Homebuilder Gets the Edge Over Solar

 | Aug 09, 2013 | 11:00 AM EDT
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Four days after U.S. stock indexes set new records, stocks have taken a breather. It's been a mild decline so far -- unless you happened to be in the wrong stocks.

First Solar (FSLR) has dropped 14% since the peak last Friday. It reported on Tuesday that sales in the second quarter fell 46% from the same quarter a year ago. Making solar panels is a tough way to make a living, when there is an abundance of efficient, low-cost competition from China.

The Tempe, Ariz., firm has taken investors on a weird and wild ride. It came public at $20 a share in 2006, rose all the way to more than $300 a share in the spring of 2008 and then began a persistent zigzag decline. The shares hit bottom at less than $12 in mid-2012, and now are trading at about $41.

First Solar has some definite strengths. It is profitable, which you can't say for most makers of solar energy equipment. It has struck up an alliance with General Electric (GE), a powerful partner. It has interest from India in building large-scale solar farms. The stock sells for less than book value (corporate net worth per share).

But this looks to be First Solar's third consecutive year of declining earnings, and analysts expect profits to fall for a fourth straight year in 2014.

I have no big quarrel with someone who wants to speculate in First Solar shares, but the risks are high -- a bit too high for my taste.

More to my liking is PulteGroup (PHM), a homebuilder out of Bloomfield Hills, Mich. Its shares are down 8% since August 2, and down 13% this year.

The homebuilder stocks, of course, are not for the faint-hearted. Pulte shares rose 188% last year, but they declined 68% in 2007, and they fell in value in five of the six years from 2006 through 2011.

I believe that homebuilding is in a secular recovery in the U.S. The glut of homes on the market has been mostly worked off. Home sales and home prices both have increased this year. People are starting to think once more that a home might be a good investment.

On a normal price/earnings measure, the homebuilders as a group are not cheap, and neither is Pulte. It sells for 20x the past four quarters' earnings. But these stocks look better if you use my "malt shop price-to-earnings ratio." That is the stock's price divided by the third-best earnings in the past ten years. It's a shorthand version of a normalized P/E.

Pulte's third-best earnings of the past decade were $2.48 a share in 2003. That results in a malt shop P/E of 6.4, which is an appealing ratio. I think the stock deserves consideration.

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