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A Look At Homebuilding Stocks

An expanded look at homebuilding stocks from my daily read on Oct. 19.
(jaturonoofer)
(jaturonoofer)
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Let’s look at homebuilder stocks. Homebuilding is an example of a heavily cyclical industry where revenues boom and wane based on the economic and housing markets. Homebuilder valuations are generally forward-looking through the ups and downs, and that an investor might invest in these stocks if he or she believes the peaks or troughs will be higher than what the market is pricing.

Here are valuations for some of the largest publicly traded homebuilders (EBITDA based on average three-year consensus estimates). 

  • 000 LGI Homes ($LGIH) – 8.5x forward EBITDA
  • 000 Lennar ($LEN) – 8.5x forward EBITDA
  • 000 D.R. Horton ($DHI) – 8.5x forward EBITDA
  • 000 Pulte Homes ($PHM) – 6.4x forward EBITDA (11.9% current free cash flow yield)
  • 000 Toll Bros. ($TOL) – 8.5x forward EBITDA

Looking over the past 5-6 years, these companies have traded within a 5.0x to 8.5x range, and we can see there is optimism embedded in the stocks. The last time they were trading over 8.0x EBITDA was late-2017, and they didn’t perform so well afterward. So the question is: will home prices and new home demand be especially strong over the next one to two years? 

On the one hand, we are in the middle of elevated home prices due to a housing shortage and lack of inventory. Plus, if you look at this chart, we’ve had a decade of much lower new housing starts, which has helped create a decade of strong price appreciation (along with other things like low-interest rates).

On the other hand, many believe the pandemic will widen the wealth gap, reducing a lower-to-middle income family’s ability to purchase a home, reducing the number of buyers. Additionally, when sellers list their homes for sale again, that will flood the market with pent-up inventory, causing downward pressure to home prices for a temporary period.

Finally, any future increase in interest rates will be a headwind to home prices, although I’m expecting a low-rate environment for at least a couple of years.

All-in-all, I believe that we’re in a multi-decade housing shortage that will be a tailwind for real estate. There’s a real chance homebuilders outperform expectations, and their stocks do well. But because homebuilders don’t look particularly cheap and there’s still so much uncertainty, I’d still be more comfortable owning private real estate at reasonable prices.

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