Andre Agassi once said: “Image is everything.” Right now, that seems to be what’s driving housing stocks.
The U.S. is in the midst of a full-on housing recovery. All evidence points to it.
- New home sales are up 18.5% in the last year.
- Existing home sales are up 10.3% in the last year.
- Home prices are up 3% in the last year.
- Construction of new homes hit its highest rate since 2008 in March.
Those are all good signs. Each of them shows that the U.S. housing market is on a steady upswing after bottoming in the wake of the 2008-09 subprime mortgage crisis. At this point, no one denies the existence of a housing recovery. But a “recovery” should not be confused with a “boom.”
On Wall Street, that’s precisely what is occurring.
The phrase “housing recovery” has been music to investors’ ears. Every time the Commerce Department releases an encouraging set of housing data – a regular occurrence in recent months – Wall Street responds by snatching up more housing stocks. The result is a sector that’s outpacing the actual recovery.
The average stock held by one of the two primary ETFs that track the housing market – the iShares Dow Jones U.S. Home Construction (NYSE: ITB) and the SPDR S&P Homebuilders (NYSE: XHB) – has a PE of 22. That’s not high enough to be a major red flag. But if the housing recovery stalls, the lofty heights many housing stocks have reached are likely unsustainable.
The ITB and XHB have risen 15% and 13%, respectively, in 2013 – outpacing the 10.4% gains by the S&P 500. Most of the higher-profile housing stocks are rising even faster, pushing their share prices into somewhat precarious positions in relation to earnings.
Here’s a breakdown of some of those year-to-date performances:
Home Depot (NYSE: HD)
2013 Gains: 16.5%
PE Ratio: 25
Bed Bath & Beyond (NASDAQ: BBBY)
2013 Gains: 22%
PE Ratio: 15
Williams-Sonoma (NYSE: WSM)
2013 Gains: 18.5%
PE Ratio: 21
Pier 1 Imports (NYSE: PIR)
2013 Gains: 18.7%
PE Ratio: 20
Lowe’s (NYSE: LOW)
2013 Gains: 9.5%
PE Ratio: 23.5
Those stocks are essentially a who’s who of home-improvement companies. All of them are trading at more than 20 times trailing earnings, and only one of them (Lowe’s) has failed to outperform the market so far this year.
But that’s home improvement. Homebuilders such as Toll Brothers (NYSE: TOLL) and Lennar Corporation (NYSE: LEN) are actually underperforming the market.
Toll Brothers shares have risen a mere 5.4% year-to-date, with the stock trading at a modest 12 times trailing earnings. Lennar, meanwhile, is up 6%, trading at less than 13 times earnings.
Why the disparity between homebuilders and home improvement companies? It’s not because home improvement companies are growing faster than homebuilders.
Net income at Toll Brothers was 12 times higher in 2012 than it was in 2011. Lennar’s 2012 profits increased seven fold from the previous year. Home improvement companies also grew last year. But not at nearly the same rate.
Image seems to be the differentiator between the two performances.
Home Depot, Lowe’s, Bed Bath & Beyond, Williams-Sonoma – those are the real faces of this housing recovery. They’re the most recognizable brands in housing, and are thus symbols of the industry’s recovery on Wall Street.
It’s the same reason shares of Trulia (NYSE: TRLA) and Zillow (NASDAQ: Z) – two very popular online real estate database companies that have gone public in the last two years – have each risen more than 100% in 2013.
People “buy what they know,” as Warren Buffett has long encouraged. Knowing that a housing recovery is in full swing, people are buying shares of the housing companies they know best – the ones with catchy slogans such as “More Saving, More Doing” (Home Depot) and “Never Stop Improving” (Lowe’s). Toll Brothers and Lennar Corp. aren’t as visible as those companies.
Right now, however, they might be better investments. As the face of the housing recovery, brand-name home improvement companies have become a tad overinflated. Homebuilders, on the other hand, have plenty of room to run and the most to gain if the housing recovery continues.
So while housing stocks are flourishing amid this recovery (not boom), only a handful of them appear well positioned for even bigger gains in the coming months. One of them is Toll Brothers, a stock I currently own in my $100k Portfolio. Since adding the stock to my portfolio last March, subscribers have been treated to 42% gains.
As the housing recovery matures, Toll Brothers – and other homebuilders – should continue to prosper.