This Homebuilder Passes the Lynch Test

 | Aug 21, 2014 | 9:00 AM EDT  | Comments
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Numbers have just been released relating to the housing construction market, and they are encouraging. The New York Times reports that U.S. housing starts rose to an eight-month high in July, and this suggests that the nation's housing market recovery is back on track after stalling in the second half of last year.

The Times story goes on to say that according to the Commerce Department, "Groundbreaking for new housing jumped 15.7 percent last month to a seasonally adjusted 1.09-million unit annual pace, the highest level since November. ... The gain snapped two straight months of declines and beat economists' expectations for a rise to only a 969,000-unit rate." The Commerce Department also reported that housing units authorized by building permits in July were 1,052,000, 8.1% higher than the revised June rate and 7.7% above the level seen in July 2013.

On Wednesday, my Real Money colleague Stephanie Link wrote about the recovery in the construction industry and cited a number of metrics that support this thesis. Though she and I have different stock recommendations, we agree that this is a good time to get involved with housing.

I looked hard to find a high-performing residential builder that has a well-priced stock. They are not easy to come by. Plenty of homebuilders are doing well, but the market knows this and has boosted up their stock prices as a result. But the guru strategy I based on the investment approach of Peter Lynch has found one firm that is worth noting.

Peter Lynch is one of history's most famous mutual fund managers, and in his bestseller One Up on Wall Street, he described how he picks stocks. Years ago, I took his approach (along with the strategies of a number of other noted investment gurus) and computerized it. This enables me to analyze any stock in a way that resembles Lynch's method of analyzing stocks.

When this strategy is applied to homebuilders, it gives the highest marks to NVR (NVR). NVR builds single-family houses, townhouses and condominiums in 14 Eastern and Midwest states, and it is especially strong in the Washington and Baltimore metropolitan areas. It operates under such names as Ryan Homes, NVHomes, Fox Ridge Homes and Heartland Homes. One unusual aspect to NVR is the price of its stock, which is in the neighborhood of $1,200 a share. Of course, that is extremely high, but the stock is still reasonably priced; its forward price-to-earnings ratio is 13.9.

The Lynch strategy's most important variable is the P/E/G ratio, which is the P/E ratio relative to growth. The P/E/G measures how much the investor is paying for growth. A P/E/G of up to 1.0 is acceptable, as this P/E/G says you are paying $1 for every percentage point of growth. NVR's yield-adjusted P/E/G is 1.0, so if you want to invest in this stock, do so now, because if its price goes up much higher, it may boost its P/E/G over the 1.0 maximum. In addition, NVR is doing a good job of managing its inventory; its inventory-to-sales ratio has dropped from 27.7% last year to 17.7% this year.

The housing market looks promising, and NVR can provide an entry.

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