Is It Safe to Buy Home Builders?

Falling Interest Rates Will Boost Home Builders

The past few years haven’t been what you might call a happy time for shares of home building stocks. Consider that the Homebuilders Exchange-Traded
Fund (XHB[2]) plunged from $40 per share in early 2007 to just $8 per share earlier this year.

Since March, however, things have improved. There are signs that the housing market is getting back on its feet — or at least, declining less slowly.
Existing home sales recently registered their biggest gain in more than a decade. Seasonally-adjusted single-family building permits are up 27% since
bottoming in March, while single-family housing starts have increased five straight months and are up 36% since March.

I’ve also seen many hopeful signs with interest rates. Freddie Mac said that the 30-year fixed mortgage rate fell to 5.12% last week, and the 15-year
rate is now down to just 4.56%. With lower prices and very low mortgage rates, housing affordability hasn’t looked so good in many years. Measuring
from the March low, shares of XHB have nearly doubled in less than six months.

So is it safe to go back into homebuilders? The short answer is yes, but cautiously. I do see some compelling values among home building stocks,
although I should add that no major home builder receives my highest grade of A, or strong buy.

Let’s run through some of the home builders I like. The following four stocks all receive a B grade from me, which signifies a buy.

Next – Home Builder Stock #1

Home Builder Stock #1 – NVR (NVR[3])

NVR (NVR[3]) is probably the healthiest of all the major home builders. In fact, the company hasn’t taken a single annual loss yet. The company
reported a quarterly loss for the fourth quarter of 2008, but all of the other quarters have recorded a profit.

Even though NVR is a fairly small company (market value of nearly $4 billion), the stock carries a very high price. The shares are currently over
$660 a piece, which is even higher than Google. I know that scares off a lot of individual investors, but I urge you to overcome your fears.

Even
if you only pick up a few shares, NVR is a solid buy.

Next – Home Builder Stock #2

Home Builder Stock #2 – D.R. Horton (DHI[4])

D.R. Horton (DHI[4]) saw its earnings-per-share plunge from a profit of $3.90 in 2006 to a staggering loss of $8.34 last year. Fortunately,
the worst is behind us. This year D.R. Horton will probably lose about $1 per share.

I don’t like to see any loss, but this is a huge improvement. In fact, I think there’s even a good chance DHI could start posting some earnings
gains by next year.

D.R. Horton is also a buy.

Next – Home Builder Stock #3

Home Builder Stock #3 – KB Home (KBH[5])

KB Home (KBH[5]) was hit incredibly hard by the housing bust. The stock fell from $82 to just $7 per share. We haven’t seen shakeouts like that
since the tech bust.

Unlike some of the other homebuilders, KBH probably hit bottom early. The company’s loss from last year wasn’t as bad as its loss from 2007, and
that’s a good sign. What I also like about KB Home is that the stock’s volatility has calmed down, which is often the result of heavy institutional
buying.

KB Home is a good stock for investors looking to pick up a beaten down home builder.

Next – Home Builder Stock #4

Home Builder Stock #4 – Lennar Homes (LEN[6])

Lennar (LEN[6]) has had one of the most impressive rebounds of all the home builders. The stock has been up as much as 340% since bottoming
last November.

Wall Street’s current consensus for Lennar’s earnings this year is a loss of $2.88. In my opinion, that’s too low. I think Lennar will have little
trouble surprising Wall Street analysts later this year.

Lennar is a good momentum buy.

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