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The homebuilders were the best performing stock sector in 2012. With the housing recovery picking up steam, 2013 was expected to be another good year for this group.

But that's not what happened.

After a hot spring market, fueled by near record low mortgage rates and low inventory, the housing market started to cool as mortgage rates rose on fears that the Fed would begin to taper its QE bond buying program in September. That didn't happen and rates fell but they never fell back to the levels seen in the spring.

On top of rising mortgage rates, prices spiked in most major markets due to lack of inventory which resulted in bidding wars. The combination of rising rates and rising prices made purchasing real estate much more expensive by the fall.

The homebuilder stocks retreated as mortgage rates rose and they continue to be lackluster.

Year to date, the S&P Homebuilder ETF (XHB - ETF report) is up just 13.8%, which is under performing all major indexes. The iShares US Home Construction ETF (ITB - ETF report) is up only 4.2%. The Home Construction ETF is made up solely of US homebuilders so it is more a pure look the homebuilding sector this year.

The Homebuilders Look Like a Deal

But the homebuilders remain optimistic. On its conference call, Lennar said inventory remained tight so it still expected a strong spring season.

None of the homebuilders have talked about having to lower prices next spring. In the major metropolitan areas, average home prices continue to trickle higher, albeit at a smaller rate than it did earlier in 2013.

Earnings continue to look strong heading into 2014. Many homebuilders are expected to have another year of double digit earnings growth.

The fundamentals are strong and the stocks have been lackluster.

Do you have patience to hang on during the ups and downs of the housing recovery?

The housing stocks are looking attractive now.

3 Housing Stocks for 2014

1. Meritage Homes
2. Toll Brothers
3. Lennar

1. Meritage Homes Corporation (MTH - Snapshot Report)

Meritage Homes reported third quarter results on Oct 23 and easily beat the Zacks Consensus Estimate by 18 cents. It was the 6th big beat in a row.

Meritage is the 9th largest homebuilder in the United States and sells homes in about 15 metropolitan markets. It focuses on the move-up and luxury buyers which should soften the blow from upcoming changes in the mortgage market, especially the lowering of FHA loan levels, which are more likely used by first time homebuyers.

Margins improved by 420 basis points in the third quarter to 22.8%, the highest level since 2006, due to pricing power and controlled construction costs. The average selling price increased 22% to $341,000.

Meritage is one of the cheaper homebuilders. It has a forward P/E of only 13.8, which is well under the industry average of 15.5 as well as the average of the S&P 500 of 16.5x.

2014 expected earnings growth = 31%
Price-to-Book = 1.9 (a P/B under 3.0 usually indicates value)
Zacks Rank #2 (Buy)

2. Toll Brothers Inc. (TOL - Analyst Report)

Toll Brothers reported fiscal fourth quarter 2013 earnings on Dec 10 and blew by the Zacks Consensus Estimate by 10 cents. It was the second big beat in a row.

Toll Brothers is a luxury homebuilder which has been moving into the urban markets through high rise condominiums in addition to its single family home sales.

Margins improved to 25.4% in the quarter. Toll also guided margins higher for 2014.

It expects to deliver homes in fiscal 2014 in the range of $670,000 to $720,000 which is higher than we've seen in the last few years. The price increases of 2013 are clearly expected to hold into 2014 despite rising mortgage rates.

Toll isn't as cheap as some of its competitors. It trades with a forward P/E of 20.5 which is above the industry average of 15.5.

Fiscal 2014 expected earnings growth = 62.7%
Fiscal 2015 expected earnings growth = 42%
Price-to-Book = 1.7
Zacks Rank #3 (Hold)

3. Lennar Corporation (LEN - Analyst Report)

Lennar reported fiscal fourth quarter 2013 earnings on Dec 18 and easily beat the Zacks Consensus by 9 cents. It has only missed the Zacks Consensus 1 time in the last 5 years.

Lennar is a mid-tier builder which saw an average home price delivered of $307,000 in the quarter, up 18% year over year.

Margins increased to 26.8%, the highest since the fourth quarter of 2005. Incentives declined while the company was able to push through price increases.

Lennar said on its conference call that due to limited land available for building, it expects the housing recovery to remain intact. There is pent-up demand and short supply which will drive the housing market into the spring buying season.

Lennar is cheap as it's trading with a forward P/E of 14.2. That is under the industry average of 15.5 and well under the average of the S&P 500 of 16.5.

Fiscal 2014 expected earnings growth = 20.6%
Price-to-Book = 1.6
Zacks Rank #3 (Hold)

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Tracey Ryniec is the Value Stock Strategist for Zacks.com. She is also the Editor of the Turnaround Trader and Value Investor services. You can follow her on twitter at @TraceyRyniec.

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