But the builders post decent earnings, so why the worry? It’s the annoying relationship of stock value to earnings. The long-term price to earnings (P/E) average for the Standard & Poor’s 500 is 15.
Based on today’s earnings, Lennar Corporation (NYSE:LEN) sits at 39, Toll Brothers Inc (NYSE:TOL) at 62 and MDC Holdings at 32. These are well above the average. What about forward-looking earnings? Based on estimates, these three companies are at 8, 26 and 17. These P/E ratios are not on the extreme but certainly higher than normal.
Plus, look at the Federal Reserve’s effort to keep interest rates artificially low. Builders are in a cyclical industry. When the economy does well, they do well, when interest rates are low, they do well. The economy may well be recovering, albeit slowly; because of that slowness the Fed has kept its foot firmly on the pedal, flooding cash into the economy.
Low rates won’t last forever, though. At the most recent Fed meeting, the 12 governors discussed tightening; in other words, letting interest rates rise. What do you think will happen to the sales of homes once that begins?
That’s why it is time to exit the builders – take profits and be happy. While the sector’s stock prices and sales could continue to rise for a while, the headwinds of higher interest rates are starting to appear. You do not want to own these stocks when they become hurricane force. Since investors and traders always look forward, they will likely sell these stocks before the problem hits.
The article Time to Exit the Builder Stocks originally appeared on Fool.com and is written by Larry Light.
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