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On Jul 2, Zacks Investment Research upgraded PulteGroup, Inc. (PHM - Analyst Report) to a Zacks Rank #1 (Strong Buy). The share price has surged on the back of a strengthening homebuilding market and a bright outlook for the year.

Why the Upgrade?

Stocks of homebuilders like Pulte, Lennar Corporation (LEN - Analyst Report), Toll Brothers (TOL - Analyst Report) and D.R. Horton, Inc. (DHI - Analyst Report) have rallied strongly since mid-2012 as the U.S. housing market has seen significant upside in new home construction activity. The housing market has steadily made a comeback from the lows witnessed in mid-2006 caused by the severe and widespread downturn.

Despite recent concerns over rising interest rates, U.S. home demand is increasing as increased rentals and historically low mortgage interest rates have improved the affordability of homes. Moreover, a sense of urgency to buy a new home before interest rates shoot up further is also pushing up demand. However, supply remains limited by low home inventories, both for new and existing homes. Home prices have thus moved up sharply with market demand gaining momentum and supply remaining limited.

Subsequently, the broader housing market has enjoyed a strong rally, reflected in the homebuilder ETF, SPDR S&P Homebuilders (XHB), jumping more than 70% since Jan 2012.

Some stronger-than-expected housing data released recently is also encouraging. The National Association of Home Builders/Wells Fargo Housing Market Index (HMI), known as the homebuilder sentiment index, jumped a robust 8 points to 52 in June from 44 in May. The index crossed the 50 mark for the first time since the downturn that began in mid-2006 and was also the biggest monthly increase since 2002. The index reflects much better sales expectations as the demand for new homes increases.

Large homebuilders like Pulte are thus witnessing increasing traffic levels due to heightened consumer demand. Most homebuilding companies are witnessing a significant growth in both volumes and average selling prices.

In fact, Pulte has beaten the Zacks Consensus Estimate in all the past four quarters with an impressive average earnings surprise of 58.98%. Pulte’s strategic initiatives to expand margins, improve overhead leverage, increase inventory turns and improve returns are helping it to better capitalize on the housing market recovery. We believe its significant land positions, broad geographic and product diversity and a better capital position will enable it to take maximum advantage of the housing recovery.

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