My regular readers know I have been significantly underweight homebuilders for more than a year now after taking some nice profits in multiple names after they had a strong rally for several quarters as the Covid lockdowns ended.
My reason for taking profits then was that rallies had brought most homebuilder stocks to fair value territory and I had worries about how long average home prices could go up annually in the mid-teens without eroding housing affordability and therefore demand.
Homebuilder stocks have recently been under a great deal of stress as average 30-year mortgage rates have shot up to just north of 5% from just a tad over 3% 12 months ago. The sector is also dealing with supply-chain challenges and labor shortages like so many parts of the economy right now.
However, the large decline in the sector is starting to bring many names back down to more than reasonable valuations -- even if we do see a slowdown in housing activity for a few quarters. Given that the U.S. has underbuilt its housing stock for 15 years after the housing bust, I believe the sector will rebound eventually as conditions improve.
This brings me back to my favorite homebuilder, LGI Homes (LGIH) , which I have profitably traded several times over the past 7-8 years. This Texas-based home builder has done a fantastic job over most of the last decade managing its considerable growth, consistently keeping its margins steady on an annual basis. The company has rapidly grown to be the 10th largest home builder in the U.S. with communities in 35 markets across 19 states. Importantly, these are almost all in places seeing significant migration from other states such as Nashville, Tenn., Las Vegas and Daytona Beach, Fla.
LGI's monthly home closings have fallen over the past few months, as they have for about every homebuilder, as mortgage rates have spiked this year. Fortunately, LGI should remain very profitable here in 2022; the current analyst consensus has the company earning more than $17 per share, which would be flat with last year.
That means the stock is currently trading under 5.5 times forward earnings estimates. So, even if estimates come down a few bucks a share in the coming months, which could happen, a lot of bad news is already priced into the equity after an approximate 40% decline so far in 2022.
Meanwhile, stock also saw its first insider buying last month since March 2018. Finally, LGI has a very solid balance sheet that should allow it to survive easily even if the country heads to recession.
One can mitigate downside risk further via the option strategy outlined below for LGIH.
What's My Option Strategy for LGI Homes?
Here is how one can initiate a position in LGIH via a covered call strategy. Remember, covered call orders involve buying an equity and simultaneously selling just out of the money call strikes against the new position.
Using the December $95 call strikes, fashion a covered call order with a net debit in the $78.50 to $79.50 a share range (net stock price - option premium). This strategy provides nearly 15% of downside protection as well as 20% of potential upside even if the stock does little over the option duration. Option liquidity is solid but not great, so it might take a bit of time for order to fill. My order Friday did fill within an hour at the midpoint of recommended range.
(Bret Jensen is a regular contributor to Real Money Pro. Click here to learn about this dynamic market information service for active traders and to receive columns from daily columns and trade ideas from Tim Collins, Paul Price, Doug Kass and others.)
