Random Walk and Un-Random Talk!!!

Before we get to the exciting part of portfolio holdings as of today, let’s talk about couple of not so mundane stuff.

People are bothered, puzzled, surprised and whatnot (is it even a real word?) about the market. Every now and then I am being asked – Why is the market going up? In fact the more ubiquitous question is – Why did the famous (or shall I say the infamous) sequestration  and the forth coming budget talks not stall the markets?

Surprise

My dear fellow investors, I know there has been lot of noise about the unemployment and the sluggish growth  but everyone is forgetting that the housing industry, the pillar that has historically pulled US out of recession, has turned the corner. It has finally started contributing to the economy. There are cities in US like San Francisco, Phoenix and believe it or not – Austin – where the houses are selling faster than the pancakes at IHOP and they are getting pricier (FYI – I meant houses).

Moreover the stock market is a leading indicator of economy’s health in future (4 to 6 months down the line). I guess currently Mr. Market is discounting the shenanigans and gobbledygook of Mr. Washington.

Anyways, I enjoyed the ride and hopefully you did too. Apart from the employment data, there is no significant data coming up in next few weeks that will derail this rally.

Note of caution – Currently the PE(ttm) of $SPX stands at 17.5. Last year it was 15.5 and historical mean value has been 15.5. This doesnt really bar $SPX from reaching 20 but around this number, we have seen strong pullbacks in the past.

SPX_PE

Switching topic.

Over the weekend I read that Mr. Buffett was unhappy with the Berkshire’s returns. Now talk about ‘Subpar’ performance. YTD out of outstanding 27000 mutual funds only 1000 mutual funds have been able the beat the Dow Jones. This would even surprise the Dad of the baby posted earlier.

FundsBeatMkt

But this was not the most interesting thing that I read in the Journal. What really caught my eyes was an article by Jason Zweig – Have Investors Finally Cracked the Stock Picking Code?

Come on Intelligent Investor!!! Is it as simple as Kramer cracking George Costanza’s secret code? (Damn! Posting youtube video used to be free.)

Don’t the numbers speak for itself – 979/26500. Do you really think that using GROSS MARGIN to evaluate a company in addition to the Net Income will make every trader a crystal ball reader like the pretty lady below? I will leave it up to you, the Intelligent Investors, to decide.

CrystalBall

I will talk about my portfolio and it’s YTD performance tomorrow. Till then happy trading! Adios. And don’t forget to get my stock tweets @sumeetvats

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Are the Homebuilders Overvalued?

After celebrating the turnaround in the housing, let’s look at some of the housing stocks. The inventories are at the rock bottom and there is pent up demand in the market. We will get deeper insight when 6 Home builders report their quarterly earnings in the coming week. So should we dip our toes in to profit or pull our money out?

ITB

Not really my dear friends. Overall, home-builders have dramatically outperformed the stock market in the last year. Pulte Group (PHM) shares have nearly tripled in price; And Ryland (RYL), Standard Pacific (SPF) and MDC Holdings (MDC) have doubled in value. As a matter of fact shares of Lennar (LEN) rose 97% and DR Horton (DHI) increased by 57%. But one thing to remember is – PulteGroup fell 69% in 2007, Lennar lost 66% in 2007 and then 52% in 2008, and DR Horton stock declined 50% in 2007 and 46% in 2008.

As Lombard Street Research analyst Melissa Kidd notes, home-builders’ profits have actually risen faster than their prices, and their net profit margins are higher than pre-crash peak levels. Let’s look at the gross margin.

GrossMargin_HB

As you can see that the gross margin of the giant Pulte and the whole sale builder DR Horton are at their pre-crash levels. But the operating margins are not there yet.

OperatingMargin_HB

All these recovery in the margins and the earnings are sans the fact that home prices are up by just 7% Year-Over-Year. Most of the analysts might concur that the recent stock price rise have all the earnings rise (see below) and the future profits baked in.

EPSchange_HB

Let’s analyze some companies whose stock prices have sky rocketed in last few months.

Even after PulteGroup’s run-up, its price-to-forward-earnings ratio is 17.7, according to FactSet; revenue for 2012 is estimated at $4.7 billion, while this year it’s expected to climb to $6.1 billion.Meanwhile, Lennar’s stock is trading at 23.3 times forward earnings, with its financial year 2012 revenue of $4.1 billion estimated to grow to $5.4 billion. It’s a similar story for DR Horton, which has a price-to-forward-earnings ratio of 21, and is expected to see its $4.4 billion FY2012 revenue grow more than 25% to about $5.6 billion. Let’s look at the historical PE comparison.

PE_HomeBuilders

Juxtaposing all the premium home-builders in US, it is easy to conclude that the mean P/E multiple was around 10 before the boom and the bust. But now the scenario is different. Even though we are far off from the peak of new home sales of 1.3 million in 2005, the new home sales are growing at brisk pace in last 5 quarters. Expectations for housing starts and new home sales are both in the 20 percent range for 2013. So a forward P/E of 23 for a growth in excess of 25% is acceptable.

Recently Lennar announced its earnings.  The Florida-based builder crushed estimates as fourth-quarter earnings more than tripled on 42% higher sales. Lennar’s new orders rose 20% and its order backlog was up 35% as of November.  Lennar CEO Stuart Miller said in the company’s earnings announcement that the housing market is stabilizing, “driven by a combination of low home prices and low interest rates, making the decision to purchase a new home more attractive.”

Similar expectations are for DR Horton and Ryland homes. The 24 analysts polled by Thomson Reuters expect Horton to report fiscal first-quarter earnings per share of 14 cents, a 56% rise from last year’s 9 cents. Sales are seen advancing 21% to $1.1 billion. Ryland is forecast to report a huge jump in Q4 EPS to 49 cents, up from 2 cents a year ago. Revenue is projected to grow 55% to $404.4 million.

“Just because the stocks are overvalued doesn’t mean they are not going to go up more,” says David Goldberg, a housing analyst at UBS. “It’s a momentum play.” Goldberg warns, however, that there is a lot of growth baked into these stock valuations for 2013, expectations that may be tough to meet. This uptick might not be at 45 Degree angle and might have pauses but the time is not to cash out of them.

Let’s hold onto them and add some more during pullbacks. So which are the companies that are worth adding to the portfolio. Based on the operating margins, earnings growth and PE ratios (historical, TTM and Forward) I believe Lennar and DR Horton are the best of the pack. I would also like to mention TOL. But please don’t buy anything now. Be patient and wait for pull back to 50 DMA. Why DHI and LEN? We will talk about it in the next post.

Lastly, if you don’t feel comfortable buying these home builders, you can own the Home Builders ETF (ITB). Another way to play housing recovery is by buying companies such as Home Depot (HD) (re-modeling,  new home set up etc.), Sherwin-Williams (SHW) (Paints), Tronox Inc (TROX) (Pigment for paints) and Corelogix (CLGX) (Mortgage related information provider).

Housing – The Return from the Ashes!!!

One of the pillars of American economy “The Housing Market” is showing the signs of resurgence. The year 2012 was a promising one for housing. With consistent improvements in housing construction and prices, home building is starting again to contribute to the economy.

But before delve deeper into the housing industry let’s paint a picture of the economy.

Jobs

The jobs market continued to recover slowly but surely.

JobReport

Talk about steady: The U.S. created, on average, 153,000 non-farm jobs each month over the course of 2012; the U.S. also averaged 153,000 non-farm jobs a month during 2011. The unemployment rate has slowly improved, falling to 7.8% at the end of the year, but the labor market remains far from booming.

GDP

GDP

GDP in lay mans terms tells you how fast the economy grew. At a high level  GDP primarily comprises of the Consumer Spending, Export vs Import and Inventory. Looking at the above chart it’s easy to conclude that growth has been at best sluggish.

In all, the anemic recovery has done little to bolster the housing market but has been enough to pull it out of the troughs.

Housing Industry

“The housing market is coming back, gaining momentum, and it’s one of the bright spots for the economy as we start 2013,” said Robert Dye, chief economist at Comerica Inc. in Dallas.

PendingVsExistingHomes

Existing and New Home Sales on the Rise

Sales of U.S. homes probably rose in December to the highest level in three years. Combined purchases of new and existing properties climbed to a 5.49 million annual rate last month, the highest level since November 2009. Purchases of previously owned home climbed to a 5.1 million annual rate in December, the strongest since November 2009, economists project National Association of Realtors figures will show Tuesday. New-home sales picked up to a 385,000 annual rate for the month, the best showing since April 2010.

ExistingHomeSales

HousingStarts2

Builder Sentiment is Running High

Nonetheless, the economic improvements witnessed in 2012 – at least compared to the terrible years that preceded it – manifested themselves in ongoing good news for housing. The December increase in starts is consistent with the upward path of builder confidence over the last few months, as measured by the NAHB/Wells Fargo Housing Market Index (HMI). You can see below that there has been a surge in builder confidence specially since the later half of 2011.

BuilderSentiment

Construction Spending Gets a Boost

Per Census data, solid gains in both single-family and multifamily production resulted in nationwide housing starts rising 12.1% to a seasonally adjusted annual rate of 954,000 units: the highest level of new home production since June 2008. Single-family starts rose 8.1% to a seasonally adjusted annual rate of 616,000 units in December, while multifamily production jumped 23.1%, to 338,000 units. The improvement in home building in 2012 has boosted construction spending. Following graph corroborates this fact.

ConstructionSpending

Dwindling Inventory

As a result of the pickup in demand, the inventory of homes for sale has dwindled, driving up real-estate values and encouraging more construction. There were 2.03 million existing homes on the market in November, the fewest since December 2001, and 151,000 new houses for sale, close to the 142,000 reached in July that was the lowest since records began in 1963.

NewHomeInventory
Prices have Bottomed
The most recent S&P/Case-Shiller index of homes in 20 cities showed prices increased 4.3 percent in October from a year earlier, the biggest gain since May 2010. The gauge is up almost 9 percent since reaching a 10-year low in March. The median sales price rose 14.9% and average prices rose 20% that are likely a combined effect of higher priced homes sold and a reflection in the cost of building materials and lot price increases.
CaseShillerIndex
The Final Numbers – Actual Sales Vs Inventory
NewHomeData
 ExistingHomeData
What will Continue to Drive this Turnaround
All the economy pundits are betting that this resurgence will not fizzle out. Progress will probably build in 2013. Sales of existing homes will rise about 7.2 percent to 4.98 million this year, the highest since 2007, according to the median estimate of economists and housing analysts surveyed by Bloomberg. Prices will gain 3.3 percent after an estimated 4.5 percent jump in 2012, according to the forecasters.

“After seven years of navigating an unprecedented market downturn, we finally saw stabilization and recovery in 2012,” Stuart Miller, chief executive officer of Lennar Corp., the largest U.S. homebuilder by market value, said during a Jan. 15 earnings call. “While there have been and still are economic and political uncertainties ahead, we feel that this housing recovery is fundamentally based and driven by a long-term demographic need for housing. 2012, therefore, we believe is just the beginning of the recovery.”

But Why?
Extremely low mortgage rates, recovering house prices in most markets and pent up demand are few of the reasons that will provide forward movement in home building and home buying in 2013.
Sustained Low Interest Rates
InterestRates
Rising Rent
RentChart
Declining Foreclosures
ForeclosureStats2ForeclosureStats1
But there is a Weak-link: New Home Sales

Here’s TD Securities with some commentary:

The new homes market has been a laggard in the overall housing market recovery, and while new home building and existing home sales activity have risen significantly from their lows, new home sales have yet to enjoy a similar turnaround in fortune. In December, we expect sales activity to improve only modestly, with the pace of sales boasting a respectable 6.1% m/m gain to 400K. The increase in sales will add to the positive momentum in November, when sales rose an equally impressive 4.4% m/m, justifying the surge in optimism among home builders (as seen in the NAHB home builders’ sentiment report) about sales prospects in recent months. In the coming months, we expect the positive momentum in new home sales activity to be sustained, though it is likely to continue to lag the buoyancy in the existing homes market.

Here’s TD’s chart. Hopefully, the increasing home buyer traffic will eventually lead to a pick up in sales.

NewHomeSalesVsTraffic
Now How do we PROFIT from all this. Next in the series we look at Lennar and some other builders.
Disclaimer: All the above data have been collected from –