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KB Home (KBH), The Ryland Group, Inc. (RYL), PulteGroup, Inc. (PHM): Explosive Gains in the New Building Boom

Housing is coming back in a big way! Residential builders have been off the radar for most people as potential investments for the last five years. Since bottoming in September 2011, the stocks and prospects for residential construction firms have been on a steady rise. These businesses currently offer an excellent opportunity to investors who act now to receive exceptional returns for the next three to five years as this already established trend runs its course.

A speculative opportunity inside a strong trend

KB Home (NYSE:KBH) is a business that was truly decimated with the collapse of the housing industry and is still experiencing its share of negative headwinds. It is diligently working to implement a plan designed to alleviate many of the issues facing its operations and is planning to issue new stock to raise capital and reduce debt. The market has reacted positively to the actions taken by the company and the share price has been moving up.

Some of the major issues facing the business are slow projected growth in five-year forward earnings of only 4%, a very heavy debt-to-equity ratio of 4.15 and a PEG ratio of almost 5. If the turnaround plan being implemented is successful, the stock could soar. For those with the willingness and ability to perform deep due diligence and accurately assess the prospects for the KB Home (NYSE:KBH) turnaround plan’s success, the opportunities for profit are enormous. For those lacking the time or ability to perform this evaluation, the risk of investing would be enormous. Unless an investor possesses the special skills needed, this is a good stock to avoid until more of the story unfolds.

Two household names for building households

The Ryland Group, Inc. (NYSE:RYL) and PulteGroup, Inc. (NYSE:PHM) are literally household names in the homebuilding industry and, in many ways, their market values put them in close proximity to each other. Both businesses have current P/E ratios over 35 but forward ratios around 14 to 15. They also have projected five-year earnings growth rates of 10%, price-to-book multiples around 3.65 and are priced at about 33 times cash flow.

PulteGroup, Inc.

While the price-to-cash-flow ratio of these businesses is only around 3.3%, both of these businesses are well positioned to see rising share prices as the momentum in this cyclical market continues to build and garner more media attention. Of the two, The Ryland Group, Inc. (NYSE:RYL) may have better prospects for investment performance over the near term as analysts’ earnings expectations for 2014 have risen about 20% in the last 90 days, while the 2014 expectations for PulteGroup, Inc. (NYSE:PHM) have fallen by about 3.6% over the same period.

If forced to choose between the two, The Ryland Group, Inc. (NYSE:RYL) would appear to be a preferable holding compared to Pulte.

The best opportunity inside a great opportunity

The upward trend in the home building industry presents a great opportunity for investors who get on board now, even though it has already been underway for about 18 months. D.R. Horton, Inc. (NYSE:DHI) appears to offer one of the best current opportunities for profits in the sector, based on its current valuation.

With a forward P/E ratio of 17 and a five-year projected earnings growth rate of 22.9%, this business is dramatically undervalued compared to the other businesses covered here. With a debt-to-equity ratio of 0.72 and interest coverage of 24.6 times, it is on far more stable footing than its major competitors and is trading at an exceptionally reasonable 7.8 times cash flow — over a 50% discount to the industry average of 19.6.

D.R. Horton presents excellent growth prospects for investors and appears to be quite undervalued within its industry and compared to the overall market. By almost any metric, it seems to present a compelling opportunity for investment.

Conclusions

While a well-informed speculator has the potential to make exceptional returns by investing in KB Home (NYSE:KBH), investors seeking high returns with less relative risk should certainly take a very serious look at shares of D.R. Horton. Those investors who wish to take advantage of the positive trend in home building but have a strong desire to spread the risk over a broader base than just one or two stocks can look to the SPDR S&P Homebuilders (ETF) (NYSEARCA:XHB), an EFT that holds a broad range of consumer cyclical stocks and homebuilders.

The article Explosive Gains in the New Building Boom originally appeared on Fool.com is written by Ken McGaha.

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