Companies to watch with a housing shortage that should benefit homebuilder stocks
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The double whammy of a falling stock market and rising interest rates has hit homebuilder stocks this year, driving valuations to rock bottom.
These valuations make housing stocks look like the worst house in a bad neighborhood. But in reality, the industry is the cheapest house in an undervalued neighborhood.
In early April, the average forward price-to-earnings ratio of homebuilder stock prices to projected earnings for 2022 was just four times earnings, the lowest of any sector in the entire stock market American. This ratio fell to 3.5 in mid-May, when the iShares US Home Construction ETF (ITB) was down about 30% year-to-date. Shares of some major manufacturers, such as industry leader DH Horton, have fallen nearly 40% this year.
This decline was triggered, in part, by investors’ assumption that rising mortgage interest rates will hollow out the market by discouraging buyers. Never mind that bidding wars in some buoyant local markets are producing selling prices higher than lenders’ valuations, forcing buyers to find additional cash at closing.
This market heat hasn’t stopped investors from selling stocks for fear that rising rates will soon dampen demand. As a result, many of these stocks went from slightly overvalued to significantly undervalued in just a few months.
Still, rumors of impending industry weakness have been greatly exaggerated. The dire state of these stocks is actually an opportunity – reflected in analysts’ lofty price targets – as data indicates that a chronic housing shortage will continue to fuel strong demand, despite higher rates.
Although mortgage rates are expected to continue to rise, they are still quite low and will likely remain so for at least a year or two. Over the past few months, typical 30-year fixed rate mortgage rates have climbed from about 3% to about 5%.
Yet, historically, this is by no means high. Since 2011, rates had rarely fallen below 5%, and many buyers looking for their second or third home recall paying 8% to 9% in 2000 or 10% to 11% a decade earlier. .
Faced with the alternative of soaring apartment rents – in April, up on average more than 25% year-over-year and expected to continue to rise with high inflation – many buyers will no doubt continue to consider home ownership as the best financial option.
Many who already have limited budgets will simply buy cheaper homes, so higher rates can largely suppress demand at the lower end. Low-end, overpriced buyers could be forced to rent, which would benefit builders of multi-family homes.
The current shortage of available housing is expected to continue for a decade. Statistics from the US Census Bureau and Credit Suisse show the extent of this shortage with these readings of key market indicators:
- Historically, the nation has had a current supply of approximately 1.5 million homes available for purchase. The current inventory of available single-family and multi-family homes – approximately 700,000 – is the lowest in over 40 years.
- Although homes are now being built at a breakneck pace, the nation has not built enough homes in the past 17 years. Since home construction peaked in 2005 with more than 2 million starts, there have been an average of 500,000 fewer starts per year, resulting in a shortfall of about 3 million homes. This shortage has eased a bit lately, but it could easily take another decade for supply to match demand.
- Overbuilding before the Great Recession led to an oversupply of nearly 2 million homes, but that supply was exhausted in 2014. The subsequent underbuilding caused supply to plummet in subsequent years, resulting in a shortfall of 3 million homes by 2020. Even with construction picking up speed now, the long period of underbuilding will maintain the supply shortfall for years to come.
- The age of the US housing stock has exacerbated the shortage. In 2019, the median age of a house in this country was 41 years old. Now it’s 44 – the oldest on record. When evaluating investment opportunities, investors should probably consider small-cap companies, although some of the bigger names are poised to generate good returns over the next two years. Suppliers should also benefit from long-term demand.
Here are a few companies with good growth prospects and low downside risk, as evidenced by fundamentals, price movements, and analyst projections:
- Meritage Homes (MTH): A builder of single-family homes primarily in the Sunbelt, this small-cap company ($3 billion market cap) was trading at $83 per share in mid-May, but has a one-year average analyst target of $122. .
- Tri-Point Houses (TPH): Another small-cap company ($2 billion), Tri-Pointe builds single-family homes on the West Coast, in Texas and in the Southeast. Its price target is $30, although as of mid-May the stock was trading at around $20.
- Lennar (LEN): This large company (market cap, $22 billion) is a single-family and multi-family builder that operates nationwide, but primarily in the Sunbelt. Trading at $74 in mid-May, Lennar has a target of $115.
- Eagle materials (EXP): With a market capitalization of $5 billion, Eagle produces concrete, wallboard and other building materials. Its price in mid-May was around $125. Price target: $172.
- Quanex (NX): This small public company (market cap, $600 million) manufactures windows and cabinets. At $32, its price target is a significant jump from its mid-May price of $20. The company’s earnings growth rate is around 12%.
- Masonite International Corp. (DOOR): Over the past six months, this maker of interior and exterior doors (market cap, $1.9 billion) has had one of the highest year-to-date sales (-27%) of any stocks from highly ranked vendors. Masonite was trading at $85 in mid-May. Price target: $133.
These and various other companies in the industry are poised to grow significantly over the next few months, likely driving their stock prices higher. Eventually, the dark clouds of fear will lift, allowing investors to see the light of sustained market demand.
— By David Sheaff Gilreath, Certified Financial Planner, Partner and CIO of Sheaff Brock Investment Advisors and institutional asset manager Innovative Portfolios.