stock bottomed in December 2011 at $16.67 and now trades in the high $30s. Not nearly as impressive as the other two yet still close to a 100% return in a little over a year.

All three stocks have had a great run-up in price and therein lies the problem. There is a relationship between price and earnings that goes back centuries, not only in the stock market but also to the tulip craze of 1636, when a bulb sold for more than its weight gold. More recently the dot-com bubble proved that, if a company does not have earnings, then stock prices are going to fall.

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