A Short Bet on Homebuilders' Troubles

 | May 07, 2014 | 3:00 PM EDT  | Comments
  • Comment
  • Print Print
  • Print
Stock quotes in this article:

bzh

,

kbh

After writing yesterday's column, I had some additional conversations about housing and dug into the situation a little more. I find that I just reinforced my agreements with Jeffrey Gundlach and my son Tom. There are way too many houses being built and not enough people with the desire and capacity to buy them. The builders will have a tough time making money, and their stocks are far too expensive right now.

I found it interesting that apparently even Warren Buffett had some comments on housing, saying that he was surprised that it wasn't stronger. Since he owns companies that make house paint, carpet and other goods used by builders and homeowners, as well as a manufactured housing company, he is in a great position to judge the strength of the marketplace.

Once of his executives, Ron Peltier, who runs the Berkshire Hathaway (BRK.B)-owned realty brokerage Home Services of America, expressed even stronger concerns. He said over the weekend, "The single most challenged sector of the market is the first-time home buyer," he said. "Historically, they make up 40% of the existing home market. In the last 18 months to two years, it has been 27% to 28%. Twelve percent of the market has been missing. It's troubling."

After pondering and calculating for some time, I decided it is time to break out the small reserve I have for aggressive bets and put on some chicken shorts. Keep in mind that while this is not exactly play money, the cash dedicated to these trades is a miniscule percentage of the portfolio. I will make a few bets that promise asymmetrical payoffs, and I will not incur enough capital risk to change my life. If these bets work, I will add several percentage points to my return for the year, and if they don't, it won't cost much at all.

When it comes to shorting, I am a huge chicken. I have had enough friends get whacked by a takeover or other event while they were short stock that I have no desire to engage in such activities. My first job as a long-term investor is to survive until the long term, and I have no interest of being carried out on my bloody shield. I will use put spreads to create the short positions.

Beazer Homes (BZH) is the most leveraged of the homebuilders, so it is at the top of the list. The debt-to-equity ratio is over 6, and the company does not earn the interest due on its debt right now. Beazer serves the first-time and first-move-up buyer, and that's the weakest part of the market right now. This segment will not improve until we see more full-time, better-paying jobs created. At 2.2x book value, the stock is not cheap at this level either.

Those who have more options experience than I can do better, but you can use the either the January 2016 $20 and $15 or $17.50 and $12.50 spread to create a trade that has a better than 2.5-to-1 risk/reward ratio. I prefer 3 to 1 or better, so I might try to jiggle around this trade and set up the long put on an up day and the short put on a down day to give me a little improvement in the potential payout.

The situation is similar at KB Home (KBH). The stock is not very cheap, as it trades at 2.4x book value, and the debt-to-equity ratio is 2.4. KB Home had a solid profit last quarter, but it was the result of huge price increases in Western markets while unit sales actually declined a bit in the region. Again, if you go out to the January 2016 options, it looks like you can construct trades without too much effort at a risk/reward ratio of 2.5, and patient and more experienced traders could get ratios of 3 or higher.

I just do not see any way the housing market will experience a strong recovery over the next year. It may just bounce along the bottom, or, if Gundlach is correct, we could see prices set new lows as demand disappears. Neither scenario is healthy for homebuilders, and it is worth a bet that they will see difficult times and falling stock prices at some point in the next 19 months.

Columnist Conversations

Market is off to a great start after yesterday's decline. Solid earnings from Caterpillar (CAT), General Moto...
With the SPX trading in 1% moves per day VIX feels priced right around 16. For now the seesaw volatility is n...
A lot of noise is being made about this morning's headline that Saudi Arabia supplied less oil to the market i...
Kass:
I would continue to avoid Altisource. I will have a comprehensive review of Ocwen on Monday. This miss will no...

BEST IDEAS

REAL MONEY'S BEST IDEAS

Columnist Tweets

BROKERAGE PARTNERS

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.


TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.