No Cracks Yet In The Foundation For Housing Stocks

7/24/2017


The Great Recession and sluggish recovery that followed forced many Americans to postpone forming households. That pent-up demand, combined with a now healthy labor market, makes homebuilders and other housing-related industries look especially attractive right now.

Homebuilders earn an average Quadrix Overall score of 91, higher than any other industry with four or more stocks in the S&P 1500 Index. Several other industries exposed to housing enjoy strong growth profiles, attractive valuations, or robust share-price action. See the table below for more details.

HOUSING STOCKS OUT FRONT
Several housing-related industries are generating outsized operating growth and returns relative to the broad S&P 1500 Index. All numbers are averages.
12-Month
EPS Chg.
(%)
Est. EPS
Chg. For
Current
Fiscal
Year
(%)
--- P/E Ratio ---
------ Quadrix Scores ------
S&P 1500 Industry
(Number Of Companies)
YTD
Total
Return
(%)
Trailing
Curr.
Year
Momen-
tum
Value
Overall
Building products (18)
7
20
8
23
22
49
57
70
Homebuilding (16)
30
22
23
17
14
71
73
91
Home furnishings (5)
0
5
(5)
18
19
46
72
75
Homefurnishing
retail (7)
19
(16)
8
21
19
47
86
74
Home-improvement
retail (4)
15
15
16
24
22
51
45
59
S&P 1500 Index
average
6
5
6
23
22
51
57
59
Note: Quadrix scores are percentile ranks, with 100 the best.
 Admittedly, stocks in highly cyclical industries don't always work well in Quadrix. For these types of stocks, key metrics that drive up the Overall score all tend to point in their favor at the same time — just as growth is peaking. Building-products stocks have averaged their strongest 12-month returns following periods when their Overall scores ranged from 21 to 40. Homebuilders have tended to perform best when their Overall scores are 61 to 80 but also have fared well with Overall scores 20 or below.

Both industries usually behave best when their operating momentum, like Goldilocks' porridge, is neither too hot nor too cold. But for valuations, extremes are preferable.

Given these groups' volatility, it's crucial to track our position in the housing cycle. U.S. housing starts have more than doubled from the 2009 low but remain well off the peaks of prior economic recoveries. The monthly supply of houses is also tight compared to historical norms.

Two structural factors could prevent housing starts from revisiting the prior highs. Rising student debt has led to lower homeownership among young Americans, based on a study by the Federal Reserve Bank of New York. It's not clear if the hefty debt burdens will have a lasting effect on the housing market.

At the same time, the number of U.S. construction firms has fallen about 30% over the past decade to reach its lowest level since at least 1977, reports The Wall Street Journal. Industry consolidation could help protect the housing market from getting too overheated.

Although housing-related stocks have rallied in 2017, they could be vulnerable if mortgage rates move sharply higher. But Janet Yellen, chair of the Federal Reserve, said in July that she remains content to increase rates gradually.

Below, we review five of our favorite stocks exposed to the housing market.

Control4 ($24; CTRL) makes software and controllers in the budding smart-home industry.

This technology lets consumers automate or control through third-party devices their TVs, stereos, lights, blinds, and security systems. With a stock-market value below $600 million, Control4 taps an expansive dealer network to sell its products in 97 countries. In the 12 months ended March, Control4 grew sales 24% and earned $0.31 per share, up from $0.04 per share in the year-ago period. Both profit margins and cash flow are rising.

The stock has more than doubled in 2017, pushing its Quadrix Value score down to 24. Shares trade at 26 times trailing earnings, 10% below the median for electronic equipment and instruments stocks in the S&P 1500 Index. Analyst estimates are steadily rising, with the consensus projecting 13% profit growth in 2017 on 15% higher revenue. Control4 is rated Best Buy in our sister publication, Upside.


D.R. Horton ($37; DHI), the largest U.S. homebuilder, targets first-time homeowners, generally an underserved market due to its lower profit margins. U.S. housing starts dipped in recent months as mortgage rates crept higher. But the housing industry's modest recovery is preventing things from getting overheated, which could potentially extend the current upswing. D.R. Horton's per-share profits and revenue both grew more than 15% in the 12 months ended March. The company appears positioned to keep delivering double-digit growth for the rest of 2017.

Unlike some homebuilders, D.R. Horton tends to perform unusually well when its Quadrix scores are high. For instance, in the 162 month-end periods when D.R. Horton's Overall score exceeded 80, its shares went on to average 12-month returns of 29%, above their average 12-month return of 22% for all periods since Dec. 1994. D.R. Horton, with an Overall score of 95, is a Buy and a Long-Term Buy.


KB Home ($23; KBH) focuses on building midpriced houses in seven states. Rising labor and raw-material costs have caused gross profit margin to contract in recent quarters. But the backlog is up 19% to $2.18 billion from $1.83 billion in May 2016, supporting future sales. Analysts expect that KB grew revenue 23% in the June quarter and target 20% growth for the full year.

KB's stock tends to perform best when it scores above 80 in Quadrix Overall (averaging a 12-month return of 23% in 109 occurrences since Dec. 1994, versus its total average return of 15%) and Value (25%, 102). Shares have risen in more than 70% of periods when the Overall or Value score exceeded 80, versus 54% for all periods. KB, with an Overall rank of 99 and Value score of 82, is rated Best Buy in Upside.


Benefiting from strong home sales, flooring company Mohawk Industries ($248; MHK) grew earnings per share 17% in the 12 months ended March. Sales rose 8%, operating cash flow 23%, and free cash flow 11%. To get ahead of rising material costs, Mohawk planned a broad price hike in June, a move that could boost profit margins for the sixth straight year.

For the June quarter, analysts target per-share profits of $3.60, up 4%, on 6% higher revenue. A spate of recent small deals and a new business venture could support long-term growth. Best known for its carpeting and floor tiles, Mohawk is now pushing into countertops, a highly fragmented U.S. industry that generates about $5 billion in annual sales. Mohawk is a Focus List Buy and a Long-Term Buy.  


Owens Corning ($66; OC) shares have delivered a total return of 28% this year and 7% in the past three months. The next catalyst for the stock arrives on July 26, when Owens will announce its June-quarter results. The consensus expects Owens to report 18% lower earnings per share in the June quarter on 5% lower sales, due to unusually strong March-quarter results from customers stocking up on insulation and roofing supplies ahead of a price hike.

But growth should bounce back, with profits projected to rise 12% for both the September quarter and full-year 2017. Encouragingly, analyst estimates have drifted higher over the past 60 days. Owens has surpassed the consensus profit estimate in 11 consecutive quarters. Owens is a Focus List Buy and a Long-Term Buy.

TOP HOUSING PLAYS
Dow Theory Forecasts and sister publication Upside recommend stocks in four of the five housing-related industries. Upside also rates as a Best Buy Control4 ($24; CTRL), which designs home-automation systems. Most of these stocks offer double-digit growth and P/E ratios below industry norms. Upside stocks are in bold.
Stock-
Market
Value
($Bil.)
Total Return
12-Month
--- Change ---
Est. EPS
Growth.
Current
Fiscal Yr.
(%)
--- P/E Ratio ---
----- Quadrix Scores -----
Company (Price; Ticker)
Past 3
Months
(%)
YTD
(%)
EPS
(%)
Sales
(%)
Trailing
Curr.
Year
Momen-
tum
Value
Overall
Industry
Builders FirstSource
($16; BLDR)
1.83
7
46
 NA 
42
30
13
15
66
80
91
Building products
Control4 ($24; CTRL)
0.60
48
131
675
24
13
26
25
83
24
75
Electronic equip.
D.R. Horton
($37; DHI)
13.88
7
35
17
16
16
14
13
55
78
95
Homebuilding
KB Home ($23; KBH)
2.29
13
49
38
18
54
18
14
96
82
99
Homebuilding
Lowe's ($77; LOW)
65.92
(6)
9
12
11
16
19
17
60
80
85
Home improve.
Mohawk Industries
($248; MHK)
18.53
7
24
17
8
6
19
19
71
60
93
Home furnishings
Owens Corning
($66; OC)
7.46
7
28
29
10
16
17
16
52
85
96
Building products
Taylor Morrison
Home
($24; TMHC)
2.92
11
26
24
18
11
13
13
91
81
98
Homebuilding
NA Not available because Builders FirstSource reported a loss in the year-ago period.

 


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