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Taking a Hammer to the Homebuilding Stocks


Investors have piled into the sector. Is it too late to get in?

To investors, some of the homebuilding stocks now look like the fantasy McMansions of their dreams.

In the past six months, KB Home (KBH) went up more than 70%; D.R. Horton (DHI) climbed more than 40%; NVR (NVR) jumped more than 80%; and Lennar (LEN) nearly doubled.

SPDR S&P Homebuilders (XHB), an exchange-traded fund that tracks the S&P Homebuilders Select Industry Index, has popped 13.6% in the past month and 66.6% in the past six months.

The most recent news that propelled the homebuilders higher was data released last week on sales of existing homes, which had stock pickers feeling giddy. Sales of single-family homes increased 7.2% in July from a month earlier, according to the National Association of Realtors. Investors loved the news: the XHB finished last week up 3.2%.

The question for nimble investors is whether there is still opportunity in this sector. After the recent skyrocketing move some of these homebuilders have enjoyed, is this a wise place for investors to commit their hard-earned capital?

First and foremost, investors should understand that much of the supposedly feel-good news lately comes with a library full of caveats. And even some of the more bullish analysts in the homebuilder sector say the smart investors now should wait for a pullback before inching into the space.

Despite the recent surge, some of these homebuilders still don't look too expensive, at least based on some measures. The simplest measure, the price/earnings or PE ratio, isn't useful because there is no "E" here. Toll Brothers (TOL), for instance, had a net loss of $297.8 million last year on sales of $3.2 billion.

However, we can employ other measures like the price-to-book ratio. Based on that measure, some of these homebuilders still don't look too pricey.

For instance, Toll Brothers is trading with a price-to-book ratio of 1.02 versus a five-year average of 1.47. In fact, DR Horton, Pulte Homes (PHM), and Lennar all currently stand at a discount to five-year historic averages.

But, with regard to industry fundamentals, it's a mixed bag.

For example, that latest housing report on existing sales was met with hand-clapping glee from investors. Longtime market pro Dennis Gartman wrote in his daily research note that the housing report was indeed positive, in his estimation.

But he alerted his readers to some important caveats they should keep in mind when reading over the housing data. Contrary to consensus, the economic landscape is not now all dotted with dancing bears and rainbows.

"[B]efore we become too enamored of the data and before we believe that the future is bright and all's well with the world, we probably should heed the fact that 30% of the sales made were to first-time home buyers and those first timers are being given a huge subsidy by the federal government in the form of an $8,000 tax credit," Gartman wrote.

He adds, "Further, almost one third of the homes sold were foreclosures. And further still, we are told that the inventories of unsold homes are still at 9.4 months."

It's that inventory overhang, along with uncomfortably high unemployment, subdued income and constrained credit conditions, which has Peter Boockvar feeling cautious about the homebuilders.

An equity strategist at Miller Tabak says that, in his opinion, this industry is still troubled and he'd be a seller on the rally.

"The homebuilders are riding their own 'cash for shelter' program," Boockvar tells Minyanville, referring to the $8,000 tax credit. "Right now, it is tough to determine what is natural and what is artificial. Once the tax credit ends, we don't know what we'll be left with."

Jeff Kleintop, chief market strategist at LPL Financial, says he's been busy buying the homebuilders. However, the pace of gains these companies have been enjoying may now begin to moderate, he thinks, along with the rest of the market.

"Our year-end target for the S&P 500 was 1000 to 1050," Kleintop tells us. "We are there now. So I think we could run up a bit more, perhaps, but we are likely to come back to that range as we expect concerns of inflation to come back."

The strategist adds, "That's a negative and those concerns could start hitting the market around November, we believe."

His advice for investors itching to carve out a stake in the homebuilders?
If you're dead set on owning the makers of those McMansions, inch in on the pullbacks, which Kleintop sees coming.

"We could get a 5% or 10% move here," he says. "Look to add on those dips."
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