Building a New-Year Portfolio

 | Dec 28, 2011 | 1:30 PM EST  | Comments
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Stock quotes in this article:

tol

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len

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spf

Now that I have the annual prediction article behind me I want to spend some time taking a look at what is cheap going into the New Year.

This is where I will be building my shopping list for stocks I want to buy when we get the inevitable market mini panic and decline at some point next year. I have no way of knowing if we will get a real panic at any point, although there are enough conditions in place to cause one. Even if the black swan doesn't show up, it's a pretty good bet that some grey ones will create an opportunity to buy stocks cheaply.

In the Value Line rankings of industry groups, the lowest-ranked group is homebuilding stocks. I am hesitant on this group as there is still an enormous inventory of homes that on the market and most of the real-estate advisory firms are predicting increasing foreclosures for at least the first half of 2012. A very high real rate of unemployment is also keeping a lid on demand. Those few buyers who want a home and can qualify for a mortgage are better off buying a distressed property in foreclosure or as a short sale. And 2012 is only going to be a little better for the builders than 2011 was when it comes to sales and profits. We have seen some pickup in permits and starts, but if we get another wave of foreclosures it will not be sustainable. That could cause these stocks to give back some of their recent games and at that point they are going to be worth a look.

The sector faces headwinds, but it has been beaten and battered for several years now. At some point we will clear out the inventories, the economy will pick up and job creation will begin to drive demand. In spite of the very serious and confident predictions you will see over the next few weeks, none of us really know when this will happen. Although there has been, and will be again next year, a point in time when it seems like we will never see housing rebound, it will happen someday. If you have a long-term perspective the builders have to be on your radar screen as we go into 2012.

Two builders stand out as the best in class and I will be a buyer if they fall back in price. Toll Brothers (TOL) is best of breed when it comes to builders. Not only has CEO Robert Toll been the most open and forthright about conditions in the industry under his direction, I think they have done the best job of managing the balance sheet. The company has more than $1 billion in cash and has been reducing debt and buying back stock at reduced levels. The company also developed a joint venture to buy land and property at distressed prices that should yield enormous profits when the residential real estate markets recover. Toll shot up in the last two months to the point that Robert Toll and other insiders sold stock, so I would hold off for now accumulating shares. But the stock should be on your list. Toll operates in the upper end and luxury home markets and these have historically been the most stable and the first to experience a recovery.

Lennar (LEN) also stands out as a well-positioned builder that could soar when markets recover. The company has seen an uptick in new orders and backlog coming into the last quarter of the year .We will find out Jan. 11 if that trend continued in the final quarter. The real story here is also a joint venture developed to acquire distressed land and homes during the crisis. This distressed subsidiary, Rialto, generated almost a third of revenue so far this year and that should increase in 2012. The company has been acquiring properties from banks as well as the FDIC and has generated significant profits for Lennar so far. As housing prices firm in the future, Rialto should become a growth engine for the company.

On the low end of the building market right now, you have to look at Standard Pacific (SPF). The company builds in some of the more troubled markets and has struggled so far. They are highly leveraged and are still taking writedowns on existing inventories. But Matlin Patterson, the distressed investing company, owns 45% of the company and I don't see them letting their investment decline to zero. With a strong presence in California and Sun Belt markets, if they can just survive until the economy recover the stock could appreciate by several multiples.

There will be plenty of bad news for builders in 2012 that will create an opportunity to buy at better prices. Rather than rush to buy as we enter the New Year, let Mr. Market work for you instead of against you.

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