Homebuilders Start to Look Constructive

 | May 02, 2012 | 11:30 AM EDT  | Comments
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The economy's recovery is tentative, and much of the tentativeness can be placed at the foot of the real estate market. But wait: Even this down-for-the-count corner of the economy is showing signs of life.

Recently, The Wall Street Journal reported: "America's biggest home builders are posting the largest gains in sales and new orders in years, fueling speculation that the sector is starting to turn the corner."

The article went on to note that although builders posted losses, the losses were narrowing, and that builder stocks, as measured by the Dow Jones U.S. Home Construction Index, are up 31% this year. Another Journal article reported that housing construction and home sales appear to have hit a floor, though the bottom may be prolonged.

I recently looked online at newspapers in various cities and found other hopeful signs. The Salt Lake Tribune just reported that "sales of existing single-family homes in Salt Lake County jumped to the highest level in five years in the first quarter."

The Los Angeles Times wrote: "Need more evidence that the housing market may be rightsizing? Zillow Inc. said home values in March made their largest monthly jump since 2006 and will stop falling in most major metropolitan areas by the end of this year."

The Philadelphia Inquirer was a bit more restrained: "The residential real estate market continues to give off mixed signals – indications of continued, yet gradual, improvement that is well shy of full recovery."

The housing market is no doubt struggling, but it is giving signs that it has started to climb out of its hole or at least has hit its bottom.

If that's true, then this a good time to invest in homebuilders. Years ago, I regularly wrote about homebuilders, because the strong real estate market made them solid investments, but it has been a long time since I have had the opportunity to recommend one.

Currently, one major homebuilder gets a recommendation from one of my guru strategies. I have computerized the investment strategies of proven Wall Street investors and use them to find stocks the savvy investor might want to buy.

The homebuilder that now earns its place in the sun is PulteGroup (PHM). This is one of the country's largest producers of homes, operating in 60 markets in 28 states. It sells homes under three names: 

  • Centex: Homes for first-time buyers
  • Pulte Homes: for those in the move-up market
  • Del Webb: for active adults age 55 and up

By segmenting the market in this way, the company says it can serve homeowners during all phases of life.

James P. O'Shaughnessy is one of Wall Street's esteemed thinkers as well as a mutual fund manager. His approach to investing has long been a favorite of mine, and the strategy I used which is based on his writings strongly recommends Pulte.

The strategy looks for a market cap of at least $150 million, and Pulte's $3.8 billion easily exceeds this minimum. Also required are earnings per share that increase in each of the past five years. Pulte has not had any earnings in the past five years, but its losses per share have dropped dramatically from $9.02 five years ago to last year's $0.55. Given the weak state of the real estate market, the company is showing it can handle adversity and is putting itself in a strong position for the time when the market turns up.

Another variable is the price-to-sales ratio, a measure of how well a stock is priced. This ratio should be below 1.5, while Pulte's is 0.90. The final variable is to pick the top 50 stocks that passed the previous criteria and have the best relative-strength scores. Relative strength is a measure of how well a stock has performed in the past year relative to the market overall. Pulte's relative strength of 86 places it in this top-50 group.

PulteGroup is, of course, a risky investment. But if you want to ride the upturn that will come when the real estate market starts to strongly recover, and if you are willing to take on a fair amount of risk, Pulte is in an excellent position to take you on this ride.

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