Rules of the Game: Think Twice on Housing

 | Nov 29, 2012 | 9:00 AM EST  | Comments
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XHB

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As a group, housing-related stocks rallied back from a big hit Wednesday as the major indices rebounded on a fresh round of "fiscal cliff" optimism. In addition, new data from the Federal Housing Finance Agency, released Wednesday, showed that new-home sales declined slightly last month. The agency also revised September's sales figures lower.

The SPDR S&P Homebuilders ETF (XHB) rose 0.2%, closing at $26.27, after the fund battled back from an intraday loss of 2.1%. But, if we look under the hood of the XHB, there may be less than meets the eye. Of the top 10 holdings in the ETF, only one -- Ryland Homes (RYL) -- is an actual homebuilder.

Here are the stocks that round out the rest of the top holdings: Whirlpool (WHR), Lowe's (LOW), USG (USG), Lennox (LII), A.O. Smith (AOS), Home Depot (HD), Leggett & Platt (LEG), Mohawk (MHK) and Masco (MAS). Sure, I can see how most of these relate to the homebuilding sector, but it's still pretty tenuous.

In general, I've narrowed my focus to the more liquid stocks and ETFs on the market -- and, when it comes to the homebuilders, the publicly traded names are all small- and mid-caps. The largest is Lennar (LEN), with market capitalization of $7.33 billion. The stock has excellent liquidity, however: It moves more than 5.6 million shares per day, on average.

Although Lennar is within striking distance of its Nov. 7 multiyear high of $39.33, it's stuck between being a growth stock and being a dividend stock.

Here's what I mean: Right now, despite the recent hoopla over a recovery, some headwinds potentially face housing. There's also fiscal-cliff-related chatter about eliminating or slashing the mortgage interest deduction, among other taxes that could make home ownership less attractive.

Given the continued economic weakness and political risk, it's hard to say how long stocks like Lennar will be able to maintain their upward trajectories. Lennar is up 95% year to date, so it would not be shocking to see a correction soon. Earnings are seen coming in at $2.99 per share in 2012, a bit of an improvement over 2011's $0.28. However, that level of growth is rarely sustainable. That's even the case for a company such as Lennar, which has cleaned up its balance sheet, streamlined purchasing and slashed overhead, among other improvements.

In 2013 the company is seen earning $1.57 per share, which would represent a year-over-year decline of 47%. Further, its dividend yield, at 0.4%, is not nearly enough to attract money from investors seeking a fixed-income alternative.

The second-largest publicly traded homebuilder is Pulte (PHM), with a market cap just shy of $6.6 billion. Here, the fundamental outlook is somewhat brighter. Analysts are eyeing earnings of $0.67 per share, up a whopping 738% from 2011. In 2013, the year-over-year growth rate is forecast at 70%, with earnings expected to come in at $1.14 per share.

Here, too, is a stock almost begging for a correction. Pulte has gained 169% for the year. The stock sliced its 50-day line a couple weeks ago, along with the broader-market pullback, but it quickly rebounded. The shares closed Wednesday at $17, 0.5% above the 50-day average.

While some traders might view the 50-day pullback and rebound as all the correction Pulte needs, I'd prefer to see something steeper. The stock has not tagged its 200-day average since it rose above that line in late December. Even in a June pullback, Pulte remained 11% above its 200-day.

Are there still potential trading gains in Pulte and Lennar? Perhaps there are. But, with earnings performance expected to slow in 2013, and with the potential for the fiscal cliff and other economic woes to hit the stocks, use some extra caution if you are intending these as longer-term holdings.

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