CHICAGO ? The housing market recovery hasn't taken off yet, but a rally in its stocks sure has. The Standard & Poor's homebuilders index is up 60 percent since October.
Given that stock prices tend to anticipate business trends, does that mean a housing market rebound is imminent during the spring home-selling season?
Not necessarily.
The biggest sustained rally in homebuilding stocks in years and recent upbeat home sales data, however, have injected some long-absent optimism into the outlook for housing.
Sales of previously occupied homes rose for three straight months at the end of last year. The glut of houses on the market is diminishing, down to 2.4 million previously owned homes on the market in December from 3.8 million in June. And buyers are slowly regaining a little bit of confidence.
"The housing market enters the spring selling season in absolutely the best shape it's been since 2005," says analyst Eric Landry, who follows homebuilding stocks for Morningstar. "Sales will still likely be below normal, but inventories are in the best shape they've been in years."
The government's landmark $25 billion settlement of foreclosure abuses is the latest dose of good news. Financial analysts see it as helping to clear the way for builders to gear up construction activity.
The CEOs of some of the biggest homebuilders said during earnings conference calls this month that the housing market has stabilized. But they were cautious about making any bullish forecasts.
Major improvement in the industry won't take place until next year, according to a forecast by the chief economist of the National Association of Home Builders, David Crowe.
More important for investors, the big run-up in stock prices in the last four months makes a correction likely soon. Homebuilding stocks have a history of declining after rising in the months ahead of spring selling season.
The current rally is seen by some as the opening act in a multi-year recovery for the stocks. Low interest rates, more affordable home prices and pent-up demand should help them rise further.
But the stocks are no longer cheap. Most are currently trading at roughly 1.5 times book value ? considered the best way to value this group. Book value is the value of a company's assets if it were to be liquidated. Their current value strongly suggests they are overpriced.
Investors would be wise to keep an eye on housing-related stocks. With prices having shot up, though, they should exercise caution. Waiting for a pullback and buying after spring home-selling season, if the industry still has momentum, makes more sense. That should put investors in much better position to profit from the coming rebound.
Here are four stocks to watch, along with an exchange-traded fund that invests in homebuilders:
D.R. HORTON INC. (DHI)
Shares of D.R. Horton are up 74 percent since an industry low-water mark on Oct. 3. That's well above the 23 percent climb of the Standard & Poor's 500, but shares are still about where they were two years ago. The company caters mostly to low-end buyers and builds homes in 26 states. Financial analysts believe that its broad customer base can help the company grow annual revenue by double digits for years.
LENNAR CORP. (LEN)
With lean construction practices, a healthy balance sheet and other strengths, Morningstar says Lennar sits poised to reap major economic gains from an eventual rebound in housing. Its revenue was up 12.5 percent and orders were up 21 percent in the fourth quarter, its highest growth in several years. The company recently created a distressed real estate unit, Rialto, that allows it to obtain land more cheaply than competitors. It also provides financial services including mortgage financing, title and closing services. Its backlog of orders is 36 percent higher than a year ago, leaving it in good shape to wait for a future surge in sales. The stock is up 88 percent since early October.
TOLL BROTHERS INC. (TOL)
Toll Brothers builds higher-priced homes in urban markets with job growth, particularly in the Northeast. That focus on the high-end consumer should enable the company to profit from a recovery in housing. Like Lennar, it has a distressed investment arm, Gibraltar, that helps it lock in land at bargain prices in marquee locations, an advantage that will show on the bottom line when home-selling picks up. It also has modest net debt of just $400 million. Along with Lennar, it may be the best-positioned of the homebuilders to profit from the recovery, according to analyst Jack Micenko of Susquehanna Financial Group. Toll Brothers shares are up 74 percent since early October.
SPDR S&P HOMEBUILDERS (XHB)
This exchange-traded fund includes seven of the largest homebuilders. It also owns shares of companies that sell building materials or furniture and other items for the home. Many of the homebuilders are sitting on large piles of cash. That will allow them to expand in the coming years. The fund is cheaper than the other homebuilder ETF, with an expense ratio of 0.35 percent versus 0.47 percent for iShares Dow Jones U.S. Home Construction.
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