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Home Builder Opportunity?

Many US home builders continue to lose money, and sentiment in this sector is decidedly bearish. But it is often among unloved, cyclical companies that value can be found. To that end, a number of home builders trade at discounts to their book values.

Of course, book values can fall in value if conditions deteriorate such that properties have to be written down further. Nevertheless, book value is a good first indicator of a home builder's worth. This article depicts how closely the market caps of a few large home builders have tracked their book values over the last 25 years.

During the housing bubble, many home builders were trading at 2-3 times book value, which seems ridiculous in retrospect but at the time their earnings prospects made their stocks look attractive. Isn't it funny how cheap forward P/E's always look when expectations are high?

The biggest risk to home builder book values today are potential write-downs of their properties. Risks of write-downs are at their highest when inventory levels are bloated, so it's worth looking at the industry's inventory level to get a handle on the magnitude of the potential risk. The following chart illustrates the number of new homes for sale throughout the country over the last year:

New home inventory is not just down over the last year, however. Consider what inventories look like relative to those of the last 15 years:

Despite the low new home inventories, there still remains a 6+ month supply at current sales rates. This is because sales rates are very low due to low demand combined with the high availability of foreclosed homes. But at least we know there isn't a ridiculous supply glut that will weigh down on prices

If home builders fall further in price, a great opportunity may confront those willing to go against the herd.

Disclosure: The author holds no positions in US home builders

This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please consider subscribing to the feed.