Bullish signals from U.S. housing industry

The Globe and Mail, Number Cruncher

By Peter Ashton

Friday, April 27th 2018

In The Globe and Mail, Peter Ashton uses Strategy Builder to find U.S. home-builder stocks with attractive valuations and return on equity.  

What are we looking for?

U.S. home-builder stocks with attractive valuations and return on equity. According to data from Red-fin, a U.S. real estate brokerage, the median price of U.S. homes soared by 8.9 percent in March compared with the prior year –the biggest annual increase in four years. Meanwhile, the supply of homes was down 11.9 percent compared with a year ago. Rising prices and low inventory are bullish for the shares of U.S. homebuilders, an industry that has struggled so far this year with the SPDR S&P Homebuilders ETF (XHB-NYSE) down more than 11 percent year-to-date.

The Screen

We will be using Strategy Builder to search for U.S. home-builder stocks that have reasonable valuations combined with a strong return on equity and low debt levels. We begin by setting a minimum market cap threshold of US$5-billion. This will focus our search on large-capitalization U.S. home-builder stocks whose revenue streams tend to be more predictable than their smaller-cap cousins. We will also limit our search to stocks displaying trailing price-to-earnings ratios of 25 or less. To select stocks with a strong return on equity, we screen for ROE ratios of 10 percent or more. Only about 25 percent of U.S. stocks have ROE levels in this range. Finally, to focus on companies with low levels of debt in this rising interest-rate environment, we will also filter to include only companies with debt-to-equity ratios of one or less.

What did we find?

After putting in a remarkable performance in 2017, D.R. Horton Inc. has struggled in 2018 and is down about 12 percent year-to-date. The company has a very good return on equity of 14.3 percent and a reasonable valuation with a P/E ratio of 16.8.

Miami-based Lennar Corp. is the largest homebuilder in the United States by market cap. The company operates in 17 states and made a new 52-week high on Jan. 22. Since then, fears of rising interest rates have suppressed the stock price, which is down 16 percent year-to-date.

Toll Brothers Inc. is interesting because of its focus on the U.S. luxury home market. It is the smallest company on our list with a market cap of US$6.2-bil-lion and also has the lowest P/E ratio at 11.7. On Feb. 27, the company announced fourth-quarter earnings that beat analyst estimates for earnings by a wide margin.

Trading Central Strategy Builder provides a back-testing capability to evaluate how well an investing strategy would have worked in the past. Using a five-year historical period with quarterly rebalancing, the screen described had a 15.7-percent annualized return compared with 11 percent for the S&P 500 index. The investment ideas presented here are for information only. They do not constitute advice or a recommendation by Trading Central in respect of the investment in financial instruments. Investors should conduct further research before investing.

The investment ideas presented here are for information only. They do not constitute advice or a recommendation by Trading Central in respect of the investment in financial instruments. Investors should conduct further research before investing.

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