Lastly, the P/E ratio for Toll is 10.96, which is well below the P/E ratio of S&P500 at 17.7. It means that the stock is undervalued with possible upside potential.
Downsides for other residential construction companies
On a long-term basis, other residential companies, such as Meritage Homes Corp (NYSE:MTH) and Standard Pacific Corp. (NYSE:SPF), are at a disadvantage.
Meritage Homes Corp (NYSE:MTH) builds and sells first family homes in the United States. In its recent quarterly results, the company reported an increase in its home orders and home closings which led to an increase in its EPS. In the current market conditions, the future performance of the company seems attractive as backlogs of the company have increased by a whopping 89% on the YoY basis. This means that its customers have renewed confidence and they are willing to commit.
The situation is similar for Standard Pacific Corp. (NYSE:SPF) as it has reported some great numbers in its recent quarterly results. Its revenue increased by a whopping 61% on a YoY basis whereas its home deliveries increased by 48%. In recent news, the company has completed its acquisition of select assets from Centerline Homes. The assets include 3,000 home sites that will come under the control of the company. This acquisition will increase the company’s community count and move-up position in several attractive markets.
It all looks great for both of these companies as they target the middle-income market for homes.The reality is not the same though as recently there has been a spike in interest rates. Market participants are concerned that the Federal Reserve may start to end its monetary policy of quantitative easing. As mortgage is the lifeline of residential real estate, the higher interest rates might slow down the recovery in the housing market. If I assume that the interest rates will keep on rising, then home builders targeting middle income groups will face a dilemma. On one hand they will have to reduce building due to the declining demand and on the other hand they will have to lower their prices, which will hurt their profits.
Toll Brothers’ answer to the downsides
The lower interest rates compelled mostly the middle income consumers to jump into the market for residential properties. If interest rates increase again, the middle income groups will be affected the most. As for Toll, its demand comes from the higher income segments of the economy and they are not affected as much as the middle income groups due to the changing interest rates. Therefore, I perceive that the demand for Toll’s residential properties will continue to rise.
The takeaway
The residential construction companies are poised for growth because the real estate sector of the United States still has to make its full recovery. With public perceiving interest rates to rise again, I believe that companies targeting middle income consumers will be affected the most. However, Toll Brothers, with its focus on a niche luxury market, will continue to prosper in the coming future.
Usman Ghani has no position in any stocks mentioned. The Motley Fool recommends Meritage Homes. Usman is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article A Niche Market Success Story originally appeared on Fool.com is written by Usman Ghani.
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