Thursday - August 10, 2006

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As the homebuilding market continues to slowly recede from its January highs, we felt it would be a good time to check in with senior homebuilding analyst Mario Ricchio. What trends is he seeing in this group going forward?

Are homebuilding companies beginning to proceed with caution with regard to the current housing market?

Yes they are. The homebuilders are responding to rising inventory levels and moderating demand with less supply. In June, housing starts fell 5% on a sequential basis and 11% on a y-o-y basis. More importantly, the latest data on permits suggests the homebuilders remain cautious for the seasonally strong summer selling season. Building permits, an indicator of future construction, fell 15% on a y-o-y basis to 1.86 million units. Supply has fallen almost 415,000 units from January’s data, in which housing permits reflected an annual pace of 2.22 million units.

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Zacks Equity Research continued...

Despite the reduction in supply from lower starts, housing demand is falling faster as evidenced by the rising inventory of homes unsold. For the month of June, the inventory of homes unsold reached a 12-month high of 566,000 units. This represents a supply of 6.1 months at the current sales rate.

Given continued high home inventory levels and moderating home demand, we believe a sharp decline in permits and starts is likely for at least the next six months to bring supply back in balance with demand. D. R. Horton (DHI) understands the need to cut supply. In the most recent quarter, DHI announced its intention to reduce starts, to carry 30,000-35,000 homes in inventory from its current level of 40,000, and to make less land investment this year relative to 2005. More telling, the company took a charge to write off the earnest money tied to land lot option contracts. We believe Horton wanted to exit out of some speculative land lot positions in California, and we applaud it for doing so.

If inventories remain your biggest concern, what could send them even higher in the near future?

The inventory for existing homes could worsen from the ARMs reset. We estimate over $2 trillion worth of ARMs reset higher in 2006 and 2007. The problem started with low home affordability as early as 2003. To allow participation in an expensive market, mortgage lenders offered prospective homeowners a teaser rate of 4% or less. The problem is that the interest rate on the typical three-year ARM is likely reset to a level of 6% in 2006 and 7% in 2007. The higher mortgage payment may lead some overstretched owners to default on payments, adding supply to an already glutted market.

The other potential source of hidden inventory comes from investors selling second properties and refraining from buying new properties. We are already seeing some anecdotal evidence of investor selling, with speculative markets such as Miami and Las Vegas reporting higher condo inventory levels.

In addition, the number of cancellations has been increasing. During the third quarter, D. R. Horton reported a 29% cancellation rate, up from 23% in the second quarter, and sharply higher from its historical range of 16 to 20%. We believe higher cancellations are partially the result of investors fearing a general price decline. With close to 40% of 2005 new homes sales coming from second home purchases, investors fleeing the market leaves a big gap in demand unlikely filled by the first-time homebuyer.

To read the complete Analysts Interview, click http://at.zacks.com/?id=2693.

Mario Ricchio is a senior analyst covering the homebuilding sector for Zacks Equity Research.

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MORE FROM ZACKS EQUITY RESEARCH...
 

Analyst Blog

Real-time market insights from Zacks Equity Research Analysts. Stocks featured recently include Aegon N.V. (AEG), Syngenta AG (SYT), Renovis (RNVS) and Kookmin Bank (KB). To see their latest posts, click here.

Intevac, Inc. (IVAC) - Six-Month Target $30. For full Zacks research report, click here.

 
BEAR OF THE DAY

Onyx Pharmaceuticals (ONXX) - Very Competitive Market. For full Zacks research report, click here.

 
EARNINGS TRENDS

Earnings Data: No Recession Soon

With double-digit earnings growth expected to continue, it is unlikely that we are about to go into a recession. More...

 
ZACKS INDUSTRY RANK

The Week of August 7

Strong reports from economically-sensitive industry groups provide proof the economy is continuing to grow. More...

 
Rating Upgrades - NEW! 

Find out which stocks have been recently upgraded by Zacks Equity Research: click here.

 
Zacks Equity Research Buys - NEW! 

Read the reports on all of the stocks on the Zacks Equity Research Buy List: click here.
 

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Zacks.com features a free investment simulator where our customers can prove their stock picking skills to the rest of the world. In these articles we will share with you the insights and recommendations from Top Simulator Players. Learn more about the current Zacks Challenge at: http://at.zacks.com/?id=2514.
 

Paco478 Francisco

The lessons that Francisco Garcia (aka: Paco478 Francisco) took away from the Second Quarter Stock Challenge helped his Simulator portfolio climb toward the top of the Third Quarter Stock Challenge. Currently in fourth place, Francisco’s overall portfolio return is about 33%.

This Simulator contender explained that he tried to follow conventional wisdom in the second quarter challenge by looking for stocks with strong growth records, high earnings and low valuations. However, he learned that while that is a good a way to screen for solid long-term plays, it would not bring him prosperity in the Simulator’s short-term quarterly challenges.

“I realized that the competition last only three months and if you seat in your portfolio waiting for stocks to grow and reach the value you are expecting, you are out!”, Franco opined. “On this Simulator, you need to make the money produce money in steady way when the market is up and when it is down.”

The quick learning trader adjusted his style to buy and sell stocks “at the right moment”. Stocks that can be found in this contestant’s Simulator portfolio include The Knot, Inc. (KNOT), Empire Resources, Inc. (ERS), Goldcorp Inc. (GG) and Patterson-UTI Energy, Inc. (PTEN). Click here to check out this player’s current portfolio: http://at.zacks.com/?id=2515.

Impressed with his successful change of style, Zacks caught up with Francisco to gain insight on his success. Like most investors, this market player starts with research. “I read all information I can get”, he explained. Franco is also big fan of stock screening, explaining that “Some times, you end with some very nice surprises.”

What and how does he buy?

“I do not have one stock I can say it is responsible for the success, it is more a combination of several stocks,” the Third Quarter Challenge participant said. He did reference a few names that he has gotten a lot of traction out of, which include Escala Group, Inc. (ESCL), PortalPlayer, Inc. (PLAY), Patterson-UTI Energy, Inc. (PTEN), Empire Resources, Inc. (ERS), Molecular Devices Corp. (MDCC), Medifast, Inc. MED and Interactive Intelligence, Inc. (ININ). Francisco also mentioned that he likes Strayer Education, Inc. (STRA) because it is predictable.

For simulator competition purposes, his most valuable investment tool is timing. The market watcher puts most of his effort into studying the behavior and trading ranges of stocks, and the ones he watches are generally priced between $5.00 and $20.00 with volume over 200,000.

Realizing that one or two huge price break-outs are quite elusive, Francisco focuses on making many small profits instead. To accomplish this, the savvy investor often executes limit orders. He also browses charts, looking for a small curve down. Francisco explained that he is fan of solid companies that have experienced small share price decreases. If the drop didn’t take place as a result of something dramatic, this market enthusiast will put in a buy order, hoping to see the shares go back up.

How about selling?

This player will sell once the investment reaches his target price with no regrets if the price continues to increase afterward, or if the shares fall 10% below the purchase price and stay there for four days. He summed up his unemotional style of selling by saying, “As soon as I buy them, I place the limit order for sell.”

Any predictions or words of wisdom?

The market novice admitted that one of the few things he has learned so far is that no one knows what the market will do. To find out how the market will end the year, “call me in January and I’ll tell you,” Francisco quipped.

As for advice, he noted that investors should be careful and not let their emotions get the best of them. He also emphasized reading, researching and learning the basics before risking real money.

“Be careful, do not let your dreams and emotions decide for you, read, search and learn the basic things and how to use the tools that exist out there for every body, before put your money on risk, in simple words ... make your homework!”

 
Stock Challenge from Zacks- Do You Have What it Takes?

It’s free. Its fun. It's the place to show your investing prowess. The best stock pickers will be rewarded with thousands of dollars in prizes. Learn more at: http://at.zacks.com/?id=2671.

Trade Options? Then sign up for the Zacks Options Challenge at: http://at.zacks.com/?id=2672.

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Zacks.com is proud to share with you some of the best trading strategies that truly allow you to Profit from the Pros. Today we highlight...
 

Profit Tracks: Discounted Fundamental Strength

Fundamental strength is often a key criterion for many investors. A strong balance sheet and a history of profitability indicate that a company has the ability to meet its obligations and the flexibility to pursue opportunities for growth. Therefore, such stocks are often perceived as having a lower level of risk.

The lower level of risk often results in higher valuations. Occasionally, however, the markets undervalue a stock relative to its company's fundamental strength. When this occurs, opportunities for profits are created. This Profit Track identifies such opportunities.

Backtesting results show just how successful this Profit Track has been. Double-digit returns have been achieved during each of the past four years. In 2005, this strategy continued to handedly beat the S&P 500.

 
Here are four stocks that make the grade for the Discounted Fundamental Strength Profit Track:

Applied Industrial Technologies, Inc. (AIT) recently reported fiscal fourth-quarter earnings of 44 cents per share (adjusted to reflect a 3-for-2 stock split). The company noted that this was its fifteenth consecutive quarter of year-over-year earnings pre share increases of 20 percent or more. The earnings result topped the previous year’s total and matched the consensus estimate. AIT satisfies the criteria of this Profit Track with a PEG ratio of 0.52 and a price/sales multiple of 0.50. Continue your research on AIT at: http://at.zacks.com/?id=2354.

Benchmark Electronics, Inc. (BHE), which completed a 3-for-2 stock split in early April, recently released its report for the second quarter. Earnings per share increased year-over-year and came in 19% ahead of analysts’ expectations. The company stated that it experienced a strong second quarter with solid year-to-date growth in each of the industry sectors that it serves. Benchmark Electronics raised its full year earnings per share guidance to a range of $1.61 to $1.69, prompting Wall Street to increase 2006 estimates to $1.64 from last month’s $1.47. BHE offers a current ratio of 2.33 and has no debt. Continue your research on BHE at: http://at.zacks.com/?id=2355.

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PROFIT TRACKS continued...

ICT Group, Inc. (ICTG) recently announced second-quarter earnings of 25 cents per share, surpassing the year-prior total of 14 cents and exceeding the consensus estimate by nearly 14%. The company said its solid revenue and earnings performance in the second quarter reflected strong demand for its domestic and international services across key vertical markets and the increasing growth of its near-shore/offshore operations. ICTG has a PEG ratio of 0.89 and a price/sales multiple is 0.86. Continue your research on ICTG at: http://at.zacks.com/?id=2356.

Labor Ready Inc. (LRW) sports a current ratio of 3.10 and has no debt. The company recently posted second-quarter earnings of 35 cents per share, eclipsing last year’s 30 cents and outpacing the consensus estimate by a penny. The provider of temporary employees for manual labor said it remains confident with its business model and optimistic about the demand for both skilled and unskilled labor. Continue your research on LRW at: http://at.zacks.com/?id=2357.

To see the full list of stocks that currently pass this winning screen, go to: http://at.zacks.com/?id=2358.

All the Profit Track strategies were created and backtested using the Research Wizard software from Zacks Investment Research. If you like this screening strategy, but want to narrow down the list of stocks and even improve the performance, then you should start a free trial to this powerful stock picking tool. Learn more about the Research Wizard free trial offer and our new special report “Top 10 Stock Screening Strategies” at: http://at.zacks.com/?id=2359.

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SCREEN OF THE WEEK

Cheap Stocks and Big Returns

Kevin Matras goes over a screening strategy for finding cheap stocks with big returns: http://at.zacks.com/?id=2360.
 

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Here you'll discover a Zacks #1 Rank stock hand selected by Ben Zacks to outperform the market over the next 30 to 90 days. This week's Timely Buy is...

 
W-H Energy Services, Inc. (WHQ)

W-H Energy Services, Inc. (WHQ) is a diversified oilfield services company that provides products and services for the drilling, completion, production, and maintenance of oil and natural gas wells. The company’s customers include major and independent oil and natural gas companies, contract drillers, and other oilfield services companies. W-H Energy’s core markets include the Gulf of Mexico (GoM) and the Gulf Coast regions of the U.S., the North Sea, and a few other international regions.

The company divides its operations in two segments: drilling-related products and services (accounted for 65% of its 2005 revenue), and completion and workover-related products and services (35%). Drilling-related products and services include logging-while-drilling (LWD), measurement-while-drilling (MWD), rental tools, downhole drilling motors, and drilling fluids.

Products and services for completion and workover activities include cased-hole wireline logging and perforating, polymers and specialty chemicals, and coiled tubing. The company’s completion and workover products are primarily used in North America.

WHQ’s strategic focus has all along been on gaining leading market positions in niche markets by offering technologically advanced and cost effective products and services. This is evident in the company’s position in the LWD, MWD, and directional drilling markets.

Over the last few years, W-H Energy has emerged as one of the few companies in the world with the technological capability to offer a full complement of LWD and MWD products and services. These tools provide real-time data about the physical properties of downhole formations, eliminating the need to halt the drilling process, as was the case with the traditional open-hole wireline logging system.

Earnings momentum is exceptionally strong at WHQ. The company has met exceeded earnings estimates in six out of the past seven quarters, with one quarter meeting expectations. Five analysts have raised their numbers for this year, while four have done so for next year.

Over the past month, earnings estimates have been on the rise. This year's estimates have increased 5.9% to $3.23 per share, while next year's numbers have jumped 4% to $3.86 per share over that time period. The stock is currently trading at 14.3x next year's estimate, well below the company's projected long-term growth rate of 25%, giving the stock a PEG ratio of 0.57.

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Here we cast the spotlight on a timely Featured Expert commentaries that recently appeared on Zacks.com.

 
Perfect Anticlimax

Gregory Spear discusses the recent Fed pause and highlights a stock that is up almost 10%. http://at.zacks.com/?id=2968

 
Quarterly Results Reflect Ongoing Transformation

Bill Martin highlights a stock that he believes will increase in price after restructuring. Receive insight on this company. http://at.zacks.com/?id=2419

 
No Clear Direction

Dr. Pasternak expects the market to hold near current levels through August. Read his technical analysis and stock updates. http://at.zacks.com/?id=1487

OTHER TOOLS FROM ZACKS

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At the heart of Zacks Investment Research is the Zacks Rank investment philosophy that continues to vastly outperform the market. Our Zacks #1 Rank (Strong Buy) List has produced the following results for investors:

• +32.4% average annual return since 1988 versus +11.9% for S&P 500
   
• Outperformed S&P 500 in 17 of the last 18 years
   
• +43.8% total return from 2000 to 2002 - the worst bear market in over 60 years.
   
• +18% in 2005
   

And just as importantly, our #5 Ranked stocks (Strong Sells) have alerted investors as to which stocks to dump from their portfolios to avoid unnecessary losses.

 
ZACKS RANK RESOURCES

• View All Zacks #1 Rank stocks : Go to http://at.zacks.com/?id=2351.
   
• Free Zacks Rank Guide: Learn how to use the Zacks Rank to pick more profitable stocks. Get the guide: http://at.zacks.com/?id=2549.
   
• Zacks Advisor: Discover Ben Zacks' hand picked #1 Rank stocks on his Timely Buys list at: http://at.zacks.com/?id=2550.
   
• Zacks Options Trader: Combine the timeliness of Zacks #1 Rank stocks with the explosive profit potential of options. Learn more at: http://at.zacks.com/?id=2689.
   
• Zacks Wealth Management: Own all the Zacks #1 Ranked stocks in a portfolio managed by Zacks. Learn more at:  http://at.zacks.com/?id=2551.
   

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We hope you enjoyed this issue of "Profit from the Pros", And we look forward to visiting with you again next week.

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Senior Market Analyst
Zacks.com

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